Due diligence audit is of great significance to the operation of a company. Through a comprehensive review of all aspects of the company, due diligence audit can identify various potential threats such as legal risk, financial risk, market risk, and operational risk. Cost is a key factor in the operation of an enterprise, which directly affects the profit and competitiveness of the enterprise. Due diligence audit plays an important role in cost control. It can help enterprises find and eliminate waste and unnecessary expenses. Due diligence audit can also identify inefficiencies and delays in the operation of an enterprise, and put forward targeted improvement suggestions to improve the operational efficiency of the enterprise. For those who want to do a good job of due diligence, there are mainly three parts: forming a professional team, whose members should have professional knowledge and rich practical experience in multiple fields; formulating a detailed due diligence audit plan to ensure that the investigation can be carried out smoothly; making full use of advanced tools and technologies can greatly improve the efficiency and accuracy of due diligence audit.

Table of Contents

1. Due Diligence Audit Definition and Purpose 2. Main Contents of Due Diligence Audit 3. Steps and methods of due diligence audit

1. Due Diligence Audit Definition and Purpose

1. Definition

Due diligence audit, often referred to as prudent investigation, is a key task carried out after the investor and the target company reach a preliminary cooperation intention and the two parties reach a consensus. It is like a comprehensive and detailed "physical examination", conducting in-depth on-site investigation and data analysis of all aspects of the target company. In business activities, when a company has the intention of investment, mergers and acquisitions, cooperation, etc., due diligence audit can help the company to have a deep understanding of the target company and avoid the risks brought by blind decision-making.

2. Purpose

Assessment of assets and liabilities: Through due diligence audit, investors can clearly understand the asset status of the target company, including fixed assets, current assets, intangible assets, etc., clarify the value, ownership and use of each asset, and avoid falling into asset disputes. At the same time, it can also fully grasp the liabilities of the target company, such as bank loans, accounts payable, contingent liabilities, etc., accurately assess the company's debt repayment ability, and provide important basis for investment decisions. If the target company has a large number of undisclosed contingent liabilities, it may cause huge economic losses to investors after the investment.

Insight into business and financial status: In terms of business, understanding the target company's operating model, business processes, market share, customer groups and other information will help determine the stability and sustainability of its operations. In terms of finance, review financial statements, financial status, internal controls, etc., ensure the authenticity and accuracy of financial data, analyze the company's profitability, debt repayment ability, operating capacity and other financial indicators, so as to have a comprehensive understanding of the company's financial health.

Control legal relations: Legal due diligence is an important part of due diligence audits, which can assess the legal compliance of the target company. It covers whether the industrial and commercial changes are compliant, how the contract is compliant, and whether there are disputes over intellectual property rights. If the target company has intellectual property infringement disputes, it may affect the normal operation of the company and even lead to huge compensation. Investors need to know these potential risks in advance.

Identify potential risks and opportunities: Due diligence audits not only focus on the current situation of the target company, but also on future development. It can help investors discover potential risks faced by the target company, such as market risks, industry risks, management risks, etc., and formulate response strategies in advance. At the same time, it can also tap into the potential development opportunities of the target company, such as the expansion potential of emerging markets and the application prospects of new technologies, providing a more comprehensive perspective for investment decisions.

2. Main Contents of Due Diligence Audit

• 1. Legal due diligence
• • Review focus: Equity structure: whether there is proxy holding, pledge or freezing. Major contracts: "overbearing clauses" or default risks in long-term procurement agreements. Intellectual property: patent validity, trademark geographical restrictions (such as the expiration of a core patent of a technology company, resulting in a halving of valuation).
• • New trend: ESG compliance review (carbon emission indicators, labor rights protection).
• 2. Financial due diligence
• • Core tasks: Financial data restoration: Eliminate "management adjustments" (such as accounts receivable aging fraud). Earnings quality analysis: Whether EBITDA relies on related transactions or non-recurring income. Cash flow verification: The matching degree of operating cash flow and net profit (beware of "paper profits").
• • Tool upgrade: AI financial analysis platforms (such as MindBridge) can automatically identify abnormal transaction patterns.
• 3. Business due diligence
• • Methodology: PESTEL analysis: the impact of politics, economy, society, technology, environment, and law on the industry. Porter’s Five Forces Model: evaluates supplier bargaining power, customer concentration, etc. (e.g., a consumer goods company’s valuation was reduced by 40% due to its reliance on a single customer.) SWOT cross-validation: whether the strengths claimed by management match market data.

3. Steps and methods of due diligence audit

1. Interview procedure

During this process, the investigators will have in-depth exchanges with the company's management and relevant personnel, and fully understand the company's operating conditions and financial accounting through face-to-face communication, telephone interviews or video conferences. When interviewing the company's management, the investigators will ask questions about the company's strategic planning, business objectives, market positioning, competitive advantages, etc. The company's management has a macro control over the overall development of the company, and their answers can help investigators understand the company's development direction and business strategy. For financial accounting, the investigators will communicate with the head of the financial department and relevant staff. Understand the company's financial accounting process, the selection and application of accounting policies, the preparation process of financial statements, etc.

2. Inspection procedures

The investigators will comprehensively review the company's sales contracts, invoices, bank statements, accounting vouchers, account books and other materials. When reviewing the sales contract, the investigators will pay attention to whether the terms of the contract are clear and unambiguous. Verify whether the signing of the contract complies with the company's business processes and internal control requirements, and whether there are abnormal contract terms or related-party transaction contracts. Invoices are important vouchers for the economic business of enterprises. Investigators will check the authenticity of invoices, the standardization of invoices, and their relevance to the business. By checking invoices, the authenticity and accuracy of the company's sales revenue can be verified. Bank statements record the flow of funds of the company. Investigators will carefully analyze the details of bank statements and pay attention to the source and destination of funds. Verify whether the company's sales revenue is truly recorded, whether the various expenses are reasonable, and whether there are any illegal or irregular behaviors.

3. Supervision procedures

The supervision procedure is an important means of on-site inspection and inventory of the company's physical assets to ensure the real existence and value of the assets. In the production and operation process of the enterprise, physical assets such as inventory, fixed assets, and projects under construction are important economic resources of the enterprise and play a key role in the normal operation of the enterprise. Investigators will visit warehouses and other storage locations to check the inventory on site, use appropriate inventory methods, and count the inventory one by one or take a certain proportion of samples for inventory. Investigators will also conduct on-site inspections of the company's buildings, machinery and equipment, transportation tools and other fixed assets. Verify the property rights certificate and other relevant information of fixed assets to confirm the ownership of the assets.

4. Analytical procedures

Analytical procedures are powerful tools for digging out potential problems and risks in due diligence audits, and conduct in-depth analysis of the acquired data in multiple dimensions. Investigators will use various analytical methods to conduct trend analysis, structural analysis and comparative analysis on the company's financial data, business data, etc. Trend analysis is to predict the future development trend of the company by observing the changing trend of the company's historical data. Structural analysis is to analyze the composition of various data of the company to understand the company's operating characteristics and financial status. Comparative analysis is to compare the company's data with the data of other companies in the same industry, or with the company's own budget and target data. By comparing with the same industry, you can understand the company's position and competitiveness in the industry.