Selling a Business? Why a Quality of Earnings Report Must Be a Top Priority

November 27, 2017

If you’re selling a business, preparing a quality of earnings report should be at the top of your to-do list.

The analysis of your expenses and revenue gives potential buyers visibility into your organization and accounting practices.

A seller’s lack of preparation is one of the most common factors to sideline a deal. Don’t let it scuttle yours. Doing due diligence ahead of time boosts your credibility and helps you avoid leaving money on the table.

Conduct Sell-side Due Diligence

A quality of earnings report shows the seller’s cash flow and its true, normalized EBITDA. As a manufacturer, your cash flow has likely been affected by product recalls, R&D costs and capital investments. A detailed QoE report will take these factors into account, while recognizing that these highs and lows do not represent a typical year for your organization. Present a normalized EBITDA over a 2- to 4-year time frame, and consider any interim periods and trailing months.

Your QoE report should provide an extensive view of your organization’s expense structure, touching upon working capital and other balance sheet-related findings. Many buyers now expect manufacturers to validate earnings with exceedingly detailed information (such as figures outlining profitability and expenses by product, customer, geography and distribution channel).

By conducting this type of detailed earnings assessment, you will identify additional ways to drive value ahead of a potential deal.

Calculate Normalized EBITDA

Calculating normalized EBITDA can be subjective. The quality of your accounting principles might not align with your view of earnings quality, or the degree to which your cash or non-cash earnings can change.

In the buyer’s eyes, your normalized EBITDA earnings will serve as a baseline for determining performance expectations. Issues your organization has faced, such as legal settlements, might not represent a long-term trend. But they can be critical to your performance during a specific period. Lower quality earnings aren’t necessarily a strike against you, but they will indicate that your earnings fluctuate, which translates to higher risk for buyers.

Your organization’s value is measured directly against your normalized EBITDA. Before engaging with prospective buyers, work with a transaction advisor to identify opportunities to boost the reported EBITDA, or determine adjustments, to ensure the best (and most accurate) story is told.

Facilitate Buy-side Due Diligence

In today’s data-driven world, prospective buyers demand more information than ever. Ensure all information is well-packaged, and get necessary customer and supplier consents.

Check on the health of your business, and understand what your capitalization table looks like. Clean up founder issues or promises of equity grants.

During a transaction, buyers will likely challenge a lot of the assumptions in your EBITDA. Check each of these:

  • General organization documents (like trade agreements with suppliers)
  • Environmental concerns (such as your firm’s adherence to chemical regulations)
  • Accounting and employment issues

Depending on how material these items are, you might dig into your story more. By working with an advisor to create a detailed quality of earnings report, you will arm yourself to fight back and assert your value.

For more content on selling a business, read Tell a Good Story with Narrative and Numbers.

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