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7 Critical Issues Related to Quality of Earnings

7 Critical Issues Related to Quality of Earnings

Bill Wiersema

Financial Due Diligence | Accounting

The importance of a Quality of Earnings (QoE) report is often underestimated, and there is more art than just science to it. Bill Wiersema returns to M&A Talk to discuss the top seven issues today in financial due diligence. How COVID has impacted earnings, the biggest change in GAAP rules in the past 70 years, the value that can be added by having a QoE report, key issues related to diligence, new lease accounting rules, and real-life examples – all wrapped up in an engaging episode that will have you enjoying this discussion of financials.

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Guest Profile

Bill Wiersema is an Audit Principal with Miller, Cooper & Co., specializing in M&A financial due diligence, and author of several books on finance. His experience has a global reach as he has assisted international entities with their locations in Asia, Europe, and Latin America. His clients include middle-market companies, private equity groups, and financial institutions. Bill has extensive experience in assisting sellers across diverse industries in preparing for sale, conducting due diligence, creating business plans and projections, assisting in negotiations with financial institutions, and advising clients on post-acquisition financial issues.

Bill is a frequent speaker, presenter, and contributor for various organizations and publications, including the Alliance of M&A Advisors (AM&AA) and the Chicago Bar Association. He is a graduate of Economics from Northwestern University, and before joining Miller, Cooper, Co., he was a Graduate Fellow in Accounting at the University of Illinois. Bill serves on the Midwest Chapter Committee of the AM&AA. He is a member and has served on the Board of Directors of the Association for Corporate Growth (ACG) and the Midwest Business Brokers and Intermediaries. He is a member of the AICPA and the ICPAS.

Topics Covered

  • Top Issues Today in Quality of Earnings: Issue #1 EBITDAC (Earnings Before Interest, Taxes, Depreciation, Amortization & Coronavirus) [6:20]
    • What is the difference between EBITDA and EBITDAC? [7:00]
    • What is the difference between non-recurring and non-operating expenses? [10:00]
    • What percentage of the QoE is related to confirming the adjustments? [11:26]
    • Net income vs. net operating income in calculating EBITDA [14:01]
  • Top Issues Today in Quality of Earnings: Issue #2 Owner Compensation [16:17]
    • What is Qualified Business Income Deduction? [17:14]
    • Owner compensation [19:47]
    • How do you deal with resistant owners/sellers? [25:00]
  • Top Issues Today in Quality of Earnings: Issue #3 Revenue Recognition: Over Time [26:02]
    • What is the most significant change to GAAP in the last 70 years? [27:05] 
    • What are the upsides and downsides of having your CPA do the QoE? [34:49]
    • Does the recognition of expenses remain the same in QoE? [35:46]
    • What prompted the changes in GAAP? [36:51]
  • Top Issues Today in Quality of Earnings: Issue #4 Inventory Holding Gain [40:39]
    • A brief definition of the concept and accounting formula for cost of goods sold [41:20]
    • Why is the ending inventory number critical in establishing EBITDA, and why is this important in an inflationary environment? [42:20] 
    • How do you get an accurate historical inventory count? [46:07]
    • Is it valuable for a seller to have an annual QoE before starting the sales process? [48:10]
  • Top Issues Today in Quality of Earnings: Issue #5 State and Local Tax (SALT) [51:50]
    • Supreme Court case South Dakota vs. Wayfair, June 2018 and the Doctrine of Economic Nexus [52:05]
    • Does SALT apply to a stock sale? [57:45]
  • Top Issues Today in Quality of Earnings: Issue #6 Normalize Pandemic Effects [1:01:00]
    • What are pro forma adjustments? [1:01:05]
    • Normalizing pandemic effects [1:03:26]
  • Top Issues Today in Quality of Earnings: Issue #7 Discounted Cash Flow (DCF) [1:05:26]
    • Why is Discounted Cash Flow an issue now? [1:05:37]
    • How do the QoE and DCF work together? [1:10:34]
  • Bonus Topic: New Lease Accounting [1:16:35]

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