Three Basic Factors of Earnings
Numbering values for earnings do not always have to be fully representative of the business’s monetary value. In fact, two business can report the same earnings and be still different. Below are three factors of earnings that prove that the earnings are more than just a number.
Quality of Earnings
Quality of earnings measures whether the earnings are padded with a lot of “add backs” or one-time events, such as a sale of real estate, resulting in an earnings figure which does not accurately reflect the true earning power of the company’s operations. It is not unusual for companies to have “some” non-recurring expenses every year, whether for a new roof on the plant, a hefty lawsuit, a write-down of inventory, etc. Beware of the business appraiser that restructures the earnings without “any” allowances for extraordinary items.
Sustainability of Earnings After the Acquisition
The key question a buyer often considers is whether he or she is acquiring a company at the apex of its business cycle or if the earnings will continue to grow at the previous rate.
Verification of Information
The concern for the buyer is whether the information is accurate, timely, and relatively unbiased. Has the company allowed for possible product returns or allowed for uncollectable receivables? Is the seller above-board, or are there skeletons in the closet?