How Due Diligence in Business Planning can help Avoid Costly Write-Offs

It really does not matter how much time, effort, and money you put into your business plan, if you do not do all of your homework, it all could come crumbling down very quickly. In the news recently, was just one more example of a company that failed to do their due diligence and suffered the consequences.

Caterpillar, one of the world’s most respected companies purchased a Chinese firm named ERA Mining Machinery Ltd and its subsidiary Siwei for $653.4 million. Unfortunately for them, they failed to research the transaction fully, and were forced to write off $580 million in goodwill.

For a company that is this sophisticated and thought to be exceptionally well managed to let a major blunder like this happen, is almost beyond belief. Especially when you take into account the reputation that some of China’s companies have when it comes to their accounting standards, and following GAAP to the letter.

A Sydney based fund manager for Bronte Capital named John Hempton, said that he shorted Caterpillar’s shares after conducting 20 minutes of research. The problem that he easily identified was that their receivables took 180 days to collect, which was twice the industry average.

Caterpillar became concerned when they discovered problems with November’s physical inventory, when compared to what was recorded on the books.

The Core Due Diligence Steps That Could Have Saved Them

If you are contemplating a merger or acquisition, there are certain basic steps that must be employed to complete your due diligence. Some of these are confirming the company’s cash and securities, reviewing the sales transactions ensuring they are being recorded properly, checking AR and doing ratio analysis, and the probably the most basic—to physically see, count, and value the assets of the company.

In accounting terms, goodwill is calculated by taking the purchase price paid for a company and subtracting the fair market value of its assets. In this instance, Caterpillar paid $653.4 million for the firm and had to write off $580 million in goodwill. That of course means they only acquired $73.4 million in assets, which is just one more troubling and unexplainable problem with this transaction.

This is not the first time an American company has suffered a huge loss because of accounting irregularities performed by a Chinese company. John Paulson, who is a billionaire hedge fund manager, invested in Sino Forest and was forced to take a massive write off when his company found out Sino Forest’s timber assets had been falsified.

In addition, dozens of Chinese companies that were once registered on U.S. stock exchanges have been deregistered because of fraud found in their accounting records.

It really does not matter if you are just starting a business, already running a business, or contemplating purchasing an existing business, producing a well researched and conservative business plan will always give you a leg up on the competition. However, they are just one of a whole host of techniques that you need to employ to ensure that your business is as successful as possible.

Building a Systematic Due Diligence Framework

The Caterpillar example is instructive precisely because the warning signs were visible to an outside observer in a short amount of time. Receivables aging twice the industry average is a red flag that a structured financial review—using a standard due diligence request list—would have surfaced early in the process. The lesson is not that cross-border acquisitions are inherently too risky; it is that diligence shortcuts have asymmetric consequences.

A disciplined due diligence process covers several distinct workstreams simultaneously: financial, legal, operational, commercial, and (for international targets) regulatory and geopolitical. On the financial side, a quality-of-earnings review goes beyond the audit to examine whether reported revenue and EBITDA will hold under new ownership. On the legal side, contract review, title searches, and IP verification are foundational. A structured diligence tracker helps ensure none of these workstreams fall through the cracks under the time pressure of a live deal process.

For deals where speed matters, it is tempting to compress due diligence in order to close faster. Understanding when and how rapid due diligence can work without sacrificing the most critical checks is an important skill for any acquirer operating in competitive deal environments.

The Role of Business Planning in Preventing Acquisition Mistakes

Rigorous due diligence does not begin after a letter of intent is signed—it starts during business planning, well before any specific target is identified. Companies that have invested in understanding their own financial metrics, customer concentration, and competitive position are better equipped to evaluate a target quickly and accurately. They know what “good” looks like because they have defined it internally.

If you are a buyer, that self-awareness translates directly into better acquisition decisions. If you are a seller, demonstrating that your own house is in order—clean financials, documented processes, and predictable cash flows—accelerates the buyer’s diligence process and supports a higher valuation. Thinking through the full due diligence phase of an acquisition from both sides of the table is a valuable exercise.

Understanding what buyers scrutinize also prepares sellers to anticipate the predictable questions that arise in any transaction. Reviewing predictable due diligence questions when selling your business allows sellers to prepare clear, well-documented answers in advance rather than scrambling during a live process—which both shortens timelines and reduces the risk of a price renegotiation after diligence surfaces surprises.

When a deal has been properly diligenced, closing execution follows a well-defined path. A structured closing checklist ensures that the final steps—escrow funding, document execution, regulatory filings, and transition planning—proceed in the right order without last-minute surprises.

Ready to approach your next transaction with proper preparation? Start preparing your transaction before a specific deal is on the table—the groundwork you lay now pays dividends under time pressure later.

Frequently Asked Questions

What is goodwill in an acquisition, and why is a large goodwill write-off so significant?

Goodwill represents the premium paid above the fair market value of a target’s identifiable net assets. When a company later determines the acquired business is worth less than originally paid—due to fraud, deteriorating performance, or overly optimistic projections—it is required to impair (write down) that goodwill on its balance sheet. A large write-off signals to the market that the acquisition destroyed value, often triggering a sharp decline in the acquirer’s stock price and raising governance questions about the original deal process.

What financial ratios should acquirers examine first when evaluating a target?

Accounts receivable days outstanding (DSO), inventory turnover, and operating cash flow relative to reported EBITDA are among the highest-signal early indicators. Significant deviations from industry norms—as in the Caterpillar case, where DSO was double the industry average—warrant deeper investigation before proceeding. Gross margin trends and customer concentration are also critical inputs to any preliminary financial screen.

How should acquirers approach due diligence when evaluating companies in emerging markets or less-regulated environments?

Cross-border acquisitions in markets with less-standardized accounting and legal frameworks require additional layers of verification. Physical asset counts, independent third-party appraisals, reference checks with customers and suppliers, and local legal counsel who understand the regulatory environment are all important. It is also worth examining the target’s banking relationships and payment history as a cross-check on reported receivables and cash balances.