The situation
A Pune SaaS company reports a healthy EBITDA for the last financial year and is talking to a strategic buyer. The buyer's advisers ask for monthly revenue by customer, a breakdown of capitalised development cost, and a list of every one time item. Two weeks later they present an adjusted EBITDA that is lower than the founder's figure. The founder wants to understand how they got there, and whether he should have done the work himself first.
What a quality of earnings review is
It is a review, usually by the buyer's accountants, of how real, repeatable and cash backed a company's profit is. It sits alongside the audit. The audit asks whether the accounts are fairly stated; a quality of earnings review asks what profit a buyer can expect to continue.
What it usually adjusts
One time items
A large insurance claim, a one off export order, a lawsuit settlement or a gain on selling land. These are removed so the profit reflects the normal business.
Owner and related party costs
Salaries paid to family members who do not work in the business, personal expenses, or rent paid to a promoter's company above market rate. These may be added back, or replaced with a market cost.
Accounting choices
Revenue recognised early, development costs capitalised, provisions released, or stock valued generously. Each can raise reported profit without raising cash.
Run rate
If prices rose or a large customer left during the year, the buyer may adjust profit to reflect the business as it is today.
Checking against cash
A key test is whether profit turns into cash. Advisers compare EBITDA with operating cash flow, and revenue with GST returns and bank receipts. Large, unexplained gaps lead to more questions.
How a seller can prepare
- Prepare your own adjusted EBITDA with your CA, with each adjustment listed and supported.
- Reconcile revenue to GST returns and bank statements, month by month.
- List related party transactions with amounts and terms.
- Explain any change in accounting policy in the last three years.
- Keep monthly management accounts that tie to the audited year end.
A seller who has done this work is in a better position to discuss the buyer's adjustments, and the review is faster.
A short checklist
- Monthly profit and loss for at least two years
- Schedule of one time items with evidence
- Related party schedule
- Revenue to GST and bank reconciliation
- Working capital by month
Where Synerger fits
The financial folder in the Synerger data room holds the schedules, and each adjustment the buyer proposes can be raised and answered in the question log with the evidence attached. See also related party transactions in diligence and our financial and risk advisory.
General information; confirm the accounting treatment with your CA.