At a time when a number of Australian companies are cash-rich and looking for acquisitions the question of the hour may not be, How to close the deal? but, When to walk away?

Making the right calls about merger and acquisitions, for buyers and sellers, is a challenge that more and more executives face, and it's getting harder. When we recently surveyed 250 senior managers responsible for M&As, half said their due-diligence process had overlooked major problems; half found that targets had been dressed up to look better for deals. Two-thirds said their approach routinely overestimated the synergies available from acquisitions. Only 30 per cent were satisfied with their due-diligence processes.

What can companies do to address such shortcomings? For starters, they can rid themselves of their "going-in" assumptions. Private-equity firms like Newbridge tell us their advantage as acquirers lies in being industry outsiders: they force themselves to ask basic questions about how an acquisition will make money for investors.

Top corporate buyers take a similarly rigorous approach. Craig Tall, vice-chairman of corporate development at US financial services firm Washington Mutual, says: "When I see an expensive deal and they say it was a strategic deal, it's a code for me that somebody paid too much."

Due diligence starts with verifying the cost economics of the proposed deal. Do the target's competitors have cost advantages? Why is the target performing above or below expectations? To arrive at a business's true stand-alone value, all accounting idiosyncrasies must be stripped away.

China Mobile's target acquisition, Luxembourg-based Millicom, walked away from the altar last month. Some say China Mobile's exhaustive approach to due diligence fostered concerns at Millicom which, along with pricing issues, helped scupper the deal.

Successful acquirers focus on creating a detailed picture of their target's customers. They begin by drawing a map of the target's market—its size, growth rate and how it breaks down by geography, product and customer segment.

It's just as important to examine the capabilities of competitors. One global food company, in its bid to buy an overseas maker of fruit flavourings, found that while the target boasted considerable global scale, the key competitors were national: local factors, it turned out, were the more relevant driver of costs. The global sourcing of fruit was not feasible after all.

In the end, effective due diligence is about balancing opportunity with informed scepticism. It's about testing every assumption and questioning every belief. It's about not falling into the trap of thinking you'll be able to fix problems after the fact. By then, it's too late.