What Does Quality of Earnings Report Mean?
A quality of earnings report provides a detailed analysis of all the components of a company's revenue and expenses. These reports are frequently prepared by independent third party firms during due diligence in an acquisition. The reports are often requested by a board of directors of a strategic buyer or an investment committees of a private equity buyer. The primary objective of a quality of earnings report is to assess the sustainability and accuracy of historical earnings as well as the achievability of future projections.
Divestopedia Explains Quality of Earnings Report
The measure of quality is the degree to which earnings are generated from internally developed initiatives, as opposed to external forces. If a company has increased earnings year over year from improved cost efficiencies or sales generated from a marketing campaign, that company has a high quality of earnings. If a company's earnings are attributed to outside sources such as increasing commodity prices, this is seen as a low quality of earnings.
Quality of earnings analysis includes:
Breakdown of revenue by appropriate components, such as customers and product/service lines
Analysis of historic revenue trends
Determination of one-time expenses vs. recurring expenses
Determination of fixed vs. variable costs
Analysis of impact on both revenue and expenses due to management changes
Analysis of assumptions used in cash flow projections and scenario analysis