Earnings Quality For Deal Teams
This conversation was generated using Cook'd AI's career assistant and reviewed by Fallon Han from our editorial team for accuracy.
I am a final-year business analytics student at a Canadian university and I am interviewing for transaction services in Toronto. I want a diligence-style practice interview focused on spotting normalized earnings issues. Can you challenge me with quality-of-earnings questions and be skeptical about management adjustments?
Absolutely. I will run this like a transaction services interview, not a friendly classroom chat. I will press on revenue quality, margin sustainability, and every adjustment management makes.
First question: Walk me through how you would test whether EBITDA is truly normalized in a target business. What specific adjustments would you challenge before accepting the number?
I would start by separating recurring operating performance from one-time items. I would review management add-backs for restructuring, legal, owner compensation, and COVID-related impacts, then check whether those costs really are non-recurring. I would also compare monthly trends, customer concentration, and gross margin stability to see if the business is actually consistent.
Good structure, but I want more skepticism. Suppose management adds back professional fees, severance, and a bad debt spike. How do you decide which of those are valid, and what evidence would you ask for to prove they will not happen again?
I would ask for invoices, board materials, and timing of each cost to see whether the event was tied to the transaction, a control failure, or normal operating risk. For bad debt, I would test whether the spike was caused by a few one-off customer failures or by weak credit policy. If the same issue is happening every year, I would not normalize it away.
Better. Now let us make it harder. The company shows strong adjusted EBITDA, but cash from operations is weak. What normalized earnings issues could explain the gap, and how would that affect your diligence view?
That could indicate aggressive revenue recognition, working capital pressure, or add-backs that improve EBITDA but do not create cash. I would look at receivable days, deferred revenue, inventory buildup, and capitalized costs. If earnings depend on stretching payables or collecting slower, I would discount the quality of earnings and flag it as a risk for debt capacity and purchase price support.
Strong answer. Final question: Management says last year included non-recurring gains and that this year is a better base year. What is the risk in using that statement too quickly, and how would you present your conclusion in a report to a Toronto deal team?
The risk is that they may be shifting the base year to make the business look cleaner without proving the underlying economics improved. I would test whether the gain was truly non-recurring and whether the current year has hidden costs that are likely to continue. In the report, I would separate identified adjustments, unsupported add-backs, and ongoing normalization items, then give a conservative EBITDA range with comments on earnings quality and key sensitivities.