Quality of earnings: adjusted EBITDA and the EBITDA bridge
A quality of earnings (QoE) analysis asks how much of the reported earnings will recur under a new owner. Many deals are priced as a multiple of EBITDA, so every euro of EBITDA that is not sustainable moves the price by that multiple.
From reported to adjusted EBITDA
The bridge starts from EBITDA as booked. Normalisations correct the history: one-off or unusual items, income and costs outside the operating business, items booked in the wrong period or on the wrong side of EBITDA. The result is normalised EBITDA. Pro forma adjustments then restate the history to the structure the buyer will own, for example an acquisition during the year, a closed division or a new cost base. The result is adjusted EBITDA.
Typical adjustments
- One-off items: a lawsuit, a restructuring, the costs of the sale itself.
- Owner-related items: a managing shareholder paid above or below the market rate, private costs booked in the company, rent paid to the owner.
- Reclassifications: income or costs on the wrong side of EBITDA, such as interest booked in other operating expenses.
- Out-of-period items: an accrual missed at a year-end and booked in the next year.
- Pro forma: a full year of an acquired business, a cost saving already contracted.
Management proposes adjustments; the diligence team accepts, questions or rejects each one. A buyer reads the rejected ones too: they show where seller and adviser disagree.
Adjusted EBITDA and cash
An adjustment changes EBITDA, but not always cash. A provision released, or a cost accrued and still unpaid at the balance sheet date, already sits in the change in working capital. Counted in adjusted EBITDA and again in working capital, it is counted twice. A cash conversion analysis therefore notes for each adjustment whether it was cash in its year.
Quality of earnings in sakto
In sakto each EBITDA adjustment has a category (one-off items, owner-related, reclassifications, pro forma or other), a source (management's proposal or the adviser's) and a status: accepted, open or rejected. Open ones count but are shown apart; rejected ones are listed, not counted.
The EBITDA bridge runs from reported EBITDA through the normalisations to normalised EBITDA, then through the pro forma adjustments to adjusted EBITDA, each adjustment with its reason, by year and LTM.
Each adjustment says whether it was cash in its year, never cash, or still unpaid at the balance sheet date, and the cash conversion reconciles to the reported cash flow.
The final databook exports only once every EBITDA adjustment has a reason. Figures come from deterministic code. An AI assistant reads them only if you connect one.
Questions
What is the difference between normalised and adjusted EBITDA?
Normalised EBITDA corrects the history as booked: one-off, unusual and non-operating items. Adjusted EBITDA adds the pro forma adjustments that restate it to the structure the buyer will own. Practice varies, so a databook should say which one it shows.
Is a quality of earnings analysis an audit?
No. An audit gives an opinion on whether the annual accounts comply with the law. A quality of earnings analysis asks how sustainable the earnings are; it is part of the due diligence and gives no opinion on the accounts.