As part of the financial due diligence in buying a company, buyers will sometimes hire a third party to perform a quality of earnings analysis. More recently, it’s becoming common for the seller to hire someone to issue a quality of earnings report as well. If you’re buying or investing, it’s called a “buy-side quality of earnings report.”If you’re selling the business, it’s a “sell-side quality of earnings report.”So why would a seller want a quality of earnings report? There are several reasons: 1. To increase the purchase price2. To increase the chance of the deal closing3. To reduce the risk of litigationLet’s start with the purchase price. If the seller gets a QoE report that shows the company has clean accounting and no issues, this will reduce uncertainty among potential buyers. Less uncertainty means more bidders, and more bidders means a higher purchase price. Also: the main purpose of a QoE report is to adjust EBITDA. But do you think the buy-side QoE team is going to be arguing for lots of adjustments to increase EBITDA? No, that would cause the buyer to have to pay more. A sell-side QoE team can thus argue for upward adjustments to EBITDA where they are appropriate. Next, let’s talk about the deal closing. A sell-side QoE can uncover any accounting problems so they can be ironed out before the company starts shopping itself to buyers. The last thing you want is for a deal to fall apart during the due diligence phase because the buyer discovers the EBITDA has been significantly overstated. A sell-side QoE report will also reduce the time it takes for the deal to close, because the seller will already have all the contracts and other documents in place when it comes time for the buy-side QoE. The selling company’s management will also be prepared for the QoE, having already gone through the process once. The buy-side QoE will thus go more quickly and the deal can close faster.Finally, let’s discuss litigation. A sell-side QoE team can help with negotiations and drafting the purchase agreement. Lawsuits can occur after a deal if there’s a disagreement about how much working capital the company would need. The sell-side QoE team can help the seller’s legal team foresee such issues and draft a clear, ironclad purchase agreement. — Edspira is the creation of Michael McLaughlin, who went from teenage homelessness to a PhD. Edspira’s mission is to make a high-quality business education accessible to all people.— SUBSCRIBE FOR A FREE 53-PAGE GUIDE TO THE FINANCIAL STATEMENTS* http://eepurl.com/dIaa5z— LISTEN TO THE SCHEME PODCAST* Apple Podcasts: https://podcasts.apple.com/us/podcast/scheme/id1522352725* Spotify: https://open.spotify.com/show/4WaNTqVFxISHlgcSWNT1kc* Website: https://www.edspira.com/podcast-2/ — CONNECT WITH EDSPIRA* Website: https://www.edspira.com* Blog: https://www.edspira.com/blog/ * Facebook page: https://www.facebook.com/Edspira* Facebook group: https://www.facebook.com/groups/561316587899818//* Reddit: https://www.reddit.com/r/edspira* LinkedIn: https://www.linkedin.com/company/edspira— CONNECT WITH MICHAEL* Website: http://www.MichaelMcLaughlin.com* LinkedIn: https://www.linkedin.com/in/prof-michael-mclaughlin * Twitter: https://www.twitter.com/Prof_McLaughlin* Facebook: https://www.facebook.com/prof.michael.mclaughlin* Snapchat: https://www.snapchat.com/add/prof_mclaughlin*Twitch: https://twitch.tv/prof_mclaughlin * Instagram: https://www.instagram.com/prof_mclaughlin*TikTok: https://www.tiktok.com/@prof_mclaughlin

The purpose of the quality of earnings analysis is to make adjustments to the seller’s EBITDA so the buyer has a full understanding of the company’s financial performance.A variety of adjustments can be made to EBITDA, but they can be grouped into 3 categories:1. Nonrecurring/nonoperational adjustments2. Pro forma/normalizing adjustments3. Accounting adjustmentsNonrecurring (or nonoperational) adjustments remove the effects of one-time gains or losses. This could include:• Asset impairments• Gains or losses from the disposal of fixed assets• Restructuring costs (e.g., lease termination fees, severance costs)Pro forma/normalizing adjustments update historical revenues/expenses to reflect recent changes. For example, what if the cost of rent, salaries, or raw materials recently increased? This wouldn’t be reflected in historical financial statements since accounting is backward-looking, but these changes would affect the company’s profit going forward. Thus, EBITDA should be adjusted to reflect these higher costs.Accounting adjustments can occur for a variety of reasons. If the company is a small firm, it’s possible they use cash-basis accounting. Thus, the seller’s EBITDA can be adjusted to be consistent with accrual accounting. Accounting adjustments might also need to be made if the company incorrectly applied accounting principles, perhaps by capitalizing costs that should have been expensed or improperly recognizing revenue to inflate profits. A good QoE analysis will catch these issues and adjust the seller’s EBITDA accordingly. — Edspira is the creation of Michael McLaughlin, who went from teenage homelessness to a PhD. Edspira’s mission is to make a high-quality business education accessible to all people.— SUBSCRIBE FOR A FREE 53-PAGE GUIDE TO THE FINANCIAL STATEMENTS* http://eepurl.com/dIaa5z— LISTEN TO THE SCHEME PODCAST* Apple Podcasts: https://podcasts.apple.com/us/podcast/scheme/id1522352725* Spotify: https://open.spotify.com/show/4WaNTqVFxISHlgcSWNT1kc* Website: https://www.edspira.com/podcast-2/ — CONNECT WITH EDSPIRA* Website: https://www.edspira.com* Blog: https://www.edspira.com/blog/ * Facebook page: https://www.facebook.com/Edspira* Facebook group: https://www.facebook.com/groups/561316587899818//* Reddit: https://www.reddit.com/r/edspira* LinkedIn: https://www.linkedin.com/company/edspira— CONNECT WITH MICHAEL* Website: http://www.MichaelMcLaughlin.com* LinkedIn: https://www.linkedin.com/in/prof-michael-mclaughlin * Twitter: https://www.twitter.com/Prof_McLaughlin* Facebook: https://www.facebook.com/prof.michael.mclaughlin* Snapchat: https://www.snapchat.com/add/prof_mclaughlin*Twitch: https://twitch.tv/prof_mclaughlin * Instagram: https://www.instagram.com/prof_mclaughlin*TikTok: https://www.tiktok.com/@prof_mclaughlin