March 12, 2018

Lately, we have heard more conversations around the importance of quality of earnings (QoE) reports, likely due to the growing M&A activity in the region. The Association for Corporate Growth recently circulated the Citizens Bank 2018 report on Middle Market M&A Outlook, noting that 56% of sellers are currently involved in M&A activity or plan to be this year, an increase from 48% in 2017.

Business owners and deal makers sometimes question what, exactly, a QoE report is. In short, a QoE report is a detailed analysis of all the components of a company’s revenue and expenses. An analogy would be when you’re selling your home, and a home inspector comes in to verify there are no nasty surprises awaiting the buyer.

Another question we hear is about timing: when would they engage an independent CPA firm to assist with one of these studies?  Typically, we see requests for QoE reports from a commercial banker looking to finance a M&A transaction, or an investment banker looking to prep a business for a competitive auction process.

We are also seeing an increase in sell-side QoE (or pre-inspection of earnings), which enables sellers to open a competitive sales process when going to market. This pre-inspection provides additional confidence to buyers that the provided earnings numbers have been verified and normalized to exclude any extraordinary revenues and expenses that would not be sustainable as future earnings.  A stream of predictable future earnings potential is really what most buyers are investing in.

Be aware, there is no AICPA guidance on these reports, so it’s critical to have in-depth conversations with your CPA about the scope of the analysis before executing an engagement.

Zachary Scott, a respected investment bank to private companies, recently posted an article about QoE reports. The article is from the perspective of the buy-side as well as sell-side and can shed a little more light on the topic.

If you have questions or would like to discuss preparing a QoE report for your business, please contact Hillary Parker.

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