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What is a quality of earnings analysis?

A quality of earnings analysis (“QoE”) is one aspect of financial due diligence, which would be performed when a buyer is considering purchasing another company. A QoE analysis typically presents three full 12 month periods, which in many cases is the last 2 audited periods and the last twelve months (“LTM”).

The starting point is reported EBITDA, and then there would be adjustments to EBITDA that would be proposed by Management (Seller) and the Buyer. These adjustments can include:

1) Non-cash items (e.g. share based compensation)

2) Non-recurring items (e.g. transaction, legal, consulting, etc.)

3) Normalizations (e.g. normalize owners’ compensation or rent to market rates)

4) Pro form adjustments (e.g. recent contracts or cost saving initiative)

5) Planned synergies (revenue and expense synergies)

The end goal is to present run-rate EBITDA for the business that can be used to analyze valuations of the business and calculate the EBITDA multiple on the purchase price. Additionally, the QoE analysis can be used to create a pro forma adjusted income statement that the Buyer can in their financial model.


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