--- name: quality-of-earnings-analyzer description: "Normalizes reported EBITDA into a defensible adjusted earnings figure by categorizing and stress-testing every management adjustment — one-time items, owner-specific costs, accounting policy differences, and pro forma run-rate changes — then builds an EBITDA bridge with a sustainability rating and commentary for each add-back. Use when running quality of earnings analysis on an acquisition target, validating management's adjusted EBITDA, or preparing a normalized earnings basis for valuation or diligence." argument-hint: "[pnl-data] [management-adjustments]" allowed-tools: ["Read"] --- # Quality of Earnings Analyzer ## Purpose Convert a target's reported earnings into a defensible normalized EBITDA by classifying, quantifying, and stress-testing each management adjustment — then present the result as an EBITDA bridge with a sustainability rating and diligence commentary on every add-back. Solves the core M&A problem of a seller's inflated "adjusted EBITDA" driving an overpriced deal. ## When to Use Invoke this skill when the user asks to: - Analyze quality of earnings on an acquisition or investment target - Normalize or "clean up" EBITDA for valuation purposes - Validate or challenge management's adjusted EBITDA add-backs - Build an EBITDA bridge from reported to adjusted earnings - Assess which earnings adjustments are sustainable versus aggressive - Prepare a normalized earnings basis ahead of a QoE report or valuation model ## Inputs Required Before starting, collect: - **Reported P&L**: Revenue, COGS, operating expenses, and reported EBITDA — ideally trailing twelve months plus 2–3 prior fiscal years - **Management's proposed adjustments**: The list of add-backs/deductions management wants credited, with dollar amounts and their stated rationale - **Ownership/management structure**: Owner compensation, family members on payroll, related-party arrangements, personal expenses run through the business - **Accounting basis**: Cash vs. accrual, revenue recognition method, capitalization vs. expensing policies, any recent policy changes - **One-time events**: Litigation, restructuring, COVID impacts, PPP loans, non-recurring gains/losses in the period - **Deal context**: Purchase multiple being contemplated and whether earn-outs or seller notes are involved If prior-year comparatives are missing, work off the TTM figure and flag that trend-based sustainability testing is limited. If a purchase multiple is unknown, quantify the valuation sensitivity per $100K of contested add-back. ## Instructions ### Step 1: Establish the Reported Baseline Anchor to reported (unadjusted) EBITDA before any add-backs. Reconcile it to the P&L: Revenue − COGS − OpEx = EBIT; add back D&A = reported EBITDA. State the number explicitly and note the period (TTM vs. fiscal year). Every adjustment downstream moves off this baseline. ### Step 2: Classify Every Adjustment Into One of Six Categories Take each proposed adjustment and each item you independently identify, and sort it: - **1 — One-Time / Non-Recurring**: Genuinely won't repeat (settled litigation, one-off consulting project, storm damage). Add-backs that increase EBITDA. - **2 — Owner-Specific / Discretionary**: Costs tied to current ownership that a buyer won't inherit or will replace at market (above-market owner comp, family on payroll, personal vehicles, country club, personal travel). Requires netting against a replacement cost. - **3 — Accounting Policy / Non-Cash**: Adjustments from policy differences (cash-to-accrual conversion, revenue recognition timing, capitalized vs. expensed items, inventory method). - **4 — Pro Forma / Run-Rate**: Forward-looking normalization (full-year effect of a mid-year hire, contracted price increase, closed-but-not-yet-reflected customer). Highest scrutiny. - **5 — Aggressive / Rejectable**: Add-backs that fail as normal operating costs (recurring "one-time" items, growth investments dressed as non-recurring, unsupported management estimates). - **6 — Missing Deductions**: Items management omitted that a buyer must add going forward (deferred maintenance, under-market key-person salary, subscription costs about to hit, missing corporate overhead in a carve-out). ### Step 3: Quantify and Substantiate Each Adjustment For every item, capture: - Dollar amount and direction (+ increases EBITDA / − decreases) - Category from Step 2 - Evidence basis: **Documented** (invoices, contracts, board minutes), **Estimated** (management-supplied, no source), or **Unsupported** - For Owner-Specific items: net the add-back against the market-rate replacement cost (e.g., add back $600K owner comp, deduct $250K market GM salary → net $350K add-back) ### Step 4: Assign a Sustainability Rating to Each Adjustment Rate each on a **High / Medium / Low** scale using these tests: - **High**: Documented, non-recurring by nature, or contractually locked (signed price increase, terminated lease). A buyer would credit this. - **Medium**: Directionally reasonable but reliant on management estimates or unproven run-rate assumptions. Credit partially or place in earn-out. - **Low**: Recurring in substance, unsupported, or speculative. Recommend rejecting or heavily discounting. Write one to two sentences of commentary per adjustment explaining the rating and the diligence step that would confirm or kill it. ### Step 5: Build the EBITDA Bridge Construct a walk from reported to adjusted EBITDA: - Line 1: Reported EBITDA - Grouped adjustment lines by category (one-time, owner-specific net, accounting, pro forma, rejected items shown but zeroed, missing deductions) - Ending line: **Adjusted EBITDA (our view)** Then show two views side by side: **Management's Adjusted EBITDA** vs. **Analyst-Supported Adjusted EBITDA**, and state the gap in dollars. ### Step 6: Quantify the Valuation Impact Translate the EBITDA gap into dollars at the contemplated multiple: (Management EBITDA − Supported EBITDA) × multiple = purchase price overstatement. If no multiple is given, express as valuation swing per $100K of contested add-back across a 4x–8x range. ### Step 7: Deliver Diligence Recommendations Close with a prioritized list of the specific documents or confirmations needed to resolve the Medium and Low items, and which contested adjustments belong in an earn-out or price adjustment rather than base EBITDA. ## Output Format - **Structure**: Narrative diagnosis supported by a categorized adjustment table and a formal EBITDA bridge table - **Length**: 1,000–1,400 words - **Format**: Prose sections plus two tables — (1) adjustment detail table with columns for Item, Category, Amount, Evidence Basis, Sustainability Rating, Commentary; (2) EBITDA bridge from reported to adjusted - **Sections**: Reported Baseline → Adjustment Classification Table → EBITDA Bridge → Management vs. Supported Comparison → Valuation Impact → Diligence Recommendations - **Tone**: Diligence practitioner — skeptical, evidence-first, quantified. Defaults to challenging add-backs rather than accepting them. ## Quality Checklist Before delivering output, verify: - [ ] Reported EBITDA baseline is stated and reconciles to the P&L before any adjustments - [ ] Every adjustment is assigned exactly one of the six categories and one sustainability rating - [ ] Owner-specific add-backs are netted against market-rate replacement cost, not credited gross - [ ] The EBITDA bridge foots — reported EBITDA plus/minus all adjustment lines equals the supported adjusted figure - [ ] The gap between management's and the analyst's adjusted EBITDA is stated in dollars and translated to a valuation impact - [ ] At least one specific document or confirmation is named to resolve each Medium- and Low-rated adjustment ## Notes - The most common inflation tactic is recurring costs relabeled as "one-time" — scrutinize any add-back that appears in more than one period and downgrade it to Low. - Pro forma run-rate adjustments are where sellers extract the most unearned value; default to placing these in an earn-out rather than base EBITDA unless contractually locked. - In carve-out deals, the biggest risk is understated standalone overhead (Category 6), not overstated add-backs — actively hunt for missing corporate costs the target absorbed from a parent. - When evidence is management-supplied only, rate no higher than Medium regardless of how reasonable the number appears. --- ## How to use this skill This file is a Claude Code skill in [Anthropic's standard format](https://docs.anthropic.com/en/docs/claude-code/skills) — markdown with YAML frontmatter at the top. **Installing in Claude Code:** - `~/.claude/skills//SKILL.md` — auto-loads in every session anywhere on your machine (recommended for skills you'll use across multiple projects) - `/.claude/skills//SKILL.md` — auto-loads only when working in that project (recommended for project-specific skills) Restart Claude Code or open a new session to register. **Using in Claude.ai, ChatGPT, Gemini, or other AI tools:** 1. 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