Sometimes, before your advisor will list your restaurant for sale, they require a financial due diligence in the manner of a quality of earnings (“QofE”) report. You might be saying, what is a QofE report? A QofE report analyzes the earnings power of a business to determine how sustainable and accurate the business’ earnings are. Specifically, a QofE report digs into the seller’s financial information and reports how well the underlying data relates to the financial statements. Another way to think about a QofE report is that it has the same purpose as a home inspection report does in a real estate transaction—to find hidden risk before the transaction is completed.
This makes a QofE report different from an ‘audit report’, which is only designed to test management’s ability to accurately prepare financial statements. For example, audited financial statements may record personal use travel expenses in the income statement and the audit report is consider accurate under generally accepted accounting principles because the amount of expense is immaterial to the presentation of net income. A QofE report, on the other hand, will identify and quantify the amount of personal use travel expenses and present an adjustment in the QofE report.
A typical QofE report analyzes the following items:
- Cost of revenue
- Selling and marketing expense
- General and administrative expense
- Other (income) expenses
- Cash requirements
- Working capital accounts
- Fixed assets
- State and local tax issues
- IT environment
- HR environment
- Management prepared forecasts or budgets
Remember, a QofE report take time, up to 60 days in some cases, and availability of data is the number one limiting factor to completing the report. As more and more M&A transactions are occurring, the sell-side QofE is becoming a necessity to accomplishing a successful M&A transaction.
If you need any help with prepping for restaurant valuation and sale, please reach out to one of our restaurant professionals.
Michael R. Metzler, CPA, ABV, CMA, CGMA, ASA