What does 'due diligence' refer to in financial management?

In financial management, 'due diligence' refers specifically to the thorough investigation of a business or individual's financial records prior to engaging in a transaction. This process is crucial for making informed decisions, particularly in situations such as mergers and acquisitions, investments, or granting credit. By examining the financial history, legal standing, operations, and overall health of the entity in question, stakeholders can identify potential risks, liabilities, or irregularities that may impact the transaction.

Conducting due diligence ensures that the parties involved fully understand what they are getting into and helps to verify the accuracy of the information provided. This process can significantly influence the decision-making process and the terms of the transaction. It is a critical aspect of financial management because it seeks to protect the interests of the investor or acquiring party by providing a clear picture of the financial landscape.