Quality of Earnings reports

Buy-side? Sell-side? Either way, you need to know.

In selling a privately held business, sellers make representations about enterprise value based on the company’s financial statements. Yet recorded income does not always accurately measure the financial performance of a business.

If a company reports large net income but also is recording negative operating cash flow, for example, the entity may not be as sound as it appears. Buyers seek assurances that cash flow and the sources of income are reliable and will continue.

Quality of eEarnings: Beyond the financial statements

A Quality of Earnings (QoE) study is an important method for valuing a closely held business that has come up for sale.

Buyers request QoE reports to assess whether a proposed acquisition will continue to operate profitably in line with the seller’s representations, and in particular to gauge the stability of future cash flows. They assess how a company accumulates its revenues — such as cash or non-cash, recurring or nonrecurring.

A Quality of Earnings study is not an audit. Instead, it incorporates metrics used to determine earnings and evaluate the sustainability of income. And while a QoE study is a routine step in transaction due diligence, it also helps company executives evaluate the performance of their own business, including in advance of a proposed tender, ownership transition, recapitalization or buyout.