In today’s dynamic business landscape, Quality of Earnings (QoE) reports are pivotal tools for businesses seeking investment, acquisition, or strategic growth. These reports go beyond standard financial statements, offering an in-depth analysis of a company’s earnings quality, sustainability, and risks. They provide a nuanced picture of operational performance and cash flow, distinguishing them from mere accounting profits.
What is Quality of Earnings?
QoE is an analytical review of a company’s financial health, specifically focused on the sources and reliability of its earnings. While traditional financial statements present a snapshot of revenue and profit, QoE delves into the nature of those figures, identifying one-time events, seasonal trends, or accounting manipulations. A robust QoE analysis highlights normalized earnings—an indicator of recurring profitability stripped of non-operational noise.
Why Does it Matter to Investment Banks?
QoE reports are indispensable for investment banks in valuation, negotiations, and deal structuring. A strong QoE report can:
Enhance Credibility: It assures buyers and investors that the presented financials are reliable, reducing perceived risks.
Aid in Pricing: By isolating sustainable earnings, investment banks can establish a realistic valuation and avoid overpaying for non-recurring profits.
Streamline Transactions: A clear financial picture fosters trust, speeding up negotiations and due diligence.
Without a thorough QoE, transactions may be delayed or collapse due to unforeseen discrepancies, which can cost time and reputation.
What is Often Overlooked?
Business owners often focus on revenue growth and net profit, neglecting the quality and sustainability of those earnings. Some common oversights include:
Weak Internal Controls—Inaccurate financial data due to loose accounting practices can erode confidence during due diligence.
Dependence on Key Customers—A heavy reliance on a few clients makes earnings vulnerable to disruption.
Non-Recurring Revenue—Owners may overestimate the value of one-time gains like large contracts, neglecting their impact on normalized earnings.
These blind spots can significantly reduce perceived value in the eyes of potential buyers or investors.
What Do Buyers Look For?
Sophisticated buyers scrutinize QoE reports for red flags and opportunities. Key areas of focus include:
Revenue Quality—Is it diversified across a broad customer base or concentrated in a few accounts?
Earnings Consistency—Are profits stable or subject to seasonal or cyclical variations?
Cash Flow Sustainability—Do earnings translate effectively into cash flow, or are they tied to receivables and inventory?
Expense Management—Are operating costs under control, and are there hidden liabilities such as lawsuits or deferred maintenance? Are all of your expenses business-related? Your kid’s holiday business trip is not an appropriate expense.
Buyers are looking for a business with predictable, recurring revenue and minimal risk.
Your Rule of Three
If you’re preparing your business for a potential sale or investment, here are three proactive steps to enhance your QoE:
Tighten Financial Reporting—Invest in robust accounting systems and ensure your financial records are accurate and current. Work with an experienced CFO or controller to implement internal controls that prevent discrepancies. Don’t have one? Let us make an introduction.
Normalize Your Earnings—Identify and adjust for non-recurring items such as one-time sales, extraordinary expenses, or seasonal fluctuations. Presenting a clear picture of normalized earnings builds buyer confidence.
Diversify Revenue Streams—To mitigate risk and reduce reliance on critical customers or sectors. A diversified customer base and product mix demonstrate resilience and sustainability. Demonstrating how that can happen is a good leverage point for discussions.
“Working with OneAccord was a transformative experience for Synergy Health Partners. Under their Partner’s leadership, we restructured our ASCs, significantly improving our utilization from 46% to 62% and reducing our staff per case from 24.6 to 13.4. SHP’s strategic initiatives, including OA’s leadership associated with optimizing our ASC operational metrics and revamping our scheduling processes, led to a remarkable 25% increase in our trailing twelve-month revenue and an 86% increase in TTM EBITDA”
—First Aid Only, a former OneAccord client
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Lawrence Lerner, Managing Principal
1018 Market St. Kirkland, WA 98033
(206) 457-3421
