Financial Model Review in Due Diligence: What Transaction Services Teams Actually Check

Financial Model Review in Due Diligence: What Transaction Services Teams Actually Check

Financial model review is a standard component of many due diligence engagements, particularly on buy-side mandates where the sponsor builds or commissions a detailed financial model to support the investment thesis. Transaction Services teams review these models not as modelers but as analysts who validate the inputs, assumptions, and outputs against the findings of the financial due diligence.

The value of this review is not in checking formulas. It is in ensuring the model accurately reflects the economic reality uncovered during diligence.

What Gets Reviewed

A financial model review in a due diligence context typically covers three areas:

Input Validation

The model's historical financials should tie to the due diligence analysis. This means checking that:

• Historical revenue, EBITDA, and key financial metrics match the Quality of Earnings analysis
• The balance sheet reflects the net debt and working capital positions identified during diligence
• Historical growth rates and margins are consistent with the granular data analysis, not just management presentations

Discrepancies between the model and the due diligence findings are common. Management teams often provide financials on a different basis than the QoE analysis (for example, using management-adjusted EBITDA rather than the diligence-adjusted figure). Identifying and quantifying these differences is a core part of the review.

Assumption Reasonableness

Projection assumptions drive the valuation. The Transaction Services team assesses whether these assumptions are consistent with historical performance and the findings from diligence:

• Revenue growth: Are projected growth rates supported by historical trends, pipeline data, and market conditions identified during diligence?
• Margin expansion: Are cost assumptions consistent with the normalized cost structure identified in the QoE analysis?
• Working capital: Do working capital assumptions reflect the seasonality and cash conversion patterns observed in the NWC analysis?
• Capital expenditure: Are maintenance versus growth capex assumptions reasonable relative to historical spending patterns?

Structural Integrity

Beyond inputs and assumptions, the review assesses whether the model structure can accommodate the deal terms:

• Does the model correctly implement the proposed working capital mechanism?
• Are EBITDA adjustments correctly reflected in the bridge from reported to adjusted figures?
• Does the debt schedule accurately reflect the proposed financing structure?
• Are tax calculations consistent with the jurisdictional analysis from diligence?

Where Data Quality Matters

The reliability of a financial model review depends entirely on the quality of the underlying diligence data. If the QoE analysis is built on poorly mapped GL data, the model review inherits those issues.

Consider a practical example. A target company reports revenue of 45M EUR in the most recent fiscal year. The management financial model uses this figure as the base for projections. During diligence, the team identifies that 2.5M EUR of reported revenue includes intercompany sales that should be eliminated, and another 1.2M EUR relates to a one-time licensing arrangement. The adjusted revenue is 41.3M EUR.

If the model uses the unadjusted figure, every projected year overstates revenue by approximately 8 percent. The resulting enterprise value error compounds through the projection period.

This kind of issue is only caught when the due diligence team has properly extracted, mapped, and analyzed the underlying financial data. Analysts reviewing a model against management accounts alone may miss adjustments that a granular GL-level analysis would reveal.

The Review Process

A thorough financial model review follows a structured approach:

1. Obtain the model and understand its structure, key sheets, and calculation flow
2. Map due diligence findings to model inputs, identifying every point where the model should reflect diligence-adjusted figures
3. Create a comparison schedule showing model assumptions versus diligence findings across all key metrics
4. Flag discrepancies with quantified impact on key outputs (enterprise value, equity value, returns)
5. Document findings in a clear format that the client (typically the PE sponsor's deal team) can use to negotiate model adjustments

Delivering the Review Efficiently

Financial model reviews are time-sensitive. The sponsor typically wants the review completed alongside or shortly after the main due diligence report. Delays in the model review can hold up investment committee papers.

Efficiency depends on having well-structured due diligence outputs. When the QoE, NWC, and net debt analyses follow standardized formats with clear summary schedules, the model review team can quickly extract the relevant data points for comparison. When the diligence workpapers are unstructured, the review team spends time hunting for numbers rather than analyzing them.

This is another area where the quality of the underlying data preparation directly impacts the team's ability to deliver under tight timelines. A model review built on clean, well-documented diligence findings is faster to execute and more reliable in its conclusions.