Reference
FDD and QoE Glossary
A reference to the financial due diligence and quality of earnings terms used in M&A transactions. Each entry sets out the definition, a worked example and the points a diligence team tests.
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Short answers to the questions deal teams ask most often.
What is included in a QoE report?The usual sections of a QoE report and how it is laid out, from executive summary to detailed schedules.Read answerWhat is the difference between QoE and FDD?A QoE tests the sustainability of earnings; FDD is the wider review that includes the QoE.Read answerHow long does a QoE take?A QoE takes a few weeks to a few months; data readiness and complexity drive the timeline.Read answerWhat affects the cost of a QoE?What drives the cost of a QoE: complexity, entities, periods, book quality and scope.Read answerWhat is the difference between a QoE and an audit?An audit gives assurance on financial statements; a QoE tests how sustainable reported EBITDA is.Read answerEBITDA vs adjusted EBITDA: what's the difference?Reported EBITDA, corrected for one-off, non-operating and owner-related items.Read answerWhat are add-backs, and which are accepted?Which expenses buyers accept as add-backs to EBITDA, and which they challenge.Read answerWhat are typical QoE and FDD adjustments?The usual categories of EBITDA adjustment, who proposes them and how each is tested.Read answerWhat is a working capital peg?The normal level of working capital agreed in the purchase agreement; the price adjusts above or below it.Read answerWhat are debt-like items?Obligations that act like borrowings and are deducted from the price like debt.Read answerWhat is a proof of cash?A reconciliation of bank activity to the books, showing earnings are backed by actual cash.Read answerDo you need a QoE for an SBA loan?From 1 October 2026, a lender-obtained QoE is required for SBA 7(a) acquisitions of $3 million or more.Read answerBuy-side vs sell-side QoE: what is the difference?Commissioned by the buyer to test the price, or by the seller to support it before going to market.Read answerWhat are red flags in financial due diligence?Findings that suggest results may be unreliable or the deal carries hidden risk.Read answer
Category
Basics
The diligence process, the documents it runs on and the vocabulary of a transaction.
Due diligenceThe buyer’s investigation of a target before closing, to verify its claims and identify risks to price and terms.Read definitionFinancial due diligence (FDD)The workstream that tests earnings, cash, working capital and debt to show what a buyer is paying for.Read definitionQuality of earnings (QoE)Tests how much reported profit is recurring and restates it as adjusted EBITDA for pricing and financing.Read definitionQoE vs auditAn audit opines on compliance with an accounting framework; a QoE assesses sustainable earnings for a deal.Read definitionBuy-side vs sell-side diligenceBuy-side diligence is commissioned by the buyer; sell-side is commissioned by the seller before going to market.Read definitionReviewed vs audited vs compiledThe three levels of CPA involvement with financial statements: no assurance, limited assurance and reasonable assurance.Read definitionLetter of intent (LOI)A short, largely non-binding document setting out the principal terms of a proposed deal before diligence.Read definitionData roomA secure, indexed repository through which a seller shares documents with bidders and their advisors.Read definitionInformation request list (IRL)The list of documents and data a diligence team requests from the seller, tracked to completion.Read definitionConfirmatory diligenceA focused review that confirms information already provided, such as a sell-side QoE, rather than starting afresh.Read definitionVendor due diligence (VDD)An independent report commissioned by the seller and shared with bidders, with reliance for the winning buyer.Read definitionValuation multipleA ratio expressing value as a multiple of a financial measure, most often EBITDA.Read definitionRed flags in due diligenceWarning signs suggesting earnings, cash or risk differ from the seller’s presentation.Read definitionTrial balance and general ledgerThe ledger of every entry and its monthly summary of account balances, the starting point for diligence analysis.Read definitionLTM (last twelve months)The most recent twelve months of results, ending on the latest month available.Read definitionQoE report partsThe usual sections of a QoE report and how it is laid out, from executive summary to detailed schedules.Read definitionQoE vs FDDA QoE tests the sustainability of earnings; FDD is the wider review that includes the QoE.Read definitionQoE timelineA QoE takes a few weeks to a few months; data readiness and complexity drive the timeline.Read definitionQoE costWhat drives the cost of a QoE: complexity, entities, periods, book quality and scope.Read definition
Category
Earnings and quality
How reported profit is tested, adjusted and normalized into a figure a buyer can price.
EBITDAOperating profit before interest, taxes, depreciation and amortization; the basis on which most deals are priced.Read definitionAdjusted EBITDAEBITDA restated for one-off items, errors, non-market costs and known changes; the figure price is based on.Read definitionNormalized EBITDAEBITDA restated to show earnings in a typical year, removing unusual items and non-market costs.Read definitionAdd-backsCosts added back to EBITDA because they are one-off, owner-specific or will not continue after the sale.Read definitionPro forma adjustmentsAdjustments restating past results as if a known change had been in place for the whole period.Read definitionRun-rate EBITDAA recent short period of EBITDA scaled to a full year to show earnings at the current pace.Read definitionQoE adjustmentsThe usual categories of EBITDA adjustment, who proposes them and how each is tested.Read definitionOwner’s compensation normalizationReplacing the owner’s actual pay and perks with the market cost of the role.Read definitionSeller’s discretionary earnings (SDE)The total annual benefit to one full-time owner-operator, used to value small owner-run businesses.Read definitionNon-recurring itemsUnusual or infrequent income and costs removed so that EBITDA reflects ongoing performance.Read definitionRelated-party transactionsDealings with owners, family or affiliated businesses, tested for market terms and continuity after the sale.Read definitionRevenue recognitionThe rules deciding when and how much revenue is recorded, under ASC 606 and IFRS 15.Read definitionQuality of revenueBreaks sales down by customer, product, price and volume to show how stable revenue is and what drives growth.Read definitionCustomer concentrationHow much of revenue depends on the largest customers, and how secure those relationships are.Read definitionRecurring revenue (MRR and ARR)Monthly and annual recurring revenue from ongoing contracts, and the movements that change them.Read definitionChurn and cohort analysisMeasures customer or revenue loss, and tracks groups of customers by start date to show retention over time.Read definitionGross marginThe share of revenue left after the direct costs of making or delivering the product or service.Read definitionContribution marginRevenue less variable costs: what each product, customer or channel contributes to fixed costs and profit.Read definitionSeasonalityThe regular within-year pattern of higher and lower activity, which affects run-rate claims and working capital targets.Read definitionCut-off testingTests that sales and expenses near a period end are recorded in the correct period.Read definitionCash-to-accrual conversionRestating cash-basis results to the accrual basis so that periods can be compared fairly.Read definitionProof of cashReconciles recorded revenue and expenses to actual bank movements, month by month.Read definition
Category
Cash, working capital and debt
Cash generation, working capital mechanics and the items that move the price at closing.
Free cash flowThe cash generated after taxes, capital expenditure and working capital, available for debt service and owners.Read definitionCash conversionThe share of EBITDA converted to cash after capital expenditure and working capital.Read definitionMaintenance vs growth capexCapital spending needed to sustain current operations compared with spending that expands capacity.Read definitionNet working capital (NWC)Operating current assets less operating current liabilities, excluding cash, debt and income taxes.Read definitionWorking capital pegThe agreed normal level of net working capital the seller must deliver at closing.Read definitionWorking capital true-upThe post-closing price adjustment that settles estimated against final closing working capital.Read definitionDSO, DPO and DIODays of sales in receivables, days of cost in payables and days of cost in inventory.Read definitionAccounts receivable ageingUnpaid customer invoices grouped by age, used to judge how much of receivables will be collected.Read definitionInventory obsolescenceStock that can no longer be sold at recorded cost, tested to confirm inventory is realistically valued.Read definitionDeferred revenueCash received for goods or services not yet delivered; a liability until performance.Read definitionAccrued expensesCosts incurred but not yet paid or invoiced at period end; often missing in smaller companies.Read definitionNet debtBorrowings less cash, deducted from enterprise value to reach the price for the shares.Read definitionDebt-like itemsObligations that are not borrowings but will require cash after closing for pre-closing events; deducted from the price.Read definitionOff-balance-sheet and contingent liabilitiesObligations not recorded on the balance sheet, or dependent on a future event, that can cost the buyer after closing.Read definitionEnterprise value vs equity valueEnterprise value is the value of the operating business; equity value is what remains for shareholders.Read definitionCash-free debt-freeThe usual basis for pricing private deals: no cash, no debt and a normal level of working capital.Read definitionEscrow and holdbackPart of the price held back to cover post-closing claims, by a third party (escrow) or by the buyer (holdback).Read definitionSeller noteA loan from the seller to the buyer for part of the price, repaid over time with interest.Read definitionEarn-outPart of the price paid only if the business reaches agreed targets after closing.Read definition
Category
US accounting and tax
US GAAP and tax exposures that surface most often in lower middle market diligence.
US GAAPThe US accounting framework, codified by FASB, that purchase agreements usually apply “consistently”.Read definitionASC 842 leasesThe US GAAP lease standard placing most leases on the balance sheet, with consequences for EBITDA and net debt.Read definitionSales tax nexusThe connection to a US state that requires a seller to register, collect and remit its sales tax.Read definitionWorker classificationWhether workers are employees or independent contractors; misclassification creates back taxes and higher future cost.Read definitionUnclaimed propertyMoney owed to others and never collected, which state law requires to be reported and remitted to the state.Read definitionTax basis step-upResetting the buyer’s tax basis in acquired assets to the price paid, creating deductions over time.Read definition
Category
Deal types and structure
Transaction structures and the diligence considerations each one brings.
Carve-outThe sale of a division or business unit that has never operated on its own, requiring standalone earnings to be estimated.Read definitionLBO (leveraged buyout)An acquisition financed mainly with debt that is repaid from the acquired company’s own cash flow.Read definitionSBA 7(a) acquisitionA small business purchase financed by a bank loan partly guaranteed by the US Small Business Administration.Read definitionSearch fundA vehicle in which an entrepreneur raises capital to search for, buy and run one established business.Read definitionIndependent sponsorA deal professional who sources acquisitions and raises equity deal by deal, without a committed fund.Read definitionDistressed M&AThe acquisition of a business, or its assets, that is in serious financial difficulty.Read definitionAsset vs stock purchaseBuying selected assets and liabilities, or buying the shares and everything the company owns and owes.Read definitionLocked box vs completion accountsTwo ways to fix the final price: on a past balance sheet with no adjustment, or adjusted after closing.Read definitionR&W insuranceAn insurance policy covering the buyer for losses from breaches of the seller’s representations.Read definitionTransition services agreement (TSA)A contract under which the seller keeps providing services to the sold business for a limited period.Read definitionPurchase price allocation (PPA)Assigning the price paid to the fair value of assets acquired and liabilities assumed, with the remainder as goodwill.Read definition
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