A comprehensive analysis of a company’s true profitability is critical for both buyers and sellers in agribusiness acquisitions. But traditional financial statements based on historical earnings often overlook operational nuances and fail to reflect the true enterprise value.

A Quality of Earnings (QoE) report overcomes this challenge by providing a detailed analysis of normalized earnings. A oQoE examines historical performance and necessary adjustments, offering insights into a company's operational health and earnings sustainability.

By addressing the unique financial challenges faced by agribusinesses, a QoE report enhances the understanding of historical performance and, in turn, future earning potential. Leveraging a QoE report in a business acquisition can significantly impact the success of the transaction.

Benefits of a QoE Report

In a business acquisition, buyers and sellers both seek to collect as much information about the company as possible. QoE reports provide crucial analysis and information during the business acquisition process for both buyers and sellers.

For buyers, a QoE report provides additional information about the historical financial performance of the business from an expert source. 

For sellers, a pre-sale QoE report identifies issues, such as incorrect accounting treatment or unique historical earnings circumstances, which may arise during a buyer’s diligence. 

Buyers or sellers that do not engage an accounting firm to perform QoE report will be operating with more limited information than those that have a QoE report. 

Key Components of a QoE Report

Enterprise value is frequently calculated using a multiple of earnings before interest, taxes, depreciation, and amortization (EBITDA), but can also be based on free cash flow (FCF) or revenue. QoE reports typically include the following analyses to help buyers and sellers understand the true value of a company:

• Adjusted EBITDA. This summary of normalized historical earnings accounts for non-recurring income and expenses and presents a clearer view of ongoing earning potential.
• Historical Normalized Income Statement. Presented on a monthly basis, this statement allows stakeholders to identify performance trends and operational consistency.
• Analysis of Key Accounts. This analysis of key financial metrics—such as revenue, gross profit, and operating expense trends— provides further insight to stakeholders of the company’s financial health.
• Net Working Capital Adjustments. Proposed adjustments to net working capital assess liquidity needs and operational efficiency, crucial for short-term financial health.

Special Considerations For Agribusiness Companies in a QoE Report

Agribusiness companies face a unique set of challenges, both financially and operationally, that influence the analysis and information included in a QoE report. The following are common issues seen in the agribusiness industry:

• Long inventory turnover. Agribusiness companies frequently capitalize farming and other inventory-related costs to the balance sheet until the related product is sold. Due to the nature of the agribusiness industry, this can result in months or years of outstanding inventory on the balance sheet. Long delays between when inventory is capitalized and when it is sold create challenges when analyzing a company’s historical earnings.
• Farming and input costs. Agribusiness involves many different input costs and many of those costs may or may not be captured when assessing the gross profit of a company. Lack of consistency in treatment of input costs may present challenges when comparing different companies’ profitability.
• Payment arrangements. Agribusiness companies must typically make payment concessions to customers. Such concessions can result in complicated or long-dated payment arrangements, presenting risks to collectability and unique cash flow considerations.
• Year-to-year variability. Agribusiness is not a steady-state business, and differences in yields from year-to-year can affect businesses up and down the supply chain. Analyzing changes in revenue and costs from year-to-year can better articulate the historical performance of the business and filter out noise from year-to-year variability.
• Legacy accounting practices. Some agribusiness companies may operate on legacy accounting methods that are inconsistent with other companies’ methods, presenting comparability challenges. Transitioning legacy accounting practices to current practices better aligns companies’ historical financial results to those of the industry.

It’s also important that a QoE consider the right key performance indicators (KPIs) in assessing a business. For agribusiness these KPIs frequently include:

• Revenue trends
• Customer concentration
• Gross profit margins
• EBITDA margins
• Working capital trends
• Inventory turnover
• Crop yields

What’s The Difference Between a QoE Report And a Financial Statement Audit or Review?

Audits and reviews prioritize compliance with accounting standards and accuracy of financial statements, while QoE reports delve into financial and operational performance.

QoE reports are prepared by mergers and acquisitions (M&A) specialists that will advise buyers or sellers through the entire transaction continuum.

Typically, audits only present annual results and do not cover any information since the end of the fiscal year. QoE reports regularly include analysis of monthly financial results and will provide financial information up to the most recent available month. Recent earnings are critical for determining value in a business acquisition.

Audits adhere strictly to the entity’s chosen financial reporting framework, typically U.S. Generally Accepted Accounting Principles or GAAP, whereas QoE reports may involve adjustments to GAAP that offer what many consider a more accurate picture of operational performance. QoE reports also provide non-GAAP metrics such as EBITDA and free cash flow, which are generally considered more relevant to buyers and sellers in the context of a M&A transaction.

Audits can take months to be complete whereas QoE reports typically take only four to six weeks, although QoE reports do not provide any level of assurance unlike an audit or review.

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Additional Resources

• Agribusiness Practice
• Due Diligence Services