Quality of Earnings (QOE) refers to the sustainability, predictability, and stability of a company’s earnings. It is a measure of the underlying economic performance of a company, and it is used to assess the quality of a company’s earnings and its ability to generate future cash flows.
The formula is Net Cash from Operating Activities/Net Income. This shows what % of net income is being actually realised. It should fluctuate around 100%. If consistently and significantly below 100, it means that the net income is suspicous. If consistently and significantly more than 100, you need to evaluate the impact of depreciation – and based on that decide if the cash flows from operations appear suspicious
QOE analysis is typically conducted during a due diligence process, when considering an investment in a company or a potential acquisition. It is a comprehensive evaluation of a company’s financial performance and operational efficiency, which includes the review of financial statements, operational reports, and other relevant financial data.
The QOE analysis typically includes:
-Evaluating the company’s revenue and cost structure, including gross margins, operating expenses, and other income and expenses.
-Analyzing the company’s working capital management, such as inventory turnover and accounts receivable aging.
-Reviewing the company’s capital expenditures, such as investments in property, plant, and equipment.
-Analyzing the company’s cash flow, to identify any potential risks or opportunities that may impact the company’s future earnings.
