Your 2025 Quality of Earnings Report Guide

Achieve Success in 2025 with Mergers and Acquisitions: A Comprehensive Quality of Earnings Report Guide

The accuracy and reliability of financial data can make or break a major transaction. The philosophy of ‘measure twice, cut once’ also applies to Mergers and Acquisitions: ensuring the health and sustainability of your target businesses’ financials is paramount to success. At the heart of these financial evaluations lies the Quality of Earnings (QoE) report—an essential tool for buyers, investors, lenders, and other stakeholders seeking clarity on a target company’s true financial performance.

A Quality of Earnings report provides a detailed and nuanced analysis of a company’s earnings, separating recurring income streams from non-recurring gains, identifying potential red flags, and helping stakeholders make informed decisions with confidence. By analyzing the core operational performance of a business, this report uncovers a company’s true earning power and paints a more accurate picture of its financial health.

This quality of earnings report guide delves into the intricacies of QoE reports, exploring their purpose, methodologies, and critical role in M&A transactions while showcasing how CKH Group’s expertise delivers valuable insights for its clients.

What Is a Quality of Earnings (QoE) Report?

A QoE report is a detailed analysis of a company’s earnings, focusing on their sustainability and reliability. While traditional financial statements provide a snapshot of historical performance, a QoE report digs deeper, examining the components of revenue, profitability, and operational cash flows. Its goal is to separate sustainable earnings from one-time events or accounting adjustments, ensuring stakeholders have a realistic view of the company’s ongoing financial potential.

At its core, a QoE report addresses two key questions:

1. How sustainable are the company’s earnings?
2. Are there any risks or irregularities in the financial data that could impact its value?

This distinction is crucial for parties involved in M&A, particularly buyers, as it helps them evaluate whether the target company’s cash flows and profitability align with their strategic objectives and financial expectations.

How are QoE Reports Different from Financial Audits?

While both QoE reports and financial audits analyze financial data, they differ significantly in their objectives, methodologies, and applications.

1. Objective and Focus:
   • A financial audit aims to ensure compliance with accounting standards (e.g., GAAP) and verify the accuracy of financial statements for external stakeholders such as regulators, investors, or lenders. It focuses on historical data and examines whether financial reports are free from material misstatements.
   • A QoE report, on the other hand, is  transaction-specific. Its primary goal is to evaluate the quality and sustainability of earnings, identifying adjustments for non-recurring or irregular items and uncovering trends or risks that could affect future cash flow or profitability.
2. Scope of Analysis:
   • Audits take a broader view of the company’s financial statements, assessing the entirety of financial records for compliance and accuracy.
   • QoE reports are more targeted, focusing on the drivers of earnings such as revenue sources, customer concentration, recurring expenses, and adjustments for extraordinary items. This analysis often includes a detailed evaluation of adjusted EBITDA to reflect normalized profitability.
3. Audience and Application:
   • Financial audits are compliance-driven and typically serve external stakeholders, such as regulatory bodies or boards of directors.
   • QoE reports are prepared for buyers, sellers, investors, or lenders involved in a transaction. They are designed to support deal-specific decision-making, such as determining valuation, negotiating terms, or identifying risks in an acquisition.

Ultimately, a financial audit ensures a company’s financial statements are accurate and trustworthy, while a QoE report provides deeper insights into the financial realities of a business and how they may impact its future performance, making it an indispensable tool for transactional purposes.

Why Are QoE Reports Essential in M&A?

In an M&A transaction, all parties are working to assess and agree on the value of the target company. While traditional financial statements such as income statements, balance sheets, and cash flow statements are informative, they often fail to reveal the full picture. They may include non-recurring income, aggressive accounting treatments, or other anomalies that artificially inflate or obscure earnings.

Here’s where a QoE report comes into play. By offering transparency and clarity, a QoE report helps:

• Buyers determine whether the price of the transaction reflects the company’s real earning potential.
• Sellers anticipate questions and address potential concerns before negotiations.
• Investors make well-informed decisions with confidence in the company’s financial stability.

In essence, a QoE report is a safeguard against surprises, ensuring stakeholders understand the underlying drivers of financial performance and avoid costly mistakes.

7 Key Components of a Quality of Earnings Report

A well-prepared QoE report is multifaceted, addressing various elements of a company’s financial performance to provide a comprehensive picture. Below are the critical areas of focus:

1. Historical Operating Results and Trends

A QoE report starts by analyzing historical financial performance to identify key trends and anomalies. This analysis helps determine whether past earnings were driven by sustainable, operational factors or by non-recurring events, such as the sale of assets or other extraordinary gains.

• Why it matters: This ensures that stakeholders are not misled by temporary boosts in performance that may not be repeatable in the future.

2. Earnings Sustainability and Normalization

This is one of the most critical aspects of a QoE report. Normalizing earnings involves adjusting reported financials to remove non-recurring, non-operational, or unusual items that do not reflect the company’s core business activities. For example:

• One-time gains, such as the sale of a subsidiary.
• Temporary expenses, like legal settlements.
• Discretionary expenses, such as owner bonuses or personal expenses that are unlikely to recur after a change in ownership.
• Why it matters: Normalized earnings (often expressed as adjusted EBITDA) provide a clearer view of the company’s core earning potential and allow for more accurate valuation.

3. Revenue Recognition and Cash Reconciliation

The QoE report verifies that revenue is recorded accurately and in accordance with recognized accounting standards, such as ASC 606. This includes an exercise known as a “cash proof,” which involves reconciling cash received in the bank with the revenue recorded, adjusted for accounts receivable.

• Why it matters: This process ensures revenue is not overstated or prematurely recognized, preventing discrepancies that could distort the valuation of the business.

4. Review of Accounting Policies and Practices

The report examines the accounting methods used by the company, ensuring they are consistent with generally accepted accounting principles (GAAP). Areas of focus include revenue recognition policies, inventory valuation, expense recognition, and depreciation methods.

• Why it matters: Aggressive or inconsistent accounting practices can inflate earnings or obscure liabilities, creating risks for buyers and investors.

5. Working Capital Analysis

The QoE report assesses the company’s working capital needs to determine whether the business has sufficient liquidity to operate effectively. This includes evaluating accounts receivable, accounts payable, and inventory levels to identify seasonal trends or cash flow constraints, targets.

• Why it matters: Buyers often adjust the purchase price of a business based on working capital requirements. An accurate assessment ensures that buyers are prepared for any cash flow challenges post-acquisition.

6. Customer and Supplier Concentration

Customer and supplier concentration can pose significant risks for a business. The QoE report evaluates the dependency on key customers or suppliers to assess the potential impact of losing a major account or experiencing supply chain disruptions.

• Why it matters: High concentration risk may necessitate adjustments in valuation or the implementation of contingency plans.

7. Product-Line Profitability

For businesses with multiple product lines, the QoE report identifies which segments are most profitable and which may be underperforming. This analysis is crucial for strategic decision-making, especially for buyers looking to optimize operations post-acquisition.

• Why it matters: Understanding profitability by product line helps buyers focus on high-margin areas and mitigate losses from underperforming segments.

Benefits of a QoE Report in M&A Transactions

The insights provided by a QoE report empower stakeholders to make better decisions at every stage of an M&A transaction. Some key benefits include:

1. Valuation Precision: By normalizing earnings and addressing accounting anomalies, a QoE report ensures the company’s valuation reflects its true earning potential. The purchase price is often primarily determined by multiplying Adjusted EBITDA by a pre-agreed multiplier. Therefore, any changes to Adjusted EBITDA identified through the QoE analysis directly affect the business’s purchase price.
2. Risk Identification: The report highlights financial red flags, such as inconsistent revenue recognition, customer concentration risks, or unsustainable earnings.
3. Negotiation Advantage: Buyers gain a stronger position in negotiations by leveraging the detailed insights provided by the QoE report.
4. Post-Acquisition Planning: Understanding the financial realities of the target company helps buyers develop effective integration strategies and allocate resources appropriately.

CKH Group’s Expertise in Quality of Earnings Analysis

At CKH Group, we deliver a comprehensive, investor-ready Quality of Earnings (QoE) report designed to provide clear insights and facilitate successful transactions. Upon completion, our clients receive a detailed report, typically 30 pages in length, that is ready to be shared with counterparties, such as investors, lenders, or buyers, to help secure investments, loans, or finalize M&A deals.

Turnaround Time

We understand the urgency of financial transactions, which is why we pride ourselves on providing fast and efficient service. For small to mid-sized companies, CKH Group can deliver a complete QoE report within 12 to 22 business days* from the date all necessary information is received. Our experienced and well-resourced team is equipped to start immediately and tailor the timeline based on your specific needs.

For a more accurate timeframe that aligns with your business requirements, we recommend reaching out directly to discuss your project.

*Please note: The 12-22 business day timeframe is an estimate and not a contractual guarantee.

Pricing

The cost of a QoE report depends on factors such as company size, business complexity, revenue, and the quality of accounting records provided.

• Small companies with minimal complexity can expect costs starting at $12,000.
• Large firms or companies with complex operations may require a more extensive report, with costs exceeding $100,000.
• For example, a typical QoE report for a company with $1 million in unadjusted EBITDA would cost approximately $20,000*.

*Please note: These price ranges are an estimate and not a contractual guarantee- please reach out for a more accurate quote.

CKH Group also offers flexible payment terms:

• 50% upfront, which covers the cost of preparing a preliminary report.
• 50% upon delivery of the final report, with payment due within 30 days of invoicing.

If critical issues are identified in the preliminary report and the client chooses to discontinue the engagement, written notice (email accepted) must be provided to CKH Group within five business days, waiving the second payment installment.

How to Get Started

CKH Group offers a free quote within 24 hours to help you determine the cost and scope of your QoE report. To get started, simply provide details about the target company’s accounting system, along with its Balance Sheet and Profit & Loss statements for the past three years.

Contact us today at 1-770-495-9077 or email us at info@ckhgroup.com. You can also reach out through our website for more information and to receive your customized quote.

By choosing CKH Group, you’re not only gaining access to a highly experienced team but also a polished and actionable deliverable designed to empower your negotiations and ensure confidence in your transaction. Visit our Transaction Advisory Services page for more details.

Final Thoughts

A Quality of Earnings report is a vital tool for ensuring transparency, accuracy, and confidence in any M&A transaction. By providing a deeper understanding of a company’s true financial health, it empowers stakeholders to minimize risks, negotiate effectively, and achieve their strategic goals. With CKH Group’s expertise in QoE analysis, you can move forward with certainty in your financial decisions. For more information, visit our Quality of Earnings service page.

The above article only intends to provide general financial information and is based on open-source facts, it is not designed to provide specific advice or recommendations for any individual. It does not give personalized tax, financial, or other business and professional advice. Before taking any form of action, you should consult a financial professional who understands your particular situation. CKH Group will not be held liable for any harm/errors/claims arising from the articles. Whilst every effort has been taken to ensure the accuracy of the contents, we will not be held accountable for any changes that are beyond our control.