QoE and FDD, explained simply
People often use the two terms for the same piece of work. In most transactions the QoE is the core of financial due diligence, and the FDD adds the balance sheet and cash items that decide how the headline price becomes the price actually paid.
Agreeing the scope at the start avoids a report that answers the earnings question but leaves working capital and debt open.
QoE and FDD compared
IllustrativeThe QoE answers the earnings question. FDD answers that question and the questions around it.
Side by side
| Quality of earnings | Financial due diligence | |
|---|---|---|
| Purpose | Show how much of reported EBITDA is sustainable | Identify what a buyer is paying for and what protects the price |
| Scope | Adjustments, revenue quality, margins, proof of cash | The QoE plus net working capital, net debt and debt-like items, cash flow and other deal items |
| Main outputs | Adjusted EBITDA | Adjusted EBITDA, normalized working capital and peg, net debt and debt-like items |
| Used for | Pricing and lender underwriting | Pricing, purchase agreement terms and closing mechanics |
Worked example
Alder Creek’s QoE shows adjusted EBITDA of $4.60 million. At 8.0x, that implies an enterprise value of $36.8 million. The wider FDD then sets the working capital peg and identifies the debt-like items that move the figure from enterprise value to the price paid for the shares.
Alder Creek Manufacturing, Inc. is a fictional company. All figures are illustrative.
Why it matters in a deal
The scope decides which questions are answered before signing. Leaving working capital or debt-like items out of the scope tends to move those discussions into the purchase agreement, where they are harder to resolve.
Red flags
- A report called a QoE that does not cover working capital or net debt on a deal that needs both
- A scope that is not written down
- Different advisers working from different definitions of EBITDA