A due diligence report is usually read for its numbers: adjusted EBITDA, net debt, working capital and quantified exposures. Yet much of what an investor learns during the process never appears as a figure. How quickly the finance team produces a reconciliation, whether monthly accounts can be tied to the audited trial balance, who in the company can answer a question on pricing, and whether explanations stay consistent from one meeting to the next: these observations say a great deal about how the business is run.
This article looks at the qualitative side of due diligence: the signals about controls, information quality, governance and people that surface during the process, how they can be tested rather than simply sensed, and how they should shape post-deal plans. It is intended for investors, board members and promoters preparing their businesses for external scrutiny.
Key points at a glance
- The process of due diligence is itself evidence: the speed, consistency and completeness of information reflect the quality of the finance function.
- Controls should be tested in operation, not only reviewed as documented policies.
- Statutory reporting such as internal financial controls, CARO 2020 remarks and audit trail compliance provides useful independent signals.
- Key-person dependency, where knowledge and relationships sit with one or two individuals, is a common and under-priced risk.
- Qualitative findings should lead to specific actions: conditions before closing, a 100-day plan or governance rights.
Why the process is as informative as the output
Every due diligence runs on an information request list. How a company responds is a direct test of its reporting systems. A business with monthly closes, reconciled ledgers and a clear chart of accounts can usually produce ageing reports, customer-wise revenue and bank reconciliations within days. Where each request needs manual rework, extraction from several systems or input from the promoter personally, the investor learns that the numbers it will receive after the deal will carry the same limitations.
Consistency matters as much as speed. Explanations for a margin movement or an unusual balance should be logical, supported by documents and the same whether given by the CFO, the plant head or the sales team. Where explanations change as questions become more specific, the gap usually lies in the underlying data, not in the presentation.
Signals that surface during due diligence and how to test them
| Signal observed | What it may indicate | How it can be tested |
|---|---|---|
| Monthly management accounts do not reconcile to the audited trial balance | Weak close process; year-end adjustments made outside the system | Bridge monthly accounts to audited figures; list and analyse year-end journal entries |
| Frequent manual journals near period-end | Estimates or revenue managed at the close | Journal entry analysis by user, date, amount and account |
| Key data held in spreadsheets outside the ERP | Limited system control over pricing, discounts or inventory | Walk through the process for a sample of transactions end to end |
| Only the promoter can explain customer terms or pricing | Key-person dependency; undocumented arrangements | Review written contracts; interview second-line managers |
| Delays in producing bank statements for all accounts | Accounts outside the books; informal cash management | Obtain statements directly; compare with bank list in loan documents and tax records |
| Repeated auditor remarks not addressed | Low priority to control improvement | Review auditor's reports, CARO 2020 remarks and management letters for several years |
Internal controls: on paper versus in practice
Many companies have documented policies for credit approval, purchase authorisation and inventory counts. Due diligence asks whether those policies operate. Simple tests include checking whether credit limits in the system are actually enforced, whether purchase orders precede invoices, whether physical stock counts are performed and differences investigated, and whether user access to the accounting system is restricted by role.
Statutory signals worth reading
- Internal financial controls: the auditor reports on the adequacy and operating effectiveness of internal financial controls with reference to financial statements under Section 143(3)(i) of the Companies Act, 2013, subject to exemptions for certain private companies.
- CARO 2020: the auditor's report under the Companies (Auditor's Report) Order, 2020 covers matters such as physical verification of assets and inventory, loans to related parties, statutory dues in arrears, and differences between quarterly statements filed with banks and the books.
- Audit trail: from 1 April 2023, companies must use accounting software with an audit trail (edit log) feature that cannot be disabled, under the proviso to Rule 3(1) of the Companies (Accounts) Rules, 2014. Auditor comments on this requirement indicate how reliable the ledger history is.
Practical point: The CARO clause on quarterly stock and debtor statements filed with banks is a useful cross-check. Material differences between drawing power statements and the books suggest either weak reporting or inflated figures given to lenders, and both need explanation.
Governance and decision-making
Governance in a closely held company is often informal. Due diligence looks at whether the board meets and minutes reflect real decisions, whether related party approvals follow the Companies Act, whether statutory registers and filings are current, and whether there is a clear separation between the promoter's personal finances and the company's. Informality is not unusual before an institutional investment, but its extent shapes the reporting covenants and board rights that an investor will seek.
People and key-person risk
Growth driven by systems can be transferred to a new owner; growth driven by individuals depends on those individuals staying and being motivated. Indicators of key-person risk include:
- Customer relationships held personally by the promoter or one sales head.
- Technical or product knowledge not documented and held by a few employees.
- A finance team where one person handles all reconciliations, tax filings and banking.
- High attrition in second-line management.
Mitigation typically includes retention arrangements, non-compete and non-solicit covenants, earn-outs linked to continued involvement and a plan to strengthen the management layer after the deal.
How to read a due diligence report for these signals
- Read the scope and limitations section first: what was not provided or could not be verified is often the most important finding.
- Note the basis of preparation: whether figures are from audited accounts, management accounts or reconstructed data.
- Look at the list of open items and the reasons they remain open.
- Compare management's explanations recorded in the report with the evidence cited for them.
- Link each qualitative observation to a proposed action: a condition precedent, a warranty, a post-closing covenant or an item in the 100-day plan.
Frequently Asked Questions on What Due Diligence Reveals
What does due diligence reveal beyond the financial numbers?
It shows the quality of the finance function, whether controls operate in practice, how governance works, how transparent management is, and how dependent the business is on a few individuals.
Why is the speed of information sharing important in due diligence?
It reflects how well data is organised and reconciled. Slow or inconsistent responses usually point to weak systems that will also affect reporting after the deal.
What is key-person risk in due diligence?
It is the risk that customer relationships, technical knowledge or financial control depend on one or two individuals, so that the business would suffer if they left.
How are internal controls tested during due diligence?
By walking through processes for sample transactions, analysing journal entries, checking whether system controls such as credit limits are enforced, and reviewing auditor reports on internal financial controls and CARO remarks.
What is the audit trail requirement for Indian companies?
From 1 April 2023, companies must maintain books in accounting software that records an audit trail of each change, which cannot be disabled, under Rule 3(1) of the Companies (Accounts) Rules, 2014.
Should qualitative findings affect the deal price?
They usually affect structure and protection rather than price directly, through conditions before closing, warranties, earn-outs, retention arrangements and governance rights.
Conclusion
A due diligence report quantifies what can be quantified, but the process also reveals how a business is run. Businesses with sound fundamentals may still have gaps, yet their explanations are logical, supported and consistent. Where numbers need defending rather than explaining, the investor has learned something that no adjustment schedule captures.
The value of these observations lies in acting on them: turning control weaknesses, governance gaps and key-person risks into specific conditions, protections and post-closing priorities so that the investor enters the transaction with a clear view of what needs to change.
This article is intended for general information and knowledge sharing only and does not constitute professional advice or solicitation of any kind. Provisions are summarised as of September 2026. Readers should refer to the relevant provisions, regulations and judicial pronouncements for their specific facts.