Understanding the underlying drivers of your business performance
When a business approaches a sale, investment, or ownership transition, attention naturally turns to the numbers: revenue, profit, growth trends. All important. All visible.
But experienced buyers and investors look deeper. They want to understand not just how much profit a business makes, but how reliable and repeatable that profit is.
That’s where a Quality of Earnings (QoE) report becomes valuable.
Profit vs. Quality of Profit
At a glance, two businesses might both report $2 million in profit. On paper, they look similar.
In reality, they can be very different.
One may have stable, recurring revenue, consistent margins and disciplined cost control. The other may rely on one-off projects, timing quirks or cost deferrals that flatter short-term results.
A QoE review helps separate these two scenarios.
It focuses on sustainable earnings, the level of profit that a new owner could reasonably expect to continue.
Normalising the Numbers
A key part of any QoE review is “normalisation”.
This means adjusting reported profit to remove items that are:
- One-off or non-recurring
- Unusual or outside normal operations
- Owner-specific or discretionary
For example:
- A manufacturing business may have experienced a temporary spike in demand due to a supply chain disruption. That additional profit may not repeat.
- A retail business owner may run personal expenses through the business. These inflate costs but aren’t relevant to a buyer.
- A construction company might delay maintenance or investment to boost short-term profit.
- A QoE review adjusts for these factors to present a clearer, more comparable earnings figure.
Understanding Revenue Quality
Not all revenue carries the same level of certainty.
A QoE review typically examines:
- Customer concentration (is revenue reliant on a few key Clients?)
- Contracted vs. non-contracted income
- Repeat vs. one-off sales
- Pricing stability and discounting patterns
For example:
A software business with long-term subscriptions will generally have more predictable revenue than a project-based engineering firm relying on tenders.
This doesn’t make one business better than the other, but it does affect risk, valuation, and buyer confidence.
Margin Sustainability
Profit margins can be influenced by timing and decisions that aren’t immediately obvious.
A QoE review looks at:
- Gross margin consistency
- Input cost volatility (e.g. materials, labour)
- Pricing strategy and its durability
- Operational efficiency trends
For instance:
A food production business may show strong margins during a period of low input costs. If those costs are rising, future margins may look different.
Understanding this helps leaders anticipate how the business may perform under different conditions.
Working Capital and Cash Reality
Profit is important. Cash is critical.
A QoE review often highlights how much working capital the business needs to operate effectively.
This includes:
- Inventory levels
- Debtor collection patterns
- Creditor payment timing
For example:
A wholesale distributor may show strong profits but require significant cash tied up in stock and receivables. A buyer will factor this into the overall transaction value.
Why This Matters Before a Transaction
Preparing a QoE-style analysis before going to market can significantly improve outcomes.
It allows business leaders to:
- Identify and address potential red flags early
- Present a clear, credible earnings story
- Support valuation expectations with evidence
- Reduce surprises during due diligence
It also puts the business in a stronger negotiating position.
Instead of reacting to buyer questions, leaders can proactively explain performance and demonstrate control over the numbers.
Beyond Transactions
While QoE reviews are often associated with sales, they are equally valuable as an internal tool.
They help leaders better understand:
- What is truly driving profitability
- Where risks exist in the model
- How resilient the business is to change
This level of insight supports better decision-making, whether or not a transaction is on the horizon.
Need help understanding the underlying drivers of your business performance or preparing for a potential transaction? Get in touch with Alliott NZ Chartered Accountants in Newmarket Auckland.
