A P&L statement tells you what happened. A Quality of Earning (QofE) report tells you whether it’s going to happen again. For sellers preparing for a transaction, that could be the difference between defending your asking price and watching it get chipped away in due diligence. 

What Is a Quality of Earnings Report?

A Quality of Earnings (QofE) report is a financial analysis that evaluates whether or not a company’s earnings are sustainable, recurring, and accurately presented.

If you’d like to learn more about QofE and how this could impact an M&A deal, contact our team at OXC Advisors. 

Key Areas a QofE Report Covers

While a QofE covers a variety of areas, three components tend to have the most impact on deal pricing and negotiation. 

EBITDA Add-Backs

A QofE identifies and defends legitimate add-backs to EBITDA. Expenses that inflate cost but will not recur under new ownership. 

Examples of such expenses could include PP load-related adjustments, the owner’s personal expenses run through the business, one-time legal fees, and above-market compensation to family members. 

Each and every add-back must be clearly documented and defensible. Poorly justified add-backs will quickly lose credibility with the buyer’s diligence team. 

Working Capital Analysis

The QofE also establishes a normalized working capital baseline. This directly informs the net working capital (NWC) peg in the purchase agreement. Such analysis ensures that neither party is left blindsided to seasonable or temporary swings in receivables and payables at closing. 

The EBITDA Bridge

The EBITDA bridge is one of the clearest deliverables in QofE. It provides an overview of how reported net income adjusts to the normalized EBITDA figure that drives the valuation multiple. Each adjustment, whether from add-backs or non-recurring revenue, is itemized, creating a clear path from the P&L number to the number the deal is actually priced on. 

Why Sellers Should Commission a QofE

A seller-side QofE should be looked at as an additional “cost”. It should be looked at as an insurance policy. It allows you to identify and resolve issues before buyers find them, defend your add-backs with validation, and set the working capital peg on your teams. 

Without one, sellers walk into negotiations relying on a standard P&L that screams “discount” for buyers. With one, though, sellers can control the earnings narrative from the start, protecting their target sale price. 

If you need help selling or acquiring a business, feel free to contact OCX Advisors. We’re an LMM M&A advisory firm that can help you acquire, sell, and scale your company in a way that suits you best.