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Financial due diligence, also known as “prudential investigation”, generally refers to a series of investigation activities conducted by the investor such as field surveys and information analysis, etc. to the target company with regard to all the matters involved in the investment, after the investor reaches a preliminary cooperation intention with the target company based on a consensus agreed upon through mutual discussions and consultations. Due diligence is mainly carried out during the process of capital operations such as acquisitions and mergers (investments), etc. However, when a corporation is about to go public and issue stock, it is also required to go through due diligence procedures in advance to be initially examined if it satisfies the conditions for being listed.
Contents of due diligence
The contents of due diligence generally include: the target company's industry research, company’s owners, historical evolution, human resources, marketing and sales, R&D, production and services, procurements, legal and regulatory issues, finance and accounting, taxation, and management information system, etc.
Formation of a due diligence team
A due diligence team consists of project principal (transaction facilitator), industry experts, business experts, marketing and sales experts, financial experts and legal experts, etc.
Purpose of due diligence:
The purpose of completing a due diligence is to identify potential fatal defects and their possible impact upon the acquisition and expected returns on investment.
Definition of financial due diligence:
In the entire due diligence system, financial due diligence mainly refers to the reviews and analysis performed by financial professionals regarding the financial position of the target company in connection with the investment.
- (1) 审阅：通过财务报表及其他财务资料审阅，发现关键及重大财务因素；
- (2) 分析性程序：如趋势分析、结构分析等，对各种渠道取得资料的分析，发现异常及重大问题；
- (3) 访谈：与企业内部各层级、各职能人员，以及中介机构的充分沟通；
- (4) 小组内部沟通：调查小组成员来自不同背景及专业，其相互沟通也是达成调查目的的方法。
During the due diligence investigation, financial professionals usually make use of the following basic methods:
- (1) Reviews: Review financial statements and other financial information to find key and significant financial factors;
- (2) Analytical procedures: Analyze the data obtained from various channels by use of trend analysis, structural analysis, etc. to discover abnormal and material problems;
- (3) Interviews: Make sufficient communications with the staffs from all functions at different levels within the company as well as with intermediate agencies;
- (4) Internal communications within the team: As the members of the due diligence team come from different backgrounds and expertise, making internal communications within the team is also an approach to reach the goal of the investigation.
Because the purpose of financial due diligence is different from that of an audit, financial due diligence normally does not apply financial audit methods such as request letter confirmations, physical inventory counts, and data recalculation, but apply analytical tools such as trend analysis and structural analysis, etc. In the process of corporate capital operations such as acquisitions and mergers, financial due diligence is an indispensable prerequisite for investment and integration planning design, transaction negotiations, and investment decision-making. It is a basis for judging whether the investment meets the strategic objectives and investment principles. And it plays a significant role in getting the understanding of the real conditions of the target company’s assets and liabilities, internal control, and its operations and management, fully disclosing its financial risks or crises, analyzing its profitability and cash flows, and forecasting its future prospects.