UNDERSTANDING THE QUALITY OF EARNINGS IN 5 MINUTES - EVER WONDERED WHAT'S INSIDE?
I've been asked 20+ times this month, "What is inside a Quality of Earnings?". Have 5 minutes?....I'll tell you.
What are the main sections of a Quality of Earnings?
1) EBITDA and Adjustments
2) Proof of Cash and validation that the cash flow is real
3) Analysis of Revenue and Cost Drivers - the basis for your projections and how you'll get ROI
What's included in each section:
Area 1: EBITDA and the adjustments (EBITDA is the same as profit)
- Start with unadjusted EBITDA
- Look at the EBITDA adjustments and be sure they are true expenses you will not need to pay going forward
- Total adjustments should be a reasonable percentage of adjusted EBITDA. Look for large areas of difference that may still make sense (like owner salary for instance)
- That's how the experts do it
Area 2: Cash Proof (building the financials out of the bank statements)
- Bank's version of revenue
- Bank's version of costs
- Banks version of profit
- A good deal has very small differences and they are especially small in the previous year leading up to the acquisition
Area 3: Analysis of Revenue and Cost Drivers - the basis for your projections and how you'll get ROI
- Consistency of margins as the business grows
- Look for any known expenses that you'd expect to see - and make sure they are represented.
- This is where your industry knowledge comes into play but it's important to analyze the historical trends
Now in a 5 minute breakdown I have summarized and missed some things that a QoE does. But I hope in this 5 minute breakdown, people who never have read the report now know what's inside and a bit more on why it's important to get on on your deal.
In the comments, tell me what I missed?
Want to know how the experts read through a QoE: I have four, 1-minute videos explaining each of the three sections. No intro, no marketing pitch, just value for you.. If you'd like the videos - please DM me and I'll share.