October 17th, 2024
Quality of Earnings – Importance of Revenue
Posted on June 25th, 2025 in Business Valuations
In the Fall 2024 issue of our FSAT newsletter, we introduced what Quality of Earnings (QoE) reports typically include and why they may be needed. In this article, we will continue discussing various aspects of QoE reports by exploring the importance of a quality of revenue analysis.
Understanding revenue quality is an important component in a quality of earnings analysis in mergers & acquisitions (M&A) transactions. Factors often considered when assessing the quality of revenue include the accuracy, sustainability, growth, profitability, and that the reported revenue has been collected. In M&A transactions, an in-depth quality of revenue analysis helps to identify potential risks and provides insight into the target company’s ability to maintain and grow its revenue and earnings post-acquisition.
Assessing Revenue Accuracy
Testing revenue accuracy is an important step in a QoE analysis. One method that can be used to analyze the accuracy of a company’s revenue is called a “cash proof of revenue” analysis. In a cash proof of revenue analysis, the company’s reported revenue in its financial statements is reconciled to the cash deposits reported in its bank statements. By completing this process, a buyer can have confidence that the reported revenue matches third-party sources, such as bank statements. If the company reports significant accrual revenue during the period or there are significant accounts receivable that have not been collected, the makeup of the balances may also be analyzed for accuracy and collectability.
Evaluating Revenue Sustainability
The sustainability of a company’s revenue is another important area to consider in a QoE analysis. Revenue is considered to be of high quality when it is generated by a company’s core operations and is derived from recurring customers, rather than one-time transactions or temporary factors. In a QoE analysis, the company’s historical revenue may be analyzed to assess its sources and to identify any non-recurring or extraordinary items. Examples of non-recurring items include one-time sales, legal settlements, or insurance proceeds. This analysis can also help identify risks associated with the company’s various sources of revenue, such as dependance on key customers or significant contracts.
Analyzing Revenue Growth
Undertaking an analysis of a company’s historical revenue growth can help assess whether the growth is sustainable and representative of the company’s future performance. Examining the company’s historical revenue may identify important trends or abnormalities that a buyer should consider during the due diligence process. It is important to identify the drivers of revenue growth, such as new products/services, new customers, or cyclical factors, to evaluate whether these growth patterns are likely to continue.
Understanding Profitability
Finally, a profitability analysis can be a valuable tool for evaluating the quality of a company’s revenue and earnings. By examining various profitability ratios, such as gross profit margin, net profit margin, and return on assets, one can gain insight into the company’s financial health. Additionally, an analysis of the profitability of the various revenue sources can help determine the sustainability of the company’s revenue and earnings in the future.
In conclusion, a thorough analysis of revenue can be a key component of a QoE report. A QoE report helps identify potential risks and support decisions regarding a potential transaction. At DJB, our team of specialists have the professional experience needed to assist prospective buyers and business owners, and their advisors and lenders throughout the transaction process.
Our trusted professionals can assist with many aspects of M&A transactions, including the financial and tax due diligence, as well as preparing QoE reports.
Article originally published in: FSAT News – Spring/Summer 2025
Article written by: Jonathan Corobow, CBV
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