The financial statements of an acquisition target tell you what was recorded. Diligence is the work of finding out what was not. Four areas produce most of the unpleasant discoveries.
Related parties and where the margin goes
Look for transactions with entities connected to the owner: supply, rent, logistics, consulting. They are not improper in themselves, but they may be carrying margin out of the business, or holding an essential asset outside it.
Ask what happens to each arrangement on completion. A target that is profitable only because it rents premises cheaply from its founder is a different business once the founder has been paid and leaves.
Payroll that does not match the floor
Compare the headcount on the payroll with the people you can see working, and compare declared wages with what the roles plausibly pay. Undeclared employment or under-declared salary is a liability that follows the business, and it is also a signal about how other obligations have been treated.
Property, permits and pending matters
Confirm title and registration for every property, and confirm that the use matches the permission. Title irregularities are common enough that this should never be assumed.
Then ask directly for the status of inspections, disputes and correspondence with authorities — not just concluded matters, but open ones. A pending review that has not yet produced an assessment will not appear in the accounts at all.
What to do with what you find
Most findings are manageable if they are known. They become deal-breakers when they surface after signing.
Use them to adjust the price, to carve the problem out of the transaction, or to obtain specific indemnities with real security behind them. A general warranty from a seller who will be difficult to pursue afterwards is worth considerably less than a retention.