How is a QofE analysis professionally performed?
March 21, 2023
Examines the accuracy, quality, and sustainability of revenue.
Transaction Advisory
Audits & Analysis
Performing a quality of earnings (QofE) analysis requires a range of professional skills and industry expertise. Below, we summarize the key steps and considerations typically involved in a QofE analysis for a healthcare entity.
Data Needs
A QofE analysis is conducted based on a thorough review of an extensive amount of relevant data. Besides financial statements (both internally and externally prepared), analysts will review a great deal of non-financial information, such as market data, organizational documents, provider and non-provider rosters and compensation history, financing documents, and payer or vendor contracts.
The non-financial information provides valuable insights into the broader context in which the subject company operates.
Management Interview
Management interviews are generally conducted after the analyst completes an initial review of the subject company’s data. It is a critical step of the QofE process because it helps the analyst better understand the reported financials, gain insights into the subject company’s operations, discover areas of risks and opportunities, and identify proper normalization and pro forma adjustments.
The topics discussed during a QofE management interview can vary depending on the subject company and the specific focus of the analysis. Some common discussion areas may include financial reporting policies, expense management practices, cash flow management procedures, competitive landscape, and growth opportunities and strategies. For more complex assignments, the analyst may conduct multiple management interviews throughout the QofE process.
Quality of Revenue
For healthcare entities, a comprehensive quality of revenue analysis is key to the QofE process.
Quality of revenue looks beyond the historical income statements and examines the accuracy, quality and sustainability of the revenues reported.
Quality of revenue analysis typically starts with a high-level review of the company’s revenue cycle management (RCM) functions, including policies and processes for charge capture, coding, claim submission, and billing and collection.
The basis of quality of revenue analysis from a quantitative perspective is raw billing data out of the practice management system(s) at the CPT-level of detail. This analysis typically comprises the following components:
- Analysis of reported revenues, including source of revenue and corresponding benchmarking and trend analyses.
- Revenue cash-to-accrual analysis for companies on cash basis accounting, using a collection waterfall analysis.
- Revenue cash proof analysis by reconciling collections against deposits recorded in the company’s bank statements.
Due Diligence and Pro Forma Adjustments
Due diligence and pro forma adjustments are identified and made to reported EBITDA to arrive at normalized EBITDA. Due diligence adjustments may include one-time, non-recurring expenses, out-of-period revenues and expenses, non-business or discretionary expenses, accounting errors, related-party transactions, unreported or underreported liabilities, and owner/executive compensation.
Pro forma adjustments are generally made to normalize the trailing twelve months’ (TTM) performance to account for changes that occurred during the year or immediately thereafter to present the performance of the target as if the new situation or scenario occurred from the beginning of the TTM period. Examples of these scenarios include discontinued operations, addition of a new service line, and material reimbursement changes.
Analysts identify due diligence and pro forma adjustments via a thorough review of the subject company’s financial and non-financial data as well as management interviews.
Other Healthcare-Specific Considerations
Several special considerations need to be taken into account when performing QofE analysis and EBITDA Adjustments on a healthcare entity. These may include, but are not limited to:
- Stability and diversity of referral source
- Volume and mix of patients, cases, and procedures
- Utilization and capacity of providers, facilities, and equipment
- Payer mix and payer contracts
- Accuracy of billing and coding practices
- Reimbursement environment on an overall basis as well as specific to the specialty or type of facility under consideration
- Seasonality factors for certain medical specialties or facilities
- Age and condition of fixed assets and required maintenance and growth capital expenditures
- Compliance and regulatory environment
- Stability and availability of non-provider staff and labor costs
- Structure and operational expenses, in particular, high-ticket items such as medical supplies, drugs and insurance, and the anticipated cost increases associated with those expenses
- Historical and anticipated go-forward provider compensation arrangements
An understanding of the unique healthcare-specific factors is required to render an accurate assessment of healthcare entities’ financial health and sustainability, and to identify and develop reasonable normalization and pro forma adjustments within the QofE analysis.
Often, an operational assessment and procedural coding audit are conducted in conjunction with a QofE analysis to identify key risks and opportunities present in the subject company’s operations. Within a sell-side QofE, these more in-depth analyses can help uncover potential issues and provide a path for remediation, thereby enhancing the business value for the seller.
Balance Sheet Considerations and Working Capital
Although QofE focuses on the subject company’s earnings (i.e., income statements items), it also involves the review and analysis of various balance sheet items.
Generally, key balance sheets reviewed include the condition of the company’s assets and debt, including any off-balance sheet liabilities. In addition, a normalized level of working capital (i.e., working capital target) will also be estimated to be maintained at the close of the transaction.
Contact us today to speak with our experienced financial consultants and see if a QofE analysis will meet your needs.
