A buyer is not paying a multiple of last year's profit. They are paying a multiple of what they believe will still be there next year, under their ownership — and those are rarely the same number.
Every transaction starts with a number that looks solid: last year's profit. It is audited, it is in the accounts, and both sides can see it. Then diligence begins, and it turns out a portion of that profit will not repeat — and the multiple was only ever meant to apply to the part that will.
A quality of earnings review is the work of separating those two. It is not an audit, and it does not question whether the reported figure is correct. It asks a different question: of this profit, how much is the ongoing earning power of the business under a new owner?
The adjusted earnings bridge
The output is a bridge, walking from reported profit to an adjusted, sustainable figure, with every step named and quantified. It matters that it is a bridge rather than a single number, because each step is negotiable and each has to be defended individually.
- One-off and non-recurring items
A legal settlement, a relocation, a bad debt from a customer who no longer exists, the cost of an aborted transaction. Real costs that happened, and will not happen again.
- Out-of-period items
Revenue or cost recognised in the wrong year. These do not change the total across two years, but they change the year being priced.
- Owner and related-party costs
Remuneration above or below market, family members on payroll, rent to a connected party at other than market rate, personal expenses run through the business. Normalised to what a new owner would actually pay.
- Accounting policy choices
Where a policy is permissible but sits at one end of the range — provisioning, capitalisation, revenue timing. Not wrong, but worth surfacing, because a buyer will apply their own.
- Run-rate adjustments
A price rise, a contract won or lost, a headcount change late in the year. Annualised, so the earnings reflect the business as it now stands rather than as it averaged.
Each adjustment is an argument, not a fact. The ones that survive are the ones with a document behind them.
Where sellers lose money
Almost always by being unprepared rather than by being wrong. A buyer's adviser raises an adjustment late in the process, the seller has no evidence to hand, and the cost of arguing it — in time, in momentum, in the risk of the deal cooling — exceeds the value of the adjustment. So it gets conceded.
The same adjustment, identified by the seller in advance with the supporting document attached, is usually either accepted or dropped. Nothing about the underlying business has changed. Only who found it first, and whether there was an answer ready.
- Owner remuneration normalised without a market benchmark to point at.
- Related-party rent adjusted with no independent view of market rate.
- A one-off cost the seller calls non-recurring and the buyer calls a cost of doing business.
- Revenue concentration treated as a risk discount rather than an earnings adjustment.
- Working capital movements confused with profit, which they are not.
Revenue quality, not only revenue
Earnings quality is partly about the revenue underneath. Two businesses with identical profit can be worth materially different multiples depending on where that revenue comes from and how likely it is to continue.
So the review looks at concentration — how much depends on the largest few customers — at contract length and renewal behaviour, at whether growth came from volume, price or a one-off, and at whether revenue is recognised on a basis that would survive a change of policy. A business earning the same profit from a hundred repeat customers is a different asset from one earning it from three.
Why it is worth doing on the sell side
Buyers commission this work as a matter of course. Sellers often do not, and then meet the findings for the first time in someone else's report, framed in the way most useful to the other party.
Commissioning it early means the adjustments are identified while there is time to gather evidence, correct what can be corrected, and decide which arguments are worth having. It also produces the analysis the buyer will ask for anyway, which shortens diligence — and a shorter diligence is a deal with less time to fall apart.
What it is not
It is not an audit and it carries no opinion. An audit asks whether historical statements are true and fair; this asks what the business sustainably earns. It is commissioned by a party to the transaction rather than by the company, it is forward-looking, and it has no statutory standing.
Where a transaction needs a statutory valuation, a prescribed certification or an audit opinion, that is performed and signed by an independently engaged licensed professional. Our work is the analysis, the evidence and the argument behind the number.