Quality of Earnings Report: What is it and Why is it important?

Quality of Earnings Report: What is it and Why is it important?

A quality of earnings report is a report that provides an in-depth and detailed analysis of a company’s revenues and expenses. This report is conducted by a 3rd party separate from the seller and the advisor, most commonly a CPA or accounting firm. These reports will be requested in most cases by the buyer of a company to verify the sustainability and accuracy of a company’s current and future valuation, similar to a home buyer hiring an inspector to check for any issues not listed in the seller disclosures.

Importance of a Quality of Earnings Report:

Can Help Prevent Future Price Renegotiation’s:

  • CPA firms will present your QoE in a way that explains your financials the way buyers think about them. This can help with the communication process when considering the financial and accounting aspects of a company, avoiding any misunderstandings or miscommunications.
  • A QoE will prevent any unwanted surprise to the buyer, as your financials will be an open book with precise interpretation. Without this, a buyer might feel the need to renegotiate as the value may have been inaccurate in their head.

May Shorten Deal Timeline:

Every day that a deal is under letter of intent is another day something could change in your business or in the mind of the buyer. A QoE can shorten post letter of intent delay or eliminate it altogether.

  • It is uncommon for buyers to enact drafting closing documents until the QoE is complete, as the risk of uncovering unknown financials could jeopardize the deal.
  • Close to 40% of private equity deals in the last five years have taken 15 or more weeks to close after the letter of intent due to financial due diligence issues that were unknown prior to a deep analysis of the company financials.

Positioning

  • Your investment banker is marketing and selling your company for you, and potential buyers devote their time and money to determine if your company is worth acquiring. If your pitch comes with a third-party valuation that verifies your current and future financials, potential buyers will be more likely pursue the deal and acquire your company, knowing an unbiased party has verified the facts.
  • A QoE can accurately display your company as a great opportunity for outside investors. Great opportunity for investors means stronger valuations, and a higher selling point.

Conclusion:

By conducting a quality of earnings report, companies can increase the likelihood that the financial valuation of their company is realized accurately. Accurate and high-quality positioning is key to having a successful deal close. This allows buyers to recognize the hidden value of your business and better understand your business’s competitive standing in a marketplace, while simultaneously being confident there are no surprise that would lessen the value of the deal. Some see a QoE as an unneeded expense that complicates an already complex transaction, but, a QoE can raise your companies valuation, solidify a buyer’s trust, and shorten the closing time.