What is Due Diligence?

Definition: Due diligence is a process where all proper steps are taken to reduce the risk of making an uninformed decision. In other words, it is a research procedure that provides enough information to issue an assessment.

What Does Due Diligence Mean?

Due diligence has some different applications depending on the context in which the term is used, but overall the term refers to a process of investigation that provides enough information to make an informed decision about a particular issue. In business, it is mostly used when someone is analyzing a financial transaction; since there are so many risks involved in making these decisions proper due diligence is required to reduce the chances of stepping into unnecessary mistakes that could have been avoided.

Due diligence is particularly important in takeover and mergers procedures since the company is exposed to the risk of not knowing the actual situation of the company being bought, which may lead to undesired consequences. Also, whenever a company is to enter a business deal there’s a due diligence requirement to have full knowledge of all the elements involved. Due diligence is normally carried out by lawyers and analysts depending on the nature of the transaction.

Here’s an illustration of this.

Example

RK Wholesalers Co. is a company that sells computer devices to retailers in the state of Florida. The company offers a credit period of 15 days to previously-screened clients that meet a particular set of financial and legal requirements. A company called PCs 4 All LLC is currently applying for this credit line. What would be the role of due diligence in this situation?

As we discussed above, due diligence is a process where all proper steps are taken to reduce the risk of making an uninformed decision. This means that RK Wholesalers must review and analyze thoroughly each of the documents and financial reports sent by PCs 4 All to make sure they comply with the criteria previously set by the company for the credit line to be approved.