Prepare Early For Due Diligence

What can you do to determine the issues that might affect a buyer’s valuation of your business and be prepared to address them since outsiders won’t have the same deep understanding and knowledge of your business as you do.

Due diligence involves a close look at your business. When looking to buy or invest in a company, investors will carefully scrutinize it from top to bottom before committing. It’s best for you to complete your own due diligence before approaching the market. Due diligence initiated by an owner is commonly referred to as “sell-side” due diligence.

Start by gathering all relevant data. Business owners who are organized and can answer buyers’ questions quickly and confidently have much higher odds of getting the sale price they want and closing the deal. Completing sell-side due diligence helps identify areas that have value implications and issues to address before approaching potential investors.

Due diligence includes a look at your company’s quality of earnings.

The quality of earnings report will highlight your company’s strengths and identify potential deal breakers. It’s best to prepare and complete the report as part of your sell-side due diligence work.

Typically, the quality of earnings report is prepared by an independent accounting firm that looks at the company’s historical financial and operating data. Their objective is to provide an unbiased evaluation of financial operations. The report focuses on economic earnings, not the balance sheet. It is not an audit.

What Is Considered Quality Earnings?

Per Deloitte, the quality of earnings comprises:

“The degree to which earnings are cash or noncash, recurring or nonrecurring, and based on precise measurements or estimates that are subject to change. Evaluating the quality of earnings will help the financial statement user make judgments about the ‘certainty’ of current income and the prospects for the future.”

Buyers and Investors are looking for high-quality earnings that are sustainable and reflect free cash flow. These are earnings that are repeatable over a series of reporting periods. Lower-quality earnings aren’t necessarily bad; however, they reflect that the earnings are higher risk and less certain.