Quality of Earnings 101 - Reading the Numbers Behind the Numbers
A quality of earnings analysis, an audit and a valuation are three engagements that get confused constantly, and only one of them is built to price earnings. An audit opines on whether the statements are fairly stated. A valuation estimates value. A QoE asks a narrower and more commercial question: how real, repeatable and reliable are the earnings the target actually reports? It expresses no opinion, offers no assurance and makes no recommendation to transact — which is precisely why it is the document buyers negotiate from.The mechanism is arithmetic, and it is unforgiving. Price is almost always a multiple of EBITDA, so a $200,000 earnings adjustment at a 6x multiple moves enterprise value by $1.2 million. The work runs from reported EBITDA to adjusted EBITDA to pro forma: owner compensation normalized to market, non-recurring professional and transaction fees, shareholder personal expenses, discontinued lines, cut-off errors, related-party transactions repriced. Working capital and net debt then move cash at closing just as directly — equity value is adjusted EBITDA times the multiple, less net debt, plus or minus the gap between delivered working capital and the target peg.At Citadelle Capital, we apply this lens to our portfolio companies and to the investments we evaluate, which means we see it from both sides of the table. A QoE is effectively non-negotiable for an owner-managed business without audited statements, for a carve-out, or wherever EBITDA sits below $10 million and add-backs drive most of the value. And the difference between a three-week diligence and a three-month one is almost always the seller's preparation: any add-back that cannot be traced to a source document is an assertion, not a fact, and it will be treated as one.