What is Included in a QoE Report: A Comprehensive Guide to Quality of Earnings Analysis

Estimated Reading Time: 12 minutes

Key Takeaways

• Understand the critical components of a Quality of Earnings (QoE) report.
• Learn the methods for calculating the working capital peg in M&A transactions.
• Differentiate between Commercial Due Diligence (CDD) and Financial Due Diligence (FDD).
• Explore sector-specific considerations and common diligence red flags.
• Discover how AI integration can optimize offshore investment advisory costs.

Table of Contents

• Understanding a QoE Report
• Key Components Typically Included in a QoE Report
• How is Working Capital Peg Calculated
• Difference Between CDD and FDD
• AI Integration in Offshore Investment Advisory

Understanding a QoE Report

A Quality of Earnings (QoE) report is an in-depth financial analysis that assesses the accuracy, sustainability, and risk profile of a company’s earnings. Unlike standard financial statements, a QoE report dives deeper to provide a more comprehensive view of a company’s financial health. Quality of Earnings Checklist

Key Components Typically Included in a QoE Report:

1. Revenue Analysis:
   • Examines revenue streams
   • Evaluates client concentration
   • Analyzes churn rates
   • Reviews pricing strategies
   • Assesses seasonality
2. Expense Analysis:
   • Reviews the structure of operating expenses
   • Identifies trends in costs
   • Flags any anomalies or volatility
3. Identification of Non-Recurring Items:
   • Adjusts for one-time transactions
   • Accounts for extraordinary gains or losses
   • Normalizes earnings by removing discretionary expenses
4. Assessment of Accounting Policies:
   • Evaluates the impact of accounting treatments on earnings quality
   • Identifies aggressive or inconsistent accounting methods
5. Working Capital Trends:
   • Analyzes the company’s day-to-day funding needs
   • Assesses implications for deal terms
6. Cash Flow Analysis:
   • Reviews sources and uses of cash
   • Focuses on actual cash generation, not just paper profits
7. Operational Risks:
   • Identifies inconsistent policies
   • Highlights internal control weaknesses
   • Flags margin volatility

These components work together to provide a comprehensive picture of a company’s financial health and earnings quality. Commercial Due Diligence Checklist Guide

How is Working Capital Peg Calculated

The working capital peg is a crucial element in many M&A transactions. It represents the agreed “target” level of working capital a business should maintain at deal closing, based on historical averages.

Significance of the Working Capital Peg:

• Ensures the buyer receives a business with sufficient liquid resources
• Protects against value erosion post-acquisition

Calculation Method:

1. Review Historical Balances: Analyze historical monthly or quarterly working capital balances.
2. Adjust for Seasonality and Trends: Modify for seasonal variations, trends, or extraordinary events that may have skewed historical data.
3. Exclude Non-Operational Items: Remove unusual or non-operational items that do not reflect ongoing business operations.
4. Average Calculation: Compute the average working capital over an agreed period, typically the past 12 months.
5. Agreement on Adjustments: Collaborate with the counterparty to agree on any necessary adjustments to the target working capital.

Importance: Accurate calculation of the working capital peg directly impacts purchase price adjustments and post-closing cash flow stability. Quality of Earnings Checklist

Difference Between CDD and FDD

Understanding the distinction between Commercial Due Diligence (CDD) and Financial Due Diligence (FDD) is crucial for comprehensive M&A analysis. Commercial Due Diligence Checklist Guide

Definitions:

• Commercial Due Diligence (CDD): Assesses market position, growth potential, and competitive risks
• Financial Due Diligence (FDD): Focuses on the financial health, historical performance, and financial projections of the target company

AI Integration in Offshore Investment Advisory

At Parsovya, we have integrated AI-enabled solutions resulting in lower operational costs, faster turnaround, and flexibility in our offerings.

• Automation of Repetitive Tasks: AI-powered automation oversees most repetitive and time-consuming tasks such as deal screening, data entry, and routine compliance checks. As per a report by Deloitte, automation will reduce human intervention, hence operational costs, by ~40-60%. Freeing human capacity results in more focus on strategic, high-value advisory roles.
• Improved Accuracy and Risk Mitigation: As per McKinsey, the use of AI results in lower error rates during due diligence and risk assessment, mitigating compliance penalties and costly mistakes. AI can reduce the margin of human error by up to 80% in financial modelling and market size estimation.
• Enhanced Deal Sourcing Efficiency: AI-driven deal sourcing platforms enable the firm’s ability to evaluate a deal four times faster. A Gartner report highlights that firms using AI-based sourcing platforms reduce sourcing costs by 50%.
• Scalable Cost Savings: Offshore advisory operations provide cost arbitrage. The integration of AI into operations strengthens this arbitrage opportunity. As per Accenture reports, investment advisory firms leveraging AI-enabled offshore operations achieve total cost savings of 50-70% compared to traditional offshore models.
• Enhanced Decision-Making: AI systems enabled with predictive analytics help advisors make faster data-backed decisions. Bain & Company states that firms using AI-driven analytics reduce decision-making timelines by up to 60%.

At Aureeos Private Limited, we have successfully integrated AI into our offshore investment advisory operations, which resulted in:

a. 50% reduction in operational costs compared to traditional offshore models.

b. Faster project turnaround with higher accuracy and consistency.

c. No minimum commitment, resulting in flexibility and scalability.

The usage of AI-driven methodologies within our consulting and advisory services offers unparalleled cost efficiency while maintaining high quality.

In a rapidly evolving financial landscape, firms harnessing the full potential of AI stand to gain substantial operational and strategic advantages. At Parsovya, we are proud to be at the forefront of the AI-powered transformation in offshore investment advisory and consulting services.

How is your firm leveraging AI to optimize advisory costs and performance? I would love to hear your insights and experiences.

FAQ

What is a Quality of Earnings (QoE) report?

A QoE report provides a detailed analysis of a company’s earnings to assess accuracy, sustainability, and potential risks.

How does a QoE report differ from standard financial statements?

Unlike standard financial statements, a QoE report offers a deeper dive into the financial health and earnings quality of a company.

Why is the working capital peg important in M&A transactions?

It ensures that the buyer receives adequate liquid resources and protects against value erosion post-acquisition.

What are the main differences between Commercial Due Diligence (CDD) and Financial Due Diligence (FDD)?

CDD focuses on market position and growth potential, while FDD concentrates on the financial health and performance of the target company.

How can AI integration reduce operational costs in offshore investment advisory?

AI automates repetitive tasks, improves accuracy, enhances deal sourcing efficiency, and scales cost savings, leading to significant reductions in operational expenses.