Understanding the difference between Audit and Financial Due Diligence

Minakshi Bindhani

24 Jan, 2023

An audit’s purpose is to ensure that management has presented a true and fair picture of a company’s financial performance and position. Whereas financial due diligence will investigate a wide range of areas, including legal, operational, marketing, information technology, and financial matters.. The present article shall discuss the difference between Difference between Audit and Financial Due Diligence to provide clarity regarding the concepts.

What does an Audit Mean?

The term audit is usually referred for a financial statement audit which is an objective examination and evaluation of an organisation’s financial statement for ensuring that the financial records are a fair and accurate representation of the transactions as claimed to be represented by the organisation. The audit can be conducted either internally by employees of the organization or externally.

What is Financial Due Diligence?

Financial due diligence is a detailed investigation of the targeted company’s books to understand any business’s financial and operational health. Due diligence is commonly used in the sale or merger of a certain company. It serves as a demonstration of the organization’s assets and liabilities to prospective investors providing the basis they need to assess purchases guided by hard data. It is a deep analysis of a company’s historical and forecasted trends to confirm the relevance and veracity of these trends.  It majorly focuses on providing potential investors with an understanding of the following information about a company:

• Sustainable economic earning
• Historical working capital needs
• Historical sales and operating expense trends
• key personnel and accounting information systems 
• key assumptions utilized in management’s forecast, and They both are quite different processes, but they both involve fairly substantial scrutiny of a company’s finances

Difference between Audit and Financial Due Diligence

There are several doubts about the differences between auditing and due diligence. However, they are not the same and differ on several points.

The difference between audit and due diligence is discussed below –

Firstly, undergoing an audit is more of an internal review. Companies may often conduct audits to obtain a sense of their financial health and status. In some cases, an internal team may conduct the audit by reviewing its company’s financial statement to verify accuracy and completeness. However, some companies conduct an audit by an external team to review and verify the credibility of the financial statement^[1].

Whereas financial due diligence is always conducted in an external capacity, meaning that a team of expert review and examines all documentation related to finances. However, the team is more inclined in reviewing and understanding a company’s assets, sales, earnings, revenue, profit, debt, and so forth.

The audit generally looks at historical performance and ensures that the data and documentation that is on the financial record are properly reflected in the balance sheet, financial statement, and other related documents.

On the other hand, financial due diligence would typically involve a review of the following areas: historical financial results, current financial position, forecast financial results, working capital requirements, employee entitlements provisions, valuation implications, risks and opportunities, and taxation implications.

Lastly, an audit is just focused on a company’s finances but is primarily concerned with the verification and examination of the accounting data.

Of course, due diligence often encompasses far more than just a company’s finances and generally involves a comprehensive examination of a company’s legal, accounting, tax, operational, and property matters as well.

Conclusion

In this article, a clear difference have been drawn between audit and financial due diligence. However, they are different despite some similarities . Therefore it is essential to understand the difference between the two concepts to avoid any confusion pertaining to the same.