In The Trenches Quality of Earnings Analysis: What You Need to Know Before Buying a Business
Mar 31, 2022
Chris Hutchinson, a Partner at Ernst & Young's Transaction Advisory Services, shares his expertise on Quality of Earnings (QofE) analysis, crucial for evaluating sustainable earnings during acquisitions. He explains its importance, particularly in the lower middle market, and highlights common pitfalls for buyers and sellers. Chris dives into working capital adjustments and their significance, alongside insights on navigating post-COVID financial evaluations. With over 15 years in M&A, he emphasizes effective communication to achieve realistic valuations and protect interests in complex deals.
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Quality of Earnings vs Audit
- A Quality of Earnings (QofE) analysis assesses sustainable earnings by analyzing historical results.
- It differs from an audit, which focuses on accuracy and GAAP compliance without assessing future earnings sustainability.
Stage Diligence to Manage Costs
- Focus initially on the biggest potential deal killers, especially questionable EBITDA addbacks and messy financials.
- Provide an interim EBITDA estimate early before deep-diving into full reporting to save costs if the deal may not proceed.
Start Quality Review With Data Book
- Build a monthly data book of income statements and balance sheets to spot unusual fluctuations or large "other income" entries.
- Examine revenue customer profiles and scrutinize EBITDA addbacks for supportability and sustainability.