Banks and other lenders often have to make decisions that involve multiple variables and require a comprehensive analysis. Risk mitigation and avoidance are usually the common themes when these decisions are being made. In other words, banks and lenders are evaluating how to minimize the potential downside if the decision is ultimately wrong or how to make the right decision from the start. An often overlooked but extremely valuable and practical tool for decision making is due diligence.

Due diligence in this particular context is the financial and operational sampling, testing and review of an entity by an independent expert. This is done to verify the financial statements of the target entity. By confirming and validating the key financial information on the entity, the decision makers can put greater reliance on these items and thereby make better decisions. 

Situations when due diligence can be used as an effective tool for lenders include internal review of portfolios and operations, evaluation of potential targets and acquisitions, and purchase of pools of assets or portfolios.  

Internal review of your portfolio and operations is critical and should be performed on a continuous or cyclical basis. Although similar, don’t confuse this due diligence process with internal audit, loan review or a compliance test. The purpose and objective of the due diligence process is being able to make the best decisions possible, which is what separates and defines a due diligence project from other types of projects. The results obtained are important for your own knowledge to identify any problems or issues and resolve them as quickly as possible. 

After the initial review, create a program that meets your particular needs. Tailor the level of due diligence performed to the perceived level of risk or what you deem a rank order of importance to your organization. Document the due diligence with the proper reports to create a historical database to which you can refer as needed.

An established baseline for your own organization can also serve as a standard against which to view external opportunities.  You can easily shift the focus from inward to outward and evaluate opportunities for mergers, acquisitions and purchases of assets.  The tools of due diligence allow you to test, confirm and validate before you make important decisions. The value of using these tools far outweighs the costs and is usually a fraction of the value being put at risk.   

For questions or comments about the issues addressed in this article, please contact Jake McDonald, CBIZ Credit Risk Advisory Practice (610-862-2202) or your local CBIZ advisor.