In the world of mergers and acquisitions, the quality of earnings (QoE) can make or break a deal. Quality of earnings looks into a company’s financial background to determine its future earning potential. Both buyers and sellers must have a reliable picture of a company’s financial health to ensure a smooth process and maximize potential for a successful outcome.
Before getting to the due diligence process, it’s essential to complete some housekeeping tasks in the accounting function to streamline the process for everyone. By completing these items in advance, the easier the engagement will be for all parties.
1. RECONCILING ACCOUNTS AND BANK STATEMENTS
Reconciling accounts is a critical step towards a seamless transaction, helping identify discrepancies and errors to ensure the financial data presented during a transaction is correct and reliable. This process involves reviewing financial records and subledgers, such as bank statements, agings, and detail listings, to ensure they align with what’s recorded on the company’s financial statements.
Accurate and up-to-date bank reconciliations are a cornerstone of QoE housekeeping. Bank reconciliations assist with developing accurate cash flow, liquidity and financial stability. Sellers should maintain detailed and accurate records making them readily available for potential buyers to review.
Maintaining bank statements and reconciliations may also help identify any unusual transactions or discrepancies that need to be addressed before entering into a transaction. Buyers will scrutinize these statements to validate the company’s financial performance, making it essential to keep this housekeeping task a top priority.
2. DOCUMENTING INTERNAL CONTROL PROCESSES
A well-documented internal control environment is another essential item for an effortless transaction. Internal control environments consist of policies and procedures a company uses to ensure the accuracy and integrity of its financial data. Make sure these are well-documented by preparing a document that lays out the responsibilities of everyone involved. That way, there are no questions about who reviews what, or who handles a specific task.
3. CONVERTING FROM A CASH BASIS TO AN ACCRUAL BASIS
If your business currently operates on a cash basis, converting to an accrual basis can help streamline the transaction practice. The accrual basis of accounting is an acceptable method under the Generally Accepted Accounting Principles (GAAP). Reporting under the accrual basis matches revenue to expenses, instead of recording activity when cash changes hands (or in many cases when an invoice is generated). Making the switch to accrual basis helps to ensure that financial statements offer a detailed view of your organization’s financial standing and operations. It also allows potential buyers to compare the financial results of your company other companies and trends in the market.
4. HIGHLIGHTING ADD-BACKS TO EBITDA
Add-backs are adjustments made to EBITDA to account for non-recurring, discretionary or similar expenses that may not be relevant to the company’s ongoing operations, such as non-market owner salaries and rent payments or unusual professional fees. Sellers should maintain an exact record of add-backs and provide detailed explanations.
Maintaining the quality of earnings is paramount for a successful and straightforward transaction in the world of mergers and acquisitions. By working through this checklist, sellers can provide potential buyers with a more precise view of the company’s economic well-being, fostering trust and confidence throughout the transaction process.
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RKL’s Transaction Advisory team can help your organization work through these tasks to prepare you for your next transaction
