How a Quality of Earnings Report Can Save You Millions
Quality of Earnings reports are vital to anyone looking to take the leap into entrepreneurship through acquisition (ETA). At the beginning of your ETA career, you will probably search for months before finding an opportunity that seems to check all the boxes. You’ll investigate, do your own research, and ask the advice of friends and colleagues. The deal may feel just right. So, what’s next?
It’s time to take a step back and evaluate. You can never be sure that what you think you’re going to get in a deal is truly what you will get. Brokers and sellers are trying to make a buck just like you are, and they will go through some surprising lengths to try to convince you that their company is worth every penny. That’s where a Quality of Earnings report comes in. It will help you make a better deal and potentially save you millions.
What is a Quality of Earnings?
A Quality of Earnings report is a comprehensive package of due diligence information that you need before making a deal. It includes vital financial metrics that provide acquisition entrepreneurs with insight into a target company’s past dealings, current operations, and future opportunities for success. It will compare how a company is representing itself with what can actually be found in that company’s financials. Those two stories are different more often than you might think.
What You Can Learn from Quality of Earnings
A company’s Quality of Earnings is determined by identifying and removing any accounting trickery or irregularities that might misrepresent a company’s actual or normalized performance and cash flow. These irregularities might result from accounting choices, the business climate, or management decisions. They are not repeatable or sustainable over time, so they should not be a metric used to judge the profitability of a company moving forward. Quality of Earnings is established by calculating the percentage of income that is a direct result of higher sales and lower costs--and no other source.
A Quality of Earnings report will focus on a company’s income statement, but it will also drill down into the other financials to examine the condition and worth of assets on the balance sheet, consider the company’s systems of control, and inspect operations. You can expect a Quality of Earnings report to include an EBITDA with adjustments, Cash Proof, and Profit Per Product or Service.
In short, an analysis for Quality of Earnings will identify where financials don’t fully represent a business’s true ability to learn. It offers a much clearer picture of the state of the company you will be operating once your deal is done.
Why You Need a Quality of Earnings Report for Your Deal
Simply put, the financial analysis in a Quality of Earnings report--and the direction provided by due diligence experts like Guardian Due Diligence--is the information you need to confidently make an acquisition decision. It will give you peace of mind that your target company is a good investment in the long run. If a Quality of Earnings report shows that a target company has misrepresented its future ability to earn, you can use it to negotiate a more reasonable price. Or you can avoid purchasing a non-cash-flowing business altogether.
Quality of Earnings gives you the chance to take a look behind the scenes for yourself. Sellers are incentivized to represent their company as being as profitable as possible. Especially if you’re inexperienced in ETA, sellers and brokers will try every trick in the book to convince you that you’re making a great investment. I’ve seen it. (Check out my War Stories below.) A Quality of Earnings report helps you remain skeptical and allow the numbers to speak for themselves. It may even prevent you from making a multi-million-dollar mistake.
How Guardian Due Diligence is Different
Guardian Due Diligence is not your average Due Diligence provider. Unlike average CPAs who are preoccupied with how well a company has followed generally accepted accounting principles (GAAP), we focus on whether the company you want to buy is worth your money.
We ensure you’re not being duped into accepting a bad deal, and we look to the future to make sure your expected profits make sense. We have years of experience making acquisition deals ourselves, and we know how to spot a great opportunity or when something isn’t adding up. Not only can we prepare a Quality of Earnings report for you, but we can also help you read it and guide you through the full ETA process.
Still want to learn more?
I covered the Quality of Earnings topic in more depth on LinkedIn. Read it here. Here are a few more resources that might help you dive deeper into how to make a great deal.
See all the ways a deal could go south in our Due Diligence War Stories.