Whether buying a business, merging with a charity, or investing in a company, financial due diligence plays a vital role in protecting your organisation from costly mistakes. At its core, due diligence is about making sure that what’s being presented, in terms of financial health, operations, and risk, matches the reality.

At Williamson & Croft, we conduct due diligence across a wide range of sectors, and often find that it’s not the big, obvious issues that trip people up.

Rather, it’s the small inconsistencies, unexplained items, or poor controls that indicate deeper problems beneath the surface. In this article, we highlight some of the most common red flags we encounter during financial due diligence assignments, and why they matter.

The Purpose of Financial Due Diligence

Before diving into the red flags, it’s worth briefly reminding ourselves of the purpose of financial due diligence. Whether you’re a buyer, investor, funder, or trustee, you’re ultimately looking to verify that:

  • The financial information is accurate and complete.
  • The business or charity is solvent and sustainable.
  • Key risks have been identified and assessed.
  • There are no unpleasant surprises post-completion.

While every due diligence assignment is different, depending on the nature of the transaction or investment, certain warning signs appear time and again across industries and organisation types.

Inconsistent or Unreconciled Financial Information

One of the most immediate red flags we encounter is inconsistency across financial statements, management accounts, and supporting schedules. The accounts may show one set of figures, while underlying ledgers, bank reconciliations or debtor reports tell a different story.

Reconciliations that haven’t been performed or are months out of date create uncertainty about whether the financial position is accurate. Unreconciled balances may conceal unrecorded liabilities, overstatements of cash, or inaccurate debtor positions. Even if the financial statements appear robust at first glance, such inconsistencies undermine confidence in the accuracy of the reported numbers.

For buyers and investors, this raises the risk of overpaying for an overstated balance sheet or inheriting unexpected liabilities that were not properly disclosed.

Unexplained Adjustments and Journal Entries

When we review accounts in detail, we often focus on unusual or unexplained journal entries. Year-end adjustments may be legitimate, such as for accruals, prepayments or provisions, but large or recurring entries that lack proper documentation warrant further investigation.

In some cases, journal entries may have been used to artificially manage profitability or smooth results between periods. For example, deferring expenses into the following year or recognising revenue prematurely to meet performance targets can inflate results and create a misleading picture of financial performance.

Journal entries made by senior finance staff without clear audit trails, especially at or after year-end, should always be carefully examined to assess their appropriateness.

Aggressive Revenue Recognition

Revenue recognition policies are often an area where financial manipulation can occur, particularly in businesses driven by revenue growth or performance-based earn-outs.

We frequently encounter situations where revenue is recognised before it is earned, for example, invoicing customers for multi-year contracts but recognising all of the revenue upfront, rather than spreading it over the contract period. This practice inflates short-term profitability but leaves future periods exposed.

In some cases, revenue may have been recognised on contracts where performance obligations have not yet been met, creating a significant risk of reversals if customers cancel or dispute the charges.

Buyers and funders need to ensure that revenue recognition policies are compliant with accounting standards, applied consistently, and properly reflect the substance of transactions.

Undisclosed or Understated Liabilities

One of the key reasons for performing due diligence is to uncover liabilities that may not be obvious from a superficial review of the accounts.

We regularly identify liabilities that have not been properly recorded, such as unpaid tax obligations, unrecorded holiday pay accruals, warranty provisions, or contingent liabilities arising from unresolved legal disputes.

Pension liabilities can also catch buyers off guard, especially where defined benefit schemes or auto-enrolment compliance issues exist. In the charity sector, we sometimes find grant conditions that could give rise to clawback risks if reporting conditions haven’t been met.

Failing to identify these liabilities before completion can have significant financial consequences, often eroding the value of the transaction or requiring costly rectification work after the fact.

Tax Compliance Issues

Tax exposures are a frequent source of hidden risk uncovered during due diligence. These may include unfiled tax returns, unpaid PAYE or VAT liabilities, or aggressive tax planning schemes that carry future challenges from HMRC.

We also see errors where VAT treatment of complex transactions, such as cross-border sales or property arrangements, has been incorrectly applied. Such issues can result in significant penalties and interest if discovered later by tax authorities.

Tax due diligence should therefore be a core part of any wider financial review, ensuring both historic compliance and identifying any future exposures arising from existing arrangements.

Over-Reliance on Key Individuals

Strong financial results may be heavily dependent on the skills or relationships of a small number of key personnel, such as a founder-owner, lead fundraiser or single client relationship manager.

In these cases, the departure of one person could have an immediate and serious impact on revenues or operations. We often assess succession planning, employment contracts, and key person insurance arrangements as part of due diligence to understand the true resilience of the organisation.

Buyers need to be clear whether they are acquiring a sustainable business or one that is overly reliant on individuals whose departure would create an immediate vacuum.

Weak Financial Controls and Governance

Poor internal controls are often one of the most telling signs of broader financial management issues. During due diligence, we often review processes for authorising payments, approving expenses, managing cash, and overseeing procurement.

Where controls are weak or overly informal, there is a greater risk that fraud, misappropriation or simple error may go undetected. The absence of regular reconciliations, dual authorisation or clear financial policies often points to underlying governance weaknesses.

In charities, we also consider the oversight role played by trustees. Where trustees have limited financial oversight or understanding, the risks of poor financial management increase, even if well-intentioned.

Inflated Forecasts and Unrealistic Projections

Finally, we often see forecast financial information that is overly optimistic. Growth assumptions may not be grounded in historic trends, and projected cost savings may lack credible supporting evidence.

In some cases, revenue forecasts rely on contracts that are not yet secured or customers that are still under negotiation. Cost projections may assume unrealistically low staffing levels or omit necessary capital expenditure. These projections create risks if buyers or investors use them as the basis for valuation.

We always encourage clients to carefully stress-test forecasts, applying conservative assumptions and seeking supporting evidence for key drivers.

Conclusion: Trust But Verify

Financial due diligence exists for a simple reason: to give confidence that what you are buying, merging with or funding is as it appears. While every business or charity has some areas of uncertainty or judgement, the red flags highlighted above often point to risks that require closer scrutiny.

Ultimately, due diligence is not about catching people out, but about protecting your investment and making informed decisions. Identifying risks early allows buyers to negotiate appropriate protections, whether through pricing adjustments, warranties or deal structure.

At Williamson & Croft, we conduct financial due diligence across a wide range of sectors, from charity mergers to SME acquisitions and investor transactions.

Our role is to ask the right questions, follow the audit trail, and give you clear, actionable advice, not just a checklist.

If you are considering a transaction or want to discuss how financial due diligence could protect your organisation, contact our specialist team today.

A single conversation could save you from costly surprises down the road.