Your Complete Checklist for Evaluating Investment Opportunities
Due diligence can make or break an investment. While many investors focus on growth potential and market size, cash flow investors need to dig deeper into the mechanics of how a business actually generates and collects cash. After analyzing over 2,000 investment opportunities, we’ve distilled our due diligence process into the 25 most critical questions every cash flow investor must ask.
At S&P Ventures, these questions form the backbone of our investment evaluation process, helping us identify businesses with genuine flywheel potential while avoiding value traps that look good on paper but fail to deliver sustainable returns.
Financial Foundation: The Cash Flow Deep Dive
1. What percentage of revenue is recurring or contractually committed?
This is the single most important question for cash flow investors. We target companies with at least 60% predictable revenue. Look for:
- Multi-year contracts with automatic renewals
- Subscription-based revenue models
- Essential services that customers can’t easily eliminate
- Historical evidence of high customer retention rates
2. How quickly does the company convert sales into actual cash?
A company might show strong revenue growth, but if it takes six months to collect payment, cash flow will lag significantly. Calculate the cash conversion cycle:
- Days Sales Outstanding (DSO)
- Days Inventory Outstanding (DIO)
- Days Payable Outstanding (DPO)
- Cash Conversion Cycle = DSO + DIO – DPO
Target companies with cycles under 45 days.
3. What is the customer payment behavior and collection history?
Review aging reports for accounts receivable:
- What percentage of receivables are current vs. 30/60/90+ days?
- Historical bad debt experience as percentage of revenue
- Collection policies and enforcement procedures
- Customer payment terms and any extended payment arrangements
4. How seasonal or cyclical are the cash flows?
Seasonal businesses aren’t necessarily bad investments, but you need to understand the patterns:
- Monthly cash flow variations over the past 3 years
- Working capital requirements during peak/trough periods
- How management handles seasonal fluctuations
- Whether seasonality is structural to the industry or company-specific
5. What is the true free cash flow after all necessary capital expenditures?
Many companies show strong EBITDA but require significant ongoing capital investment:
- Maintenance capital expenditures vs. growth capex
- Required technology upgrades and replacements
- Facility improvements and equipment updates
- Free Cash Flow = Operating Cash Flow – Necessary Capital Expenditures
Customer Quality and Retention Analysis
6. Who are the top 10 customers and what percentage of revenue do they represent?
Customer concentration risk can destroy an otherwise solid cash flow business:
- No single customer should exceed 15% of revenue
- Top 10 customers should represent less than 50% of total revenue
- Understand the creditworthiness of major customers
- Review contract terms and termination clauses
7. What is the historical customer retention rate by year and by customer segment?
Customer retention directly impacts cash flow predictability:
- Calculate gross and net revenue retention rates
- Understand why customers leave and what drives retention
- Identify any recent changes in retention patterns
- Analyze retention by customer size, industry, or geographic segment
8. How does the company acquire new customers and what does it cost?
Sustainable growth requires efficient customer acquisition:
- Customer Acquisition Cost (CAC) by channel
- Customer Lifetime Value (CLV) calculations
- CAC payback period (should be under 12 months for service businesses)
- Scalability of current acquisition methods
9. What is the pricing power and how often are prices increased?
Pricing power indicates market position and competitive moats:
- Historical price increase frequency and amounts
- Customer response to price increases
- Competitive pricing dynamics
- Contract terms regarding price escalations
10. How dependent is customer satisfaction on key employees?
People-dependent businesses face retention and scalability challenges:
- Which employees have direct customer relationships?
- What happens if key customer-facing employees leave?
- How institutionalized are customer relationships?
- What systems exist to maintain service quality as the business scales?
Operational Efficiency and Scalability
11. What are the major cost components and how do they scale with revenue?
Understanding cost structure is critical for predicting cash flow scaling:
- Fixed vs. variable cost breakdown
- Operating leverage potential as revenue grows
- Cost components that might face inflation or other pressures
- Opportunities for economies of scale
12. How automated and systemized are the core business processes?
Manual processes limit scalability and create operational risk:
- Which processes are still manual vs. automated?
- What systems and technology infrastructure exist?
- How easily can the business handle 2x or 3x current volume?
- What are the technology upgrade requirements and costs?
13. What is the management team’s track record with cash flow generation?
Management capability directly impacts execution:
- Previous experience managing cash flow-focused businesses
- Track record of achieving financial projections
- Understanding of working capital management
- Approach to capital allocation and reinvestment decisions
14. How does the company manage working capital throughout the business cycle?
Working capital management separates good operators from great ones:
- Inventory management policies and turnover rates
- Accounts payable management and supplier relationships
- Cash flow forecasting and management processes
- Banking relationships and available credit facilities
15. What are the key operational metrics and how are they trending?
Look beyond financial metrics to operational indicators:
- Productivity metrics (revenue per employee, utilization rates)
- Quality metrics (error rates, customer satisfaction scores)
- Efficiency metrics (processing times, automation percentages)
- Trend analysis over the past 2-3 years
Market Position and Competitive Dynamics
16. What are the barriers to entry in this market and how sustainable are they?
Competitive moats protect cash flows over time:
- Regulatory barriers or licensing requirements
- Capital requirements for new entrants
- Network effects or switching costs
- Proprietary technology or intellectual property
17. How fragmented is the market and what is the competitive landscape?
Market structure affects pricing power and growth opportunities:
- Number and size of competitors
- Market share trends and dynamics
- Opportunities for consolidation
- Competitive advantages vs. key competitors
18. What is the total addressable market and how is it evolving?
Market size and trends impact long-term growth potential:
- Current market size and growth rate
- Market trends favoring or threatening the business
- Regulatory changes affecting the market
- Technology disruption potential
19. How essential is the company’s product or service to its customers?
Essential services have better retention and pricing power:
- What happens if customers stop using the service?
- How difficult and costly is it for customers to switch?
- Is this a “nice to have” or “must have” service?
- How has demand held up during economic downturns?
20. What regulatory or compliance requirements affect the business?
Regulatory risks can impact cash flows and growth:
- Current regulatory environment and compliance costs
- Pending regulatory changes that could affect the business
- Compliance requirements for growth or expansion
- Professional licensing or certification requirements
Risk Assessment and Mitigation
21. What are the key risk factors that could disrupt cash flows?
Identify and quantify major risks:
- Single points of failure in operations or customer base
- Technology risks and cybersecurity vulnerabilities
- Key person dependencies and succession planning
- Economic sensitivity and recession resilience
22. How does the company’s debt structure align with its cash flow characteristics?
Debt structure should match cash flow patterns:
- Debt service coverage ratio (should exceed 1.25x)
- Debt maturity profile and refinancing requirements
- Covenant requirements and financial flexibility
- Interest rate exposure and hedging strategies
23. What insurance coverage exists and what risks are uninsured?
Proper insurance protects cash flows from unforeseen events:
- General liability and professional liability coverage
- Key person life insurance policies
- Cyber liability and data breach coverage
- Business interruption insurance
24. How experienced is the management team with growth and scale?
Growth requires experienced leadership:
- Track record managing businesses at larger scale
- Experience with acquisitions or major expansions
- Financial management experience and sophistication
- Board composition and advisory support
25. What is the realistic exit strategy and timeline?
Understanding exit options affects investment structure:
- Strategic buyer universe and historical multiples
- Financial buyer market for similar companies
- Management buyout potential and capability
- Dividend distribution capacity for hold strategies
Red Flags to Watch For
During due diligence, certain warning signs should immediately raise concerns:
Financial Red Flags:
- Consistently missing financial projections
- Unexplained fluctuations in key metrics
- Deteriorating working capital trends
- Off-balance-sheet liabilities or commitments
Operational Red Flags:
- High employee turnover, especially in customer-facing roles
- Outdated technology or systems
- Lack of standard operating procedures
- Quality control issues or customer complaints
Market Red Flags:
- Declining market or industry disruption
- New competitive threats or price pressure
- Regulatory changes that could impact the business
- Customer concentration increasing over time
The Due Diligence Process: A Systematic Approach
Phase 1: Initial Screening (Week 1) Review basic financials and business model to determine if detailed due diligence is warranted.
Phase 2: Financial Deep Dive (Weeks 2-3) Comprehensive analysis of historical financials, cash flows, and working capital management.
Phase 3: Operational Assessment (Weeks 4-5) Evaluate operations, management, systems, and scalability potential.
Phase 4: Market and Competitive Analysis (Week 6) Assess market position, competitive dynamics, and growth opportunities.
Phase 5: Risk Assessment and Legal Review (Weeks 7-8) Identify risks, review legal structure, and evaluate exit strategies.
Documentation and Verification
Remember that due diligence isn’t just about asking questions—it’s about verifying answers:
Financial Verification:
- CPA-prepared financial statements
- Bank statements and cash flow records
- Customer payment history and aging reports
- Tax returns and compliance documentation
Operational Verification:
- Customer references and interviews
- Supplier and vendor discussions
- Employee interviews (with appropriate confidentiality)
- Site visits and operational observations
Legal Verification:
- Legal review of major contracts and agreements
- Regulatory compliance verification
- Intellectual property validation
- Litigation and claims history
Making the Investment Decision
After completing due diligence, the investment decision should be based on:
- Cash Flow Quality: Are the cash flows truly predictable and sustainable?
- Growth Potential: Can the business grow cash flows while maintaining quality?
- Risk Assessment: Are the risks manageable and properly priced?
- Management Capability: Can the team execute the growth plan?
- Exit Strategy: Does a clear path to attractive returns exist?
Conclusion: The Foundation of Smart Investing
Thorough due diligence is the foundation of successful cash flow investing. While it requires significant time and effort, the investment in proper due diligence pays dividends through better investment selection, improved risk management, and stronger returns.
Remember that due diligence isn’t a one-time event—it’s an ongoing process that continues throughout the investment period. The companies that deliver the strongest cash flow returns are those where investors maintain active oversight and continue asking the right questions long after the initial investment.
The 25 questions outlined above represent our core due diligence framework, developed through years of investment experience and refined through both successes and mistakes. Use them as your starting point, but remember that every business is unique and may require additional specific inquiries.
The goal isn’t to find perfect companies—they don’t exist. The goal is to find good companies with manageable risks and clear paths to improving cash flow generation over time. With systematic due diligence and the right questions, you can identify these opportunities and build a portfolio of cash flow-generating investments that create lasting wealth.
