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.
You might also be interested in...
What is the relationship between volume and variable cost per unit?
If the variable cost per unit remains fixed, then any increase or decrease in unit volume will result in an increase or decrease in total variable costs for a business. For example, if variable cost per unit was steady at $5, then if unit volume were to increase from 100 to 200 units, then total […]
How can variable sampling risk impact the efficiency or effectiveness of an audit?
Audit risk is comprised of inherent risk, control risk, and detection risk. The level of substantive testing that the audit performs is based on detection risk, which is set after the audit team assesses inherent risk and control risk. Variable Sampling – Substantive Testing When the audit team is performing substantive testing, they will use […]
What happens if control risk is set too high or too low?
Audit risk is comprised of inherent risk, control risk, and detection risk. Depending on how the audit team assesses control risk, they would set detection risk, which determines the level of substantive testing that should be performed. To assess control risk, the audit team would use attribute sampling to determine if the controls were operating […]