Financial due diligence involves analyzing the circumstances and values of an investment before making a deal. It originated in the 1930s as a way to protect investors and has become a common standard for any investment involving risk. Due diligence helps ensure transparency and accuracy in investment information, but investors must also research and understand the level of risk involved.
Financial due diligence is the idea that investors and others should analyze the actual circumstances and values of an asset or investment before making a deal. Due diligence is a concept that has been in place and proven valuable to the financial community for nearly a century. According to many experts, it started as a way to help protect investors, but has now become a common standard for almost any type of investment or business that involves risk.
The origin of the term financial due diligence in the US dates back to the actions of the US Securities and Exchange Commission, a regulatory board, in the 1930s. Originally, due diligence was something that potentially it could absolve brokers or money managers of liability related to “non-disclosures” or things that were not fully explained to the investor. The idea was that if a broker performed accurate financial due diligence, he was not responsible for other “unknowns” beyond the critical standard of pre-investment research.
In modern times, due diligence is something that experts recommend for individual investors. Due diligence basically means doing your own research on desired investments. With online tools and other technologies, it’s much easier for investors to learn more about stocks and other investments before buying than it used to be.
One problem with financial due diligence relates to volatility. Each investment has its own level of risk, and without good research, the investor may be unable to understand that risk correctly. Pricing risk is big business on Wall Street and in the financial community in general. Due diligence helps ensure that buyers and others are on the same page at the time of a purchase or acquisition.
Another issue driving the need for due diligence has to do with what many professionals call “transparency.” Transparency is a term that is often used in reference to government, but it is also essential for large companies and financial institutions. The lack of transparency, for example from CEOs, who can even push findings of faulty internal accounting, has led many investors to be more proactive about due diligence, seeking to ensure that all assets and operations contain in a description of a company or department are accurate.
A basic finding in due diligence is whether an investment actually matches its prospect. The prospectus is immediately valuable to a potential investor. It is a summary of the investment and what it contains. Experts say that active due diligence is often necessary to make sure that all of the information in this documentation is true and unvarnished.
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