Learn Why You May Be Using a Quality of Earnings Report Incorrectly
A company’s financial history tells a story. One that unveils its day-to-day operations through numbers: what is annual revenue? What is the company’s profit? How does it perform compared to its competitors? However, like any story, a company’s financial history can be easily manipulated into different tales depending on who you hear it from.
Investing Answers finds that a Quality of Earnings (Q of E) Report tells an objective account: “A company that is genuinely doing well will show increases in sales and steady changes in expenses rather than rely on accounting changes to artificially pump things up. Regardless, the temptation to rely on accounting methods to improve earnings is widespread and is especially strong for companies that have cyclical sales and profits.”
A complex report to gather, the Q of E Report provides a detailed analysis of all significant components of a company’s revenue and expenses. Unlike an audit or review, the Q of E Report focuses on the ongoing normalized operations of the company; this insight helps assess the sustainability and accuracy of historical earnings and the achievability of future projections.
How to Use a Quality of Earnings Report
The goal of a Quality of Earnings Report is to present facts and analysis to help the end user gather conclusions. It is NOT an audit or review.
It features everything a buyer needs to know about a company to determine if it’s a worthy investment, and everything a seller needs to accurately (and honestly) present their company’s historical earnings and achievability of future projections. According to Seeking Alpha, a Q of E Report, “won’t tell you if the company is undervalued, if it’s experiencing growth, if its cash flow is strong or if it has too much debt. It will tell you whether you can trust the earnings presented by the company [and] if the earnings are the result of a fundamental advantage that will persist over time or if they are temporary or possibly the result of manipulation.”
Why Get a Quality of Earnings Report?
Aside from the insight it gives you into a company’s earnings quality (stock, sales, steady changes in expenses), a Q of E Report can be utilized in many ways, including:
- Merger & Acquisition Transactions
- Sell-side and buy-side due diligence
- Final purchase price negotiations
- By a seller to highlight financial strengths and provide an independent and objective analysis of the company
- By private equity firms
How to Use a Q of E Report to Your Advantage
Companies may use a Q of E Report to compare its performance against another or determine whether it is making a sound investment. This report serves as a “professional financial analysis” that identifies any inaccuracies or trends which can help inform a business strategy moving forward. In addition to an audit or a review, a Q of E report that is assembled appropriately from a GAAP perspective and analytical perspective will tell you the most honest truth about a company.
For more information on Quality of Earnings or to set up a review, please contact our team.
About the Authors
BRAD HERMES, CPA
Brad Hermes, CPA, partner for Sikich accounting services, has experience serving private, closely-held business and their owners. His service approach focuses on understanding and listening to management’s needs in order to provide timely and effective service with a focus on increasing efficiency within financial reporting and analysis.
BRAD NETZEL, CPA
Brad Netzel, CPA, is a partner on Sikich’s accounting and audit team and has over 18 years of experience serving companies in the manufacturing and agriculture industries. His service approach focuses on establishing a strong collaborative environment with ownership and management in order to deliver timely and effective service with a focus on helping owners meet both their business and personal goals.