10 Questions
What is the main reason audited financial statements are considered of limited use in a Quality of Earnings (Q of E) analysis?
They do not include adjustments for non-recurring events or gains.
Why might a buyer end up paying more than necessary for an acquisition if a gain from a legal settlement is not normalized in a Q of E analysis?
Because the buyer may pay a multiple of that unnormalized gain.
Which direction should adjustments to EBITDA be made when dealing with a one-time loss in a Q of E analysis?
Decrease EBITDA to reflect the loss.
How do audit programs usually determine whether an adjustment falls within the materiality threshold?
By setting a percentage threshold of net income or other metrics.
What primary component is used to calculate a Quality of Earnings (Q of E) analysis?
Net income as reported
What does Quality of Earnings (Q of E) refer to in the context of a potential acquisition?
Normalized earnings derived from adjustments to reported results.
Why is Adjusted EBITDA considered a critical element in building a valuation model for acquisitions?
Because it helps buyers understand sustainable cash flows by normalizing adjustments.
In acquisition pricing, what is typically used as the basis for determining the purchase price?
Reported earnings before interest, taxes, depreciation, and amortization (EBITDA).
What could be a consequence if a buyer does not properly analyze and adjust the reported EBITDA of a target company during an acquisition?
The buyer may pay too much, leading to lower potential returns.
What does Adjusted EBITDA represent in an acquisition context?
Sustainable run-rate of earnings after normalization adjustments.
Understand the difference between reported results and quality of earnings in potential acquisitions. Learn how a quality of earnings analysis can affect purchase price decisions and value expectations.
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