Quality of earnings is report and true reflection of the income that a company is capable of generating from its core operation without anomalies or accounting trick. The company’s expenses and revenue are documented in the quality of earnings report which is usually prepared by third-party firms. This report can be requested by an investment committee or board of directors. This report is essential because it gives historic earnings of a company that will be be used to determine the achievability and sustainability of future projections.

Net income doesn’t give substantial proof on the financial capabilities of a company. A company can have a huge net income but negative operating cash flow.

Some companies can manipulate their earnings using accounting conventions to make the company have an intuitive value which will attract more investors. Others do so to lower tax liabilities. Therefore, this article will help you understand more about the quality of the earnings report. Let’s get started.

Quality of Earnings Report

The quality of the earnings report is based on both the internal and external financial capabilities of a company. For instance, if the company has come up with a strategy to boost its sales through marketing then it is appropriate to say that that particular company has a high quality of earnings. This is because it was an internal initiative that was evaluated and implemented and eventually it brought returns to the company.

However, if a company largely participate in external forces as a way of building its credibility the increasing the price of commodities that the company is regarded yo have low-quality earnings. Therefore, there is a high possibility for a company that has low-quality earnings to manipulate its earnings. The companies that have high-quality earnings will stick to GAAP standards which are based on relevance and Reliability. Relevance has predictive power which can be used to ascertain the previous predictions that had been made. On the other hand, reliability is a verifiable metric which helps in accurately representing the transaction.

How to Gauge Quality of Earnings

It is possible to gauge the quality of earnings by looking at cash flow statement, balance sheet and income statement.Net income are among the most aspects that financial analysis focuses on to tell the overall performance of a company. Quality of earnings gives the reliability of the figures obtained during the very important analysis. Cash flow details and balance sheet will enable a financial analyst to come up with hypotension as to why the company has high-income net but negative cash flows. There might be a variation between the net income and cash flows.

Therefore the quality of earnings analysis include:-

-Determining fixed and variable costs

-Analyzing assumptions used In cash flow projection analysis.

-Breaking down of revenue based on appropriate components such as products/services and customers.

-Analyzing historical revenue trends

-Determining recurring expenses and one time expenses

-Analyzing the impact on revenue and expenses due to management changes.

Other items that can help to gauge the quality include transparency of disclosures, disclosure of related party transactions, consistency in accounting policies and reserve balances. Low-quality report earnings are largely influenced by inflation, an increase in the pricing of commodities, aggressive use of accounting rules and profit from the sale of an asset.

How Quality Earnings Works

As we have seen several options can be used to gauge the quality of earnings by analyzing the company’s financial report.

Most analysts will look at the highest income statement because a company can show high growth in both the sales and credit sales. Other parameters like the variation between net income will greatly help in coming up with a substantial report. However, non-recurring expenses or income is a red flag for the company. This is because a company may refinance all its debts leading to a decrease of that year’s expenses but it might affect future payments.

It brings worries when a company resort to take another debt. That is why some companies resort to manipulating their earnings through price to earnings ratio and earnings per share. In this way, they will have to purchase Sha of its stocks this reducing the number of outstanding shares. When such a case happens the company financial stability will gradually fade because when investors get to establish such a creepy move they will no longer invest in such a company.

Therefore, relying only on financial statements without a clear understanding can be disastrous. That is why it is always advisable as an investor to have a side quality of earnings report which provides a more detailed and representative picture of how the business is being conducted. This helps in evaluating whether it is worth investing.

Quality of earnings report sample

Factors Affecting Quality Of Earnings

Quality of earnings is important to prospective investors. Quality of earning can be used to determine the congruence between the integrity of the company balance sheets and economic earnings. The financial statements that are normally given might not reflect the true picture. Therefore, these factors can be summarized as the degrees to which earnings are recurring or non -recurring,cash or non-cash and basing on estimates and precise measurements that are subject to change.

Why You Need a Quality of Earnings Report
A financial statement is a useful tool for gauging the general health of a company. However, it does have its weaknesses. Since a financial statement tries to present information that encompasses a broad spectrum, it tends to miss the finer details.

And yet, specific minute details can have a significant impact on how you should see the overall picture. For example, a change in production, an unusually low expenditure, or big single-time sales does not reflect the entirety of the image. It’s like injecting nitro into a car to accelerate it faster and labeling the rate as the car’s normal speed.

It can also work the other way around. And, that means trying to downplay a specific metric for whatever reason. Most of these activities can deflate or inflate the statement, which consequently alters the perceived value and performance.

So if you are investor, buyer, or seller, how do you get a more accurate picture? That’s where the quality of earnings (QoE) report comes into play.

Quality of Earnings Report – What Is It

QoE is generally a crucial part whenever you are investing in a business. It’s also essential whenever you want to sell or buy a business. In fact, it should be a part of every due diligence.

QoE also comes in different sub-categories. For example, if you are selling a business, then you’d want to check the sell-side QoE. If you are buying a business, then you should be looking at the buy-side QoE. Generally, the difference is based on who is requesting such a report.

One of the purposes of QoE is to identify earnings that can significantly impact the report. Yet, it’s not the normal or an unrepeatable cashflow or performance of a business over a period of time. The reason for such a “spike” could be a multitude of sources like business climate changes or accounting choices.

While QoE often focuses on the income part of the financial statement, but it also combs through other details with finer teeth. As an example, it examines the worth and condition of various assets that are reported on the balance sheet.

Finally, QoE also considers the systems of control of a company. And, some aspects within the business operation like product line, industry, clients, and other related metrics.

Generally, QoE is fundamentally different when it comes to analyzing the balance statement when compared to a review or audit.

Quality Of Earnings Report VS. Financial Statement – The Difference

One of the significant purposes of a financial statement is to give a certain level of assurance that a business conforms to the generally accepted accounting principles. You can say that a financial statement looks into the past.

On the other hand, QoE is aimed at understanding the sustainability of the company’s income on a detailed level. In other words, it is a report that looks into the future health of the business.

Why Do You Need Quality Of Earnings Report?

There are plenty of reasons why you may need a QoE report. Perhaps, the most important reason is that a QoE is a report which analyzes detailed aspects of a business that may not be readily available when checking the financial statement only.

Keep in mind that the report, like the QoE, is not an evaluation. However, it still plays a critical part when structuring or negotiating a deal. It can help in significantly reducing risk. Avoiding the possibility of a buyer’s or seller’s remorse is another desirable outcome of a QoE report.

Sell-Side QoE Report

For a seller, the sell-side QoE can help in uncovering potential business problems that may derail the sale of the business. Or, it can also reduce the pressure of some buyers that like to press aggressive negotiation tactics. After all, a solid QoE report will deter buyers from using “uncovered” information with the hopes of reducing the price. The QoE can also shorten the selling process as more information is already on the table.

However, if you are selling a business, it’s also a good idea to comb through the buy-side QoE report. It will give you a better perspective from the buyer’s side of the fence, which can then lead to a smoother selling process.

Buy-Side QoE Report

If you are the one buying a business, then you must comb through as much information as you can. Always remember that more information can reduce risk further. If your idea of due diligence is only checking out the financial statement, then that can potentially lead to disastrous results.

It’s highly advisable that if you are buying a business, the due diligence should include a buy-side QoE done by an independent third party. The report should drill down the operations, cash flow, and account balances.

The buy-side QoE report will also be an invaluable tool for investors. It can help paint a better picture of how well the business is doing. Ultimately, it can help you gauge if the company is worth the current price of its stock.

Keep in mind that the QoE report is typically done by a third-party that is not connected with the business that’s going to be analyzed. This is to minimize any bias that may affect the final report. Generally, the QoE will typically include, but not limited to:

* Unusual variances and trends within the internally prepared income statements and balance sheet.

* Potential accounting practices or policies.

* Non-recurring or unusual items found in the expense or income tabs.

* Transactions with unusual parties

* In-depth report of proof of cash.

* Customer sales, backlog, and concentrations analysis.

* Analysis on key allowance and reserves.

Conclusion

A financial statement is a crucial component if you want to gauge the health of a business. Hence, every seller, buyer, or investor will check it before doing anything. However, the nature of financial statements is merely to give you a broad stroke picture or to ensure that the business is compliant with the generally accepted accounting practices. In other words, it tends to miss things that can significantly impact the overall picture. It’s the reason why that financial statement should be complemented with a QoE report.

A QoE report takes a closer look at the sustainability of the business. It helps uncover income, performance, or other vital aspects that are “unusual” or not part of what’s “normal.” At its core, it’s a report that looks into the future by making sure that the current sales or performance of a business will likely continue and not brought on by something unusual.

It is important to know that you can’t measure the quality of income with a single characteristic.Therefore, certain indicators should be used to access the quality of income which explains why there is a need for the audit committee and financial statement experts to be prudent when evaluating financial reports.

Understanding Purchase Price Concession

A purchase price concession is an adjustment to the purchase price agreed to in the letter of intent. It occurs during or after due diligence, but before closing of the transaction.

Price concession or purchase price concession is an adjustment to the purchase price agreed to in the letter of intent and it is competed before the final closing of the initial transaction. Price concessions are typically used for a decrease in price, however it is possible for a price concession to be used to increase the price. There are a few main reasons why price concessions are used. The first main reason for price concessions is due to a fault in initial valuation.

When there is a miscalculation and fault in valuation, prince concessions are used to correct the price. The second reason is due to unforeseen circumstances that revealed themselves after the price was set. These findings would affect the company if the price was not adjusted. The final reason that price adjustments occur is due to appraisal valuations and capital assets. For example, when appraisal occurs, the valuation may be below what the company expected.

Price concession example
For example, if asset sale price is $100,000 ( home or any other asset), you and the seller may agree on a higher price of $103,000, with the additional $3,000 representing the concession amount. So in this example of the concessions we are adding value on mortgage.This amount will be used to pay closing costs.

These are the main reasons why price concessions occur on a regular basis. The purchase price can be negotiated properly between buyers and seller for a solution that all parties are in favor of and agree upon. If the buyer is motivated to complete the transaction as quickly as possible, they often engage in price concessions. Another important factor to note is the process than buyer engage in. For example, buyers often estimate the amount of non-working capital needed in order to sustain annual profit/ revenue.

This number is then used for future reference. Capital asset appraisals also play a large contributing factor in price concessions. The seller will engage in estimates for fair market value. The buyer reserves their full right to adjust price based on appraisals. This is a very important factor that helps buyers and sellers to work together cohesively. There are many strategies that can be used to help make this process easier. When the process is completed with ease, both buyer and seller are likely to agree upon the specific terms of the deal.

If the value of the property is listed higher than the most recent appraisal, the buyer has the right to lower the price on a dollar for dollar basis. This is one of the best ways to ensure that the price is in alignment with the most recent appraisal value. Appraisal values are one of the most reliable methods for ensuring the subject of the appraisal (property, company etc.) is alignment with current market values. As many investors know, market value are constantly changing. For this reason it is important for both buyers and sellers to stay up to date on these transactions and trends. It is also important to note that price concessions typically always occur post due diligence and before closing. Due diligence is an important step in the process of finalizing a deal. There are many steps for finalizing a deal and purchase price concessions are one of them.

This term “Price Concession” we can see in real life but we can see in the reports and financial statements as well when we analyze companies and their stocks. So, it is nice to know !

Reps and Warranties

Representations and Warranties or Reps and Warranties is a term that constitute the underlying facts of the contract and it describes the assertions that a buyer and/or seller makes in a purchase and sale agreement.
Every contract has some sort of representations and warranties (reps and warranties) that constitute the underlying facts of the contract. Typically when a contract has both the terms, reps, and warranties, they tend to blend everything from the past, and present as well as of the future along with the terms of that contract.

Although every contract may be different, the language used in them is pretty similar. Both buyer and seller rely on each other for providing all the supporting documents and necessary information for closing the transaction.

Reps and Warranties: Description

The representations of a seller will relate to all the information that a buyer will be relying on for valuing a company. Hence, the seller is not only limited to say that all the related information are true, but have to showcase sufficient information for supporting the statement with the help of valuable documents such as copies of major contracts, consumer/supplier listings, financial statements, equipment listings, etc. Such information can act as a reference after post transaction for ensuring that the purchase truly exists.

The representation of a buyer will relate to that type of consideration taken for completing the transaction. When a buyer’s stock will take part in a transaction, the buyer must ensure that it represents the stock legally. Additionally, a shareholder agreement has to be provided by the buyer to the seller for reviewing those stocks to find out if they are free from hindrance.

In general, a warranty may take place between a present and a future scenario. The product you are buying will be free from defects, with the warranty to fix defects during a specific time in the near future by the Company. Some products are made available to the consumers as a lifetime warranty. That means every time that particular product malfunctions, the company will get that fixed for you. A warranty obligates a seller to adhere to the terms of that contract.

There are two types of warranties, expressed or implied. Expressed warranties are written within the contract and buyers must insist upon them. Whereas, the implied warranties will fall under the Uniform Commercial Code, which will make sure that there will be fitted for some particular purpose. An expressed contract holds better in law rather than implied warranties.

For reducing the risk of a financial loss incurred from either of the two parties for not representing anything significant, the agreement must contain the indemnification clause. This will protect the other party for misrepresentation, or omitted representation that might lead towards a financial loss post-transaction. Hence, it is extremely important that both the buyer and seller provide sufficient information in their representation and warranties for avoiding legal disputes which might be costly, in an attempt to impose indemnification clauses.

Reps and warranties example – representations and warranties clause example

Representations and Warranties. The representations and warranties of the Company contained herein shall be true and correct on the date hereof and on and as of the Closing Date; and the statements of the Company and its officers made in any certificates delivered pursuant to this Agreement shall be true and correct on and as of the Closing Date.

or Reps and warranties example in stocks trading example :

Brokers and Finders. Neither Seller, on its own behalf or on behalf of Global, Holding or the Company, nor any of Seller’s, Global’s, Holding’s or the Company’s respective officers, directors or employees has employed any broker or finder for which Seller (or a Subsidiary of Seller other than the Company and its Subsidiaries) is not responsible for such broker’s or finder’s fees or incurred any Liability for any brokerage fees, commissions or finder’s fees in connection with the Transaction for which Seller (or a Subsidiary of Seller other than the Company and its Subsidiaries) is not responsible.
Ownership of Purchaser Common Stock. As of the date hereof, Seller does not Beneficially Own any shares of Purchaser Common Stock.

Reps and Warranties: Benefits

So far the buying and selling agreement goes, a seller is needed to provide sufficient detailed information for backing up all the facts and features so that they can be presented to a buyer, who has practically no experience or maybe have a little knowledge, about the nature of business. The benefits of reps and warranties for both buyers and sellers serve better, and here are some of them.

Lessening The Chances Of A Financial Loss – An indemnification clause is included in the reps and warranties that help to diminish any kind of financial losses if either of the two parties withdraws important reps that might lead to some sort of financial loss post-transaction of the agreement.

Setting Grounds That Are To Be Required For Closing The Deal – The seller will be required to disclose about the business’s position in a detailed document that will include information about the number of consumers, inventory, past revenues, current contracts, etc. and hence the reps and warranties sets a stage for closing a sale transaction.

Providing A Detailed Confession About The Seller’s Business – The seller will be having full knowledge about its business, whereas a buyer will be interested more in getting a full disclosure about the nature of business for a smooth understanding of the transaction.

Assuring Further Proceedings Of The Transaction – To get a further continuation of the deal, the seller will be provided with the reps and warranties by the buyer, which reflects their ability to get the deal closed with proofs of financing or funds.

Reps and Warranties: Challenges

It is pretty natural that both the parties involving in a business transaction want to lose, and hence it will be the mutual interest of both the parties to have a winning deal. On some rare occasions, however, the reps and warranties face some challenges. On such an issue may be the cost that relates to the survival periods.

While dealing with the negotiations, the costs of doing business vary with the survival period. Generally, a buyer might prefer a longer survival time for more inspection. Although it may not be suitable for some sellers that want to close the deal as early as possible. A poor negotiation on a survival period will result in both parties paying unnecessary expenses.

Another challenge arises when both the parties get confused with the two terms. It might be confusing when using the reps and warranties separately because of their interpretation shifts legally. A representation will be used to lure the consumer for entering the contract. But if a seller violates and breaks the contract, the buyer might terminate the contract and seek for compensation of those damages.

Whereas, only after a representation, the warranty comes within the contract. If by any chance the seller breaks the agreement, a buyer might not terminate the contract but can seek compensation for the damages.

Reps and Warranties: What Lawyers Look For

The reps and warranties will present directions to the buyers for conducting attentiveness for the transaction. The parties will be represented by the attorneys who will scrutinize the deal for ensuring that a fair deal is conducted between both the buyer and seller. Everything related to the deal will be scrutinized that might include legal information about the business, tax audit, financial statements of the business, inventory status, employee’s contribution, environmental liability, and few other things.

Conclusion:

Reps and Warranties are nothing but that a buyer and a seller give to one another through an agreement. The assurances are recorded statements that help the purchasing party to rely on those facts as authentic.

Asset Sale – Meaning and Definition

An asset sale occurs if a bank or another company sells its debts to a third party. It is a form of a non-resource sale for various reasons, including mitigating the risk associated with assets, obtaining cash flows or liquidation needs. Sales of assets also affect the net revenue of a company. Let us walk through the definition of the asset sale and its benefits among business traders.

Definition

An asset sale includes the selling of a property to another business, i.e. to the purchaser. This selling usually comprises of tangible assets like pieces of equipment and inventories, as well as intangible assets like the goodwill of a business, customer lists, and intellectual property. This article explains how business assets are traded and asset sells are operated.

An asset sale is only accomplished if a purchaser acquires the ownership of a business. In addition to contractual agreements, the purchaser can join the new company or use an existing business to obtain the selected property. It ensures that the seller selling the property maintains the company ownership and has to compensate for all current obligations and expenses before earning net cash.

Asset sales include a real asset of a company–usually a combination of assets–in contrast to stock shares. A complex transaction can be carried out from an accounting point of view. The receivable accounts are held on a balance sheet as an asset.

Asset sales are considered as such because, after compensation, the seller gives the purchaser possession of the property. After the transaction, the purchaser can not use the property. If this feature is allowed, the transaction is considered as financing — usually a loan. The company would not have the desired result of increasing free cash flows.

Comparison For Success: Asset Sales vs. Share Sales

Asset Sale VS. Share Sale

Asset sales and share sales are two very different types of sales. Asset sales is commonly associated with property, land, buildings, investments and cash. These are known as asset sales. On the other hand, share sales are defined as a stock sale. Asset sales and share sales are used in different ways.

Asset Sale example
For example, asset sales can be used to sell all types of business as opposed to stock sales which can only be used for incorporated businesses. These types of sales differ in many ways, however they do posses some similarities. For an asset sale, the seller has some degree of control over what is being sold. For example, you can retain the rights to a business name as well as specific assets. In a share sale, the liabilities are completely sold in addition to the rest of the business.

The original owner of an asset sale may still be responsible for liabilities. The main different between an asset sale and a share sale comes down to liability. The liability of each type differs. In terms of tax exemptions, a share sale may be exempt from taxes if able to write off with capital gains. This is one of the many minute differences between asset sales and share sales. Asset sales and share sales are meant to be taken seriously as they can have a significant impact on the owners and their liability agreements. It is recommended that sellers of an asset sale or a share sale receive advice from accountant or professional on the implications of taxes. This is the best way to ensure you receive the most accurate information for your specific business type.

Sole ownership for asset sales are defined in a few main ways. There is no proper and clear distinction between personal and business assets when it comes to asset sales. As a result of this, problems often occur during the transferring process. Transferring tangible assets can be difficult in this type of situation. However, this is why ensuring the asset sales are clearly outlined can help to avoid future complications. A prime example of this is home businesses. If a business has been entirely operated out of an owner’s home, relinquishing total assets can often present itself as a challenge.

The owner of a home business may also choose to retain other assets such as equipment or vehicles as their own personal assets. Another example of this is with financial consulting. For example, a successful financial consultant may choose to sell their business at a high rate on the basis of their vast client list with reputable clients. However, the preexisting clients may not appreciate or value the skills of the new owner. In this case, clients may choose to work with another financial consultant as a result. These are the main situations in which an asset sale can be difficult without strategic measures in place. By providing strategic measure, both asset sales and share sales are predicted to run smoothly with benefit to all involved.

Special Considerations on asset sale

You retain the legal entity of the company and only sell the assets of the company in assets sales. A company can choose what it is selling in an asset sale. The seller shall remain in the ownership of the business entity while the purchaser purchases any or all of these assets.

In order to purchase the assets along with the contracts and management, the buyer can create a new enterprise or use an existing business. An asset sale poses significantly less risk to a buyer as the seller remains responsible for any liabilities (liability, debt, etc.) and contingent expenses.

Tax benefits for customers

In contrast to a loss of corporate responsibility coverage, asset sales give consumers tax benefits. Asset sales enable purchasers to increase the tax basis for the assets acquired.

By assigning higher value for fast depreciating assets (as equipment) and slowly amortizing assets (like goodwill, which has a life of 15 years), purchasers are able to achieve significant discounts on taxes.

Wrapping up

In this article, we can see that asset sale involves a company that decides to sell its properties, whether they are tangible or intangible. Sales of assets are very common to companies and an asset agreement is required to reduce confusion and potential disputes among the traders.