Red Flags in Financial Statements: What a Quality of Earnings (QoE) Analysis Reveals That Financial Reviews Miss
In the world of mergers and acquisitions, numbers can be deceiving.
Just ask Hewlett-Packard. In 2011, HP acquired UK software company Autonomy for over $11 billion—only to write down $8.8 billion the following year, citing “accounting improprieties and misrepresentations” [source].
This costly oversight highlights a critical truth for investors and acquirers: financial statements alone don’t tell the full story. To truly understand a business’s performance and value, a deep-dive Quality of Earnings (QoE) analysis is essential.
What Is a Quality of Earnings (QoE) Analysis?
While audits verify whether a company’s financial statements adhere to accounting standards, a QoE analysis goes much deeper. It evaluates the sustainability, accuracy, and source of earnings—filtering out noise to uncover the true earning power of the business.
In M&A, where valuations often hinge on headline numbers like EBITDA or net income, a QoE report exposes whether those numbers reflect genuine performance or accounting manipulation.
🔗 Learn more from Harvard Business Review on the dangers of earnings manipulation
At MARC, we deliver forensic-level QoE analysis that surfaces operational, financial, and structural red flags—long before a deal is inked.
5 Red Flags That QoE Analysis Can Uncover
A thorough QoE review can reveal far more than routine due diligence. Here are five critical red flags it often brings to light:
1. Aggressive or Inconsistent Accounting Practices
– Red Flag: Premature revenue recognition or deferred expense reporting
– QoE Impact: Reviews accounting policy consistency (GAAP/IFRS), flags aggressive methods, and adjusts inflated earnings that mislead investors
🔗 Investopedia: Aggressive Accounting
2. Unreliable Revenue Quality
– Red Flag: One-time or seasonal revenue passed off as recurring
– QoE Impact: Assesses how revenue is generated and sustained—vital in understanding future performance, customer churn risk, and topline reliability
🔗 McKinsey: The truth behind revenue growth
3. Customer and Supplier Concentration Risk
– Red Flag: Heavy reliance on one or two clients or suppliers
– QoE Impact: Evaluates the financial risk posed by overdependence and its impact on business continuity and valuation
🔗 CFO.com: How customer concentration affects valuations
4. Cost Structure Gaps & Margin Manipulation
– Red Flag: Artificial margin boosts via cost suppression
– QoE Impact: Identifies fixed vs variable costs, delayed investments (like marketing or hiring), and assesses how sustainable current margins truly are
🔗 EY: Improving margin transparency
5. Unjustified EBITDA Add-Backs
– Red Flag: Inflated EBITDA due to non-standard adjustments
– QoE Impact: Filters out non-recurring items (e.g., personal expenses, inflated salaries), recalculates normalized EBITDA, and assesses true profitability
🔗 Corporate Finance Institute: What is EBITDA and its pitfalls
Case Studies: When QoE Made or Saved the Deal
Wirecard’s €24 Billion Collapse (2020)
A QoE-style review exposed €1.9B in fictitious cash accounts, leading to one of the biggest financial frauds in Europe. Investors lost billions—proof that revenue quality is everything.
🔗 Read full case via Financial Times
Aeon’s Terminated Acquisition of SeABank’s Lending Unit (2025)
Post-deal analysis revealed accounting inconsistencies not disclosed earlier. The acquisition was abandoned, emphasizing how early QoE can prevent costly litigation and deal failure.
🔗 Read more on DealStreetAsia (use internal search or customize if direct URL is available)
How MARC Delivers Confidence Through QoE
At MARC, our Quality of Earnings reviews aren’t just about numbers—they’re about clarity, risk reduction, and smarter dealmaking.
Case Study: XYZ LLC – U.S. Contract Research Organisation
A MARC-led QoE review revealed:
– Normalized EBITDA declined from -2% to -14%
– 62% of revenue came from low-margin, core offerings
– Customer acquisition fell by 45% YoY
– General/Admin expenses rose despite headcount cuts
– 36% increase in payables, 67% overdue
– 99% of fixed assets were fully depreciated
– EBITDA was adjusted down by $500K for non-sustainable related-party income
– Internal control gaps and outdated assets impacted valuation
Outcome: The client renegotiated valuation, avoided a risky acquisition, and gained full transparency before closing.
Final Thoughts: Don’t Let Financial Red Flags Derail Your Next Deal
In an era where deal velocity is high but trust is low, a Quality of Earnings analysis is no longer optional—it’s essential. It empowers you to cut through financial fog, uncover hidden risks, and invest with precision.
✅ Ready to unlock deeper financial insights?
Partner with MARC to ensure your next deal is driven by insight, not hindsight.
📩 Contact us for a confidential discussion.
