Due diligence on a business's financials: a buyer's checklist

When you buy a business, you’re buying its future profit. Due diligence is how you check that the past profit — the basis of the price — is real, sustainable and transferable to you. Sellers aren’t necessarily dishonest, but they’re optimistic, and the information memorandum is a sales document.

Which documents should you ask for?

Start with a written request list. business.gov.au suggests reviewing three to five years of financial statements. A thorough list includes:

• profit and loss statements and balance sheets for three to five years, plus year to date;
• business tax returns for the same years;
• BAS lodgements for at least the last two years;
• business bank statements for at least 12 months;
• aged debtors and creditors reports;
• stock records and the latest stocktake;
• payroll reports, employee list, awards and leave balances;
• the lease, key supplier and customer contracts;
• asset register and equipment service records;
• the ATO account position, including any payment plans.

How do you check the numbers are real?

Reconcile three sources that should tell the same story:

Source	What it shows	What to compare
Profit and loss	Reported sales and profit	Sales figure per year and quarter
BAS lodged with the ATO	GST on sales reported to the ATO	Should reconcile to P&L sales (allowing for GST-free sales)
Business bank statements	Money actually received	Deposits should support reported sales

Where they don’t line up, ask why. There can be good reasons — timing, GST-free sales, a separate merchant account. There can also be bad ones. Sales that show in the accounts but never reach the bank should make you pause.

Our feature on reading a profit and loss statement is a useful refresher before you start.

How should you test the seller’s add-backs?

Sellers often present an “adjusted” profit that adds back expenses they say a new owner won’t have. Common add-backs:

• the owner’s vehicle, phone and personal expenses;
• one-off costs such as a legal dispute or relocation;
• above-market wages paid to family members;
• depreciation, interest and owner’s super.

Test each one. Is the cost really personal or one-off? Will you need a vehicle too? Will you have to replace an unpaid family member with a paid employee? Every dollar of add-back you accept is likely multiplied in the price, so it deserves scrutiny.

Also check the owner’s own role. If the seller works 60 hours a week unpaid, the “profit” includes the value of their labour. You’ll either do that work yourself or pay someone.

Lining up funding alongside due diligence? See what you could qualify for — no credit check to ask.

What should you look for beyond the profit?

Customer concentration. If one customer is a large share of revenue, the business is fragile. Our feature on losing your biggest customer explains why.

Trends. A profit that jumped in the year before sale deserves questions. Look at three to five years and the direction of travel.

Margins against benchmarks. The ATO’s small business benchmarks show typical cost ratios by industry. Unusually high margins can mean a great business — or under-reported costs.

Working capital. How much stock, debtors and creditors does the business need to run? You’ll need to fund it after settlement.

Liabilities. ATO debt, supplier arrears, employee entitlements and lease make-good obligations. The ATO can report business tax debts to credit bureaus once at least $100,000 is more than 90 days overdue and the business isn’t engaging with the ATO — worth checking the seller’s position.

What are the red flags?

• Reluctance or delay in providing documents.
• Figures that don’t reconcile and explanations that change.
• Heavy dependence on the owner’s relationships.
• A lease that’s short, unassignable or up for review soon.
• Declining trends explained away as “temporary”.
• Large, unusual cash transactions.

None of these automatically kills a deal, but each should shape the price, the contract or both. Use your findings in the valuation — see how to value a small business.

What questions should you ask the seller directly?

Documents tell you what happened. Conversations tell you why. Ask the seller, and note their answers:

1. Why are you selling, and why now?
2. Which customers, suppliers or staff would you worry about losing after the sale?
3. What would you do differently if you were staying for another five years?
4. How many hours a week do you work, and on what?
5. Are there any disputes, warranty claims or complaints in progress?
6. Is there any ATO debt, payment plan or overdue lodgement?
7. What capital spending is overdue — equipment, fit-out, vehicles?
8. What’s changed in the last 12 months that the accounts don’t show yet?

Compare the answers with the documents. Consistency builds confidence; contradictions deserve another look, and may belong in the contract as warranties. Our guide to valuing a small business shows how your findings feed into the price.

From diligence to settlement

Good due diligence gives you a price you can defend and a clear picture of the working capital you’ll need after settlement. It also gives lenders the confidence to fund the deal.

We consider property-secured loans from $20,000 to $5,000,000 and unsecured facilities for trading businesses typically from $5,000 to $500,000. There’s no credit check to enquire, your details stay with one team, and a real person calls to understand the purchase. Please answer the form accurately — price, contribution, property you own — so we can point you in the right direction on that first call.

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