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Look inward with an effective quality of earnings analysis

May 16, 2014


As a manufacturing business owner, you’ve spent countless resources on the betterment of your organization. You’ve dedicated time, money and expertise to ensure the company’s success, and in the process have developed the knowledge and confidence needed to prosper in the industry. If you’re looking toward the horizon and you see an eventual exit from this business, then without question you’ll want to see it accompanied by a strong return on your investment and sacrifice. Above all else, you’d like to be be guaranteed your company will get the best price.

This is where a quality of earnings analysis comes into play. In our decades of experience as valuators, Clark Schaefer Hackett has worked with owners in a similar position to yours countless times to help boost their company’s value. If you’d like to understand which operational changes will impact your sale price, it is imperative that you place yourself in the potential buyers’ shoes.

Think from the buyer’s perspective
The impetus behind a quality of earnings analysis is seeing what possible buyers go through when evaluating your company. The secret here is to look at your own business with the same objectivity and resources your buyer will eventually use. Unfortunately, this shrewd step is one that many manufacturing business owners miss. Conducting reverse due diligence – or the sale-side of a quality of earnings analysis – will allow you to arm yourself with the intelligence needed to gain leverage in your future deal.

When buyers evaluate a target company, they often find that the estimated value of the organization isn’t in line with the actual cash flows. According to the American Institute of Certified Public Accountants, a quality of earnings analysis can bring those figures closer together. Buyers are looking for any opportunity to lower the purchase price. The key for you is to do the work beforehand, so no potential weaknesses can be used against you.

Most importantly, you have to increase your company’s value. To achieve this goal, you should:

  • Streamline operating efficiency
  • Invest in additional opportunities
  • Add profitable customers
  • Remove non-profitable customers and business lines
  • Correct detrimental operational issues

A quality of earnings analysis will allow you to look inward, make corrections and establish accurate expectations for a potential sale, so your business is in line with the buyer’s existing company. What makes your company valuable? Is it new technology, customers, market share or profitability? Find out before the buyer enters the picture.

The elements behind strong due diligence
A quality of earnings analysis varies depending on the depth of the study, but for manufacturing firms, this process is more involved due to the complexity of business lines. Performing due diligence here will illustrate the true costs of your sale, potential weaknesses and other problems.

To begin, you should focus on assessing operations and internal data. A breakdown of revenue and an analysis of financial trends are valuable components of due diligence. Looking at your sales functions and capabilities often provide substantial insight, as well as your purchasing behavior. Evaluate your strategy, resources, processes and abilities, so you understand the fundamentals of your organization, in addition to the sustainability of its business plan and the common risks that could disrupt operations.

The value of another set of eyes
Certainly you’re not unfamiliar with the aspects of your company which could be improved. No one knows your business as well as you do, from its strengths to its opportunities. But from the owner’s office, it can be nearly impossible to objectively determine which improvements will most affect sale price.

Another valuable aspect of due diligence and a quality of earnings analysis is time management. This process is more complicated for the manufacturing sector, and professionals know how to mitigate your weaknesses despite these complications. While you may have heard of these steps, you might not be aware of the complexity of implementation. Planning ahead can help you prepare for any bumps along the way.

Start this process years ahead of a sale
Conducting due diligence and a quality of earnings analysis is just the beginning of the process. You’ve got to allow time to implement the operational improvements you decide to make. Streamlining, attracting new customers, making difficult decisions about weaker business lines, these are actions that take time. And seeing the decisions positively affect your company to increase its value will take even longer. It would not be wrong to undertake reverse due diligence five to ten years before you’re ready to exit.

When your reverse due diligence is conducted by an experienced certified valuator, your decision will be driven by hard data as well as experienced expertise. When looking to work with an advisor prior to your eventual sale, be sure you work with a team that has experience in the manufacturing sector. You need a sophisticated firm who can field a team of experienced, certified valuators, advisors accustomed to guiding business through accounting and operational improvements, as well as transaction specialists who will structure the sale to your best tax advantage. We have focused and specialized knowledge of this industry, and can analyze your operations to identify areas that need improvement. While some firms may not understand the true costs associated with mergers and acquisitions, we do – making us a valuable asset for you.

The business owners who’ve done this well have looked at this long-term process end to end, and engaged a firm who could advise them well through all of it.

© 2014

Further resources for understanding reverse due diligence:

All content provided in this article is for informational purposes only. Matters discussed in this article are subject to change. For up-to-date information on this subject please contact a Clark Schaefer Hackett professional. Clark Schaefer Hackett will not be held responsible for any claim, loss, damage or inconvenience caused as a result of any information within these pages or any information accessed through this site.


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