In any business acquisition or sale, traditional financial statements—even audited ones—only provide a partial view. While an audit confirms compliance with accounting standards, it doesn’t assess the sustainability or quality of a company’s earnings. A Quality of Earnings (QoE) report is therefore essential for providing the comprehensive, nuanced understanding of financial health required for confident deal-making.
The Core Components of a QoE Analysis
A QoE analysis enables stakeholders to assess whether reported earnings are sustainable, repeatable, and realistic within the context of a potential transaction. This assessment allows decision-makers to better evaluate risks, justify valuations, and structure deals with confidence.
Unlike an audit, which focuses on compliance, a QoE report is designed to analyze and interpret the underlying drivers of financial performance. It typically includes:
- Normalized EBITDA
Adjustments for nonrecurring, discretionary, or one-time items, as well as owner-related expenses. - Revenue Quality
Assessment of client concentration, churn, pricing dynamics, and seasonality. - Working Capital Trends
Evaluation of working capital requirements and potential implications for post-close negotiations. - Cash Flow Analysis
Review of operating cash flow and the true sources and uses of cash. - Operational Risks
Identification of inconsistencies in accounting policies, margin volatility, or weak internal controls.
These components are critical for buyers seeking to understand what they are truly acquiring and for sellers preparing to defend the value of their business.
Key Benefits: Decision-Focused Insights for a Successful Deal
A well-prepared QoE report goes beyond traditional accounting analysis. It offers practical, decision-focused insights that inform valuation, shape negotiations, and support post-transaction planning.
Key benefits include:
- A clear view of adjusted historical earnings (Normalized EBITDA).
- Transparency into operational drivers and future cash flow.
- Identification of financial risks and inconsistencies before close.
- Confidence in financial reporting for stakeholders, lenders, and investors.
This level of detail helps all parties approach the transaction with greater clarity and fewer surprises.
Who Benefits from a QoE Report?
- Buyers: Use QoE analysis to validate reported earnings, identify risks, and inform deal structure and pricing.
- Sellers (Sell-Side QoE): Benefit by identifying potential due diligence issues in advance and preparing a clear, consistent financial narrative, which ultimately helps to defend the valuation.
- Investors/Lenders: Rely on QoE findings to guide capital allocation and financing decisions.
- Advisors: Use the report to enhance credibility and ensure a smooth diligence process.
Timing is Critical: When to Start Your QoE
- Buyers: Initiate analysis before the Letter of Intent (LOI) is finalized.
- Sellers: Begin a sell-side QoE two to three months before entering the market to allow sufficient time to address issues and present the business in the most compelling manner.
Navigating Your Transaction with Confidence
A Quality of Earnings report is not just a due diligence checklist; it is the foundation for an informed and successful transaction. By clarifying the sustainability of earnings, highlighting potential risks, and providing a deep understanding of a company’s financial position, a well-prepared QoE is essential.
At Calvetti Ferguson, we deliver clear, actionable analysis backed by deep industry knowledge and practical M&A experience to support confident decision-making at every stage of your transaction. Contact us today to discuss your next acquisition or sale.
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