Long before a buyer’s quality of earnings team ever sees your books, problems can already be sitting in them, waiting for someone to go looking. In a recent financial review for a specialty contractor, we found roughly $212,000 in negative liability balances across ordinary payroll and accrual accounts that hadn’t been fully reconciled.
There was no transaction underway, no quality of earnings review in progress, and no buyer asking questions yet. That was exactly why the timing mattered. These were the kinds of balances a buyer would eventually examine when deciding whether the company’s historical financials could be trusted.
Finding them early gave management time to understand what happened and clean up the records while nobody else was waiting on the answers.
What Will a Quality of Earnings Review Find Before You Sell?
A quality of earnings review looks beyond reported profit to determine how much of the company’s historical performance is sustainable, properly supported, and relevant to valuation.
The review can extend into working capital, balance sheet accounts, historical adjustments, accounting policies, and the records supporting reported earnings.
For construction and specialty contractors, buyers may also examine WIP, job costing, estimated costs to complete, billing positions, payroll, and how project systems tie back to accounting.
What Does a Negative Liability Balance Tell You?
A liability account normally carries a credit balance, so a debit or negative balance deserves investigation.
There can be a legitimate explanation, including an overpayment, timing difference, reclassification, or correcting entry. The concern grows when the balance remains unresolved and nobody can readily explain what created it.
In this review, several payroll and accrual accounts were carrying negative balances at the same time, and together they totaled roughly $212,000.
A negative balance in a current liability account reduces reported current liabilities and can make the current ratio appear stronger until the balance is corrected or reclassified. More importantly, an unexplained debit balance can point to entries posted as plugs rather than true reconciliations, which raises the question of whether the balance is supported by the underlying records.
How Did an October Imbalance Lead Back to a Bonus Accrual?
Another issue surfaced in the October balance sheet.
The balance sheet didn’t actually balance that month, which means an entry was posted incorrectly somewhere. We traced the discrepancy to a bonus accrual true-up.
During financial due diligence, a buyer may request supporting schedules, reconciliations, journal entry detail, and explanations for unusual movements. Rebuilding an old discrepancy months or years later takes time and can create follow-up questions about other accounts.
Left alone, this is exactly the kind of issue that becomes a costly, time-consuming finding in a future quality of earnings review, which is why resolving it now, during the normal accounting cycle, is much easier than explaining it after a buyer finds it.
Why Can Intercompany Accounts Create Problems During a Transaction?
Intercompany accounts become difficult when the amount recorded by one entity doesn’t agree with the corresponding balance in another.
For contractors operating through multiple entities, these balances can accumulate through shared expenses, cash transfers, equipment charges, management fees, payroll, or other related company activity. Each side needs to agree, and the balances should eliminate correctly when consolidated financial statements are prepared.
We raised intercompany reconciliation early because, in our experience, it is one of the most common areas that creates real cost and delay in a future transaction, and one that is worth getting ahead of years before a sale is even on the table.
A buyer may need to determine which entity owns a balance, whether the corresponding entry exists, whether the amount is recoverable, and how it should be treated in consolidation.
Why Fix These Problems Before You Are Ready to Sell?
Once a letter of intent is signed, management is already balancing buyer requests, adviser questions, legal work, and the day-to-day demands of running the company, which makes it a difficult time to discover that years of reconciliations need to be rebuilt.
That’s why financial readiness should be the first step in your exit plan. To properly prepare a business for sale, you need to start well before a buyer enters the picture. This gives you time to address issues during the normal accounting cycle instead of as an emergency project.
The stakes are real. If a QoE team reduces adjusted EBITDA by $100,000 on a deal priced at 5x EBITDA, the indicated enterprise value can drop by $500,000. Working capital findings can also change what the seller receives at closing.
What Can You Check Before a QoE Team Ever Sees Your Books?
You can run a simple self-check this week. Pull your trial balance, flag every liability account with a negative balance, and ask for an explanation supported by underlying records.
In this review, the flagged accounts included Cafe Plan and Medical, Life Insurance Withheld, Holiday and Vacation Accrual, and Accrued Income Taxes. Because these are routine payroll and accrual accounts, they are a practical place to start your own review.
Then look beyond negative liabilities. Accounts that stay unchanged for unusual periods, large round-number adjustments, unexplained journal entries, and balances that don’t agree across entities deserve the same attention.
FAQs About Quality of Earnings Reviews
Is a quality of earnings review the same as an audit?
No. An audit evaluates whether financial statements are fairly presented, while a QoE focuses on sustainable earnings, working capital, and adjustments that may affect a transaction.
What is the difference between a sell-side and buy-side QoE?
A sell-side QoE is commissioned by the owner before going to market. A buy-side QoE is commissioned by the buyer to test the seller’s financial information, and some transactions involve both.
How many years of financials will a buyer want to see?
Buyers commonly request multiple years of historical financials plus current year and trailing results. The exact period and level of monthly detail depend on the transaction.
What are add-backs, and will a buyer accept mine?
Add-backs adjust earnings for costs the seller believes won’t continue after the transaction. Buyers evaluate each adjustment, and weak support can reduce or eliminate it.
Read More >>>
Janine Smith is a Consulting CFO with TGG. She has a wealth of experience in accounting process development and management, supervising both TGG staff and client’s internal staff (banking, AR, AP, inventory management, payroll), and working with many different types of accounting software. She has worked with clients to develop KPIs that fit their current needs and coached them to support the goals of the business. One of her favorite tasks is budget development and using that as a tool to help organizations meet their goals.