Quality of Earnings vs Business Valuation for Buying a Business
Buying a business is complicated and daunting. In addition, determining what business to buy and performing the necessary due diligence can be a lengthy and costly processes. Two of the most common financial analyses are a quality of earnings analysis and a business valuation for buying a business. While both of these assessments contain important information, the two are not interchangeable. In this report, we discuss the similarities and differences between a quality of earnings and a business valuation for buying a business.
Peak Business Valuation, business appraiser, regularly values businesses for transaction purposes. If you are looking to buy a business, Peak Business Valuation can provide a comprehensive business valuation for you. Additionally, Amplēo (Peak’s parent company) can provide you with a professional quality of earnings report that provides vital information about the business. Schedule a free consultation below to get started today!
What is a Quality of Earnings Report?
A quality of earnings report is a financial analysis of the historical revenues of a business. This assessment helps determine the accuracy and sustainability of a business’s earnings. This includes an analysis of the sources of the business’s earnings and the recurring nature of those sources. A quality of earnings report also includes an analysis of the company’s expenditures to determine their necessity for typical business operations. An often overlooked element of a quality of earnings report is an analysis of the balance sheets. The “quality” reflects when earnings are high, medium, or low in reliability. “Earnings” represent the cash the business generates, with EBITDA serving as a common proxy.
What is a Business Valuation for Buying a Business?
A business valuation for buying a business is a financial analysis to determine the fair market value of a company. Professional business appraisers, such as those at Peak Business Valuation, determine the fair market value by using a combination of valuation approaches. The most common valuation approaches are found within the income approach, the market approach, and the asset approach. An expert valuation analyst tailors a valuation by using the approaches that are most appropriate for the subject business.
Key Differences Between Quality of Earnings and Business Valuation
While both quality of earnings reports and business valuations include in-depth financial analysis, there are many unique aspects of each. Among the main differences are the focus of each report, the use of projections, and the income source analyses.
Primary Focus
The primary purpose of a business valuation for buying a business is to determine the fair market value of the business. A quality of earnings analysis does not attempt to determine the fair market value of a business, but to assess the sustainability of past performance. While each report conducts similar financial analyses, the underlying purpose of each report is one of the key differences between the two.
Projections
A quality of earnings report looks to determine whether the past performance of a business can be expected in the future. In this process, a financial analyst focuses their analysis on the historical data of a business. Furthermore, business valuations frequently forecast future earnings and expenses to create future expectations and conclude the fair market value. Although this analysis is based on past data, it focuses more on future financial data.
Income Source Analysis
A key element of a quality of earnings report is an income source analysis. An income source analysis assesses the company’s earnings history and analyzes the sustainability of those sources. As such, an income source analysis can help business owners decipher when the volume of revenue sources is too much or too little. Additionally, a business valuation may account for the risk involved in customer concentration, but it conducts minimal analysis into a business’s income sources.
Peak Business Valuation, business appraiser, is happy to answer any questions you may have about a quality of earnings or a business valuation for buying a business. Our team of experts is ready to help and increase your understanding. Additionally, we can provide you with a professional business valuation for buying a business. Schedule a free consultation below to get started today!
Similarities in Quality of Earnings and Business Valuation
While there are many differences between the quality of earnings and a business appraisal, there is also significant overlap. Both reports conduct an in-depth analysis of a business and its financial state. Some of the main similarities are the financial statement analysis, normalization, adjustments, and purchase price impact.
Financial Statement Analysis
In both a quality of earnings and a business valuation, valuation experts conduct a comprehensive analysis of the company’s financial statements. This includes analyzing income statements, balance sheets, and, in the case of quality of earnings reports, cash flow statements. The financial statement analysis is a key element of both reports. When conducting this analysis, valuation experts can assess and clearly report the financial health of a business.
Normalization and Adjustments
After an initial financial analysis is completed, both a quality of earnings and a business valuation may include various normalizations and adjustments. These adjustments are to account for non-business revenues or expenses primarily. This can include personal discretionary expenses in the business or income from company-owned real estate. This ‘normalizes’ the financial statements to what a new owner may consider typical business operations.
Purchase Price Impact
Both a quality of earnings and a business valuation can have a significant impact on the purchase price. As part of the normalization and adjustments to the business financials, each report determines the adjusted EBITDA of the business. In a business valuation, the adjusted EBITDA is then used further to conclude the fair market value of the business. Using either report, the EBITDA of a company is frequently used to determine the purchase price.
Conclusion
If you are interested in buying a business, it is important to obtain a quality of earnings and/or business valuation report. Both of these reports contain vital information that you may not be able to identify simply by looking over the financial statements. Understanding the difference between a quality of earnings report and a business valuation can help you identify which is more suited for your needs.
Peak Business Valuation, business appraiser, works with hundreds of current and potential business owners every year. Our expert team of valuation experts can provide you with a business valuation for buying a business. Additionally, Peak can connect you with professionals at Ampleo to provide you with a quality of earnings report for your business. Schedule a free consultation below to get started today!
