Quality of Earnings: What a Buyer Actually Checks

When a buyer puts a multiple on your business, they're not paying it against the profit you reported. They're paying it against the profit they think will still be there next year, once you're gone and the one-time stuff has been stripped out. Quality of earnings is the work of finding that second number, and in nearly every deal the buyer, or an accounting firm they hire, runs it on you. Understanding how it works before you sign a letter of intent beats anything you can say across the table afterward.

The gap between those two numbers is usually not fraud, or even a disagreement. It comes from the difference between how a business gets run for its owner and its tax bill, and how that same business has to look once an outsider starts pulling it apart. Closing that gap early, on your own terms, is one of the highest-return things you can do with the year before a sale.

From Reported Profit To Real Profit

You start with reported EBITDA, earnings before interest, taxes, depreciation, and amortization, which is a rough stand-in for the cash a business throws off. A starting point, and nothing more than that. The real work sits in the adjustments that turn it into a normalized number a buyer will actually underwrite. Some adjustments push the figure up and are completely fair. A founder who pays himself well above what a hired manager would cost can add the difference back, because the buyer won't be carrying that expense. A lawsuit that'll never come around again, the year the warehouse flooded, the cost of a software system the company is done buying: all of it fairly comes out of a picture of ongoing earnings.

Other adjustments are wishful, and this is where you make or lose your credibility. An add-back for a cost that actually recurs every year. Revenue booked before it was really earned. Margins propped up by one unusually good year. A sharp buyer finds these, and every one they find makes them trust the rest of your numbers a little less. The most expensive thing an aggressive presentation does isn't the one add-back that gets thrown out. It's the quiet discount the buyer then applies to every other figure you've put in front of them.