Operational Due Diligence (Explained: All You Need To Know)

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What is an Operational Due Diligence?

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What Is An Operational Due Diligence

Operational due diligence is a type of due diligence where the objective is to assess the operational structure and efficiency of an organization.

Typically, operational due diligence is done in the context of mergers and acquisitions, particularly in the industrial sector.

The effectiveness of a company’s operations can be directly linked to its profitability.

In other words, a highly operationally efficient organization will incur lower costs and produce more rapidly than another organization that is not operationally optimized.

The main objective of operational due diligence is to assess if a company has the right operational structure and process in place, if it has the potential to scale, and the potential operational risks associated with the business.

Very often, the operational due diligence is done by an external firm being a third party to a potential M&A transaction or financing deal.

Keep reading as I will further break down the meaning of operational due diligence and tell you why it’s important.

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Why Is Operational Due Diligence Important

Operational due diligence can be important in many ways.

A company may perform operational due diligence on its own operations to objectively assess its own operating efficiency.

When you look at your operations in an unbiased and objective manner, you will be better able to assess your strengths and weaknesses.

In essence, you’re looking to see what aspects of your operations need improvement, allowing you to plan for change ahead of time.

Doing operational due diligence is also important for companies looking to sell their business (the sell-side).

The objective is to see if your company is performing at the level it should be, do you need to invest in new technology, better machines, do you have the capacity to scale, and so on.

Operational due diligence is also very important for companies looking to acquire another company.

For the buy-side in an M&A transaction, the objective is to see if the company’s operations will be sustainable in the future years.

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Operational Due Diligence Framework

Performing operational due diligence requires adequate preparation and structure.

If you are considering operational due diligence, here are some aspects that you should keep in mind.

First, you should understand the company’s business model.

In other words, it’s important to see exactly how the company is generating its cash flow.

If the company’s cash flow is heavily tied to its operating capacity, then the company’s operation should be evaluated more thoroughly for potential risks.

The second element you should consider is the company’s human capital.

It’s important to know who is involved in the company’s operations, their skill sets, how difficult it is to find the same skill set in the market, and how the people contribute to the company’s success.

The third aspect of operational due diligence is to assess the company’s operating assets, particularly its long-term assets.

The more a company relies on its long-term assets to be profitable and generate its cash flows, the more it’s important to assess how the company manages and maintains these assets.

The fourth aspect that should be considered has to do with operational risks and mitigation factors.

What are the operational elements that pose a risk to the company?

What can the company do to mitigate such operating risks?

As you can see, having an operational due diligence framework is important to ensure that you adequately review the company’s operations and obtain the intelligence you need to make an informed business decision.

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Operational Due Diligence FAQ

What is operational due diligence?

Operational due diligence is a type of due diligence where you assess a company’s operations, operational processes, efficiency, and effectiveness.

Operational due diligence can include the review of a company’s internal operations, supply chain management, logistics, departmental efficiencies, human resource capacity, use of technology, cost optimization, and risk assessment.

Why perform an operational due diligence?

Performing operational due diligence is important for companies, particularly those who are in the industrial segment heavily focused on production.

It’s also important in the context of mergers and acquisitions, corporate financing, and assessing the company’s overall ability to create value.

Buyers will assess their target’s operations to ensure it is sustainable in the future, they can scale in the future, and create synergies.

What does operational due diligence include?

Depending on the company that you are looking to purchase or why you are looking to do operational due diligence, the specific operational activities that you will evaluate may be different.

Operational due diligence can look at a broad range of operating activities such as operational risk across the entire organization, regulatory compliance, information technology, operating assets, supply chain, scalability of operating activities, and other aspects.

What are the operational due diligence objectives?

In a broad sense, the objectives of operational due diligence are to:

• Assess the sustainability of a company’s operations
• Identity what actions need to be taken to accelerate value creation
• Assess and understand the extent of operational investments

Also, in most cases, operational due diligence is forward-looking.

This means that evaluating the current operation is important but having a forward-looking plan is crucial.

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Takeaways 

So there you have it folks!

What does an operational due diligence mean?

In a nutshell, operational due diligence is the process of investigating a company’s operations, effectiveness, and future sustainability.

Typically, operational due diligence is performed in the context of an M&A or by a lender before providing financing to a company.

Having a good understanding of a company’s operations can provide good insights into the company’s ability to create value and attain its objectives.

Companies that are heavily dependent on their operations to generate cash flow will need to perform more in-depth operating due diligence than companies that are less operationally reliant.

Companies can perform internal operational due diligence to better understand the intricacies of their business or have the review done by third parties to get a more objective and unbiased perspective.

Now that you know what operational due diligence means and how it works, good luck with your research!

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