Earnings quality and a price gap in a distribution business

The business had grown revenue steadily and reported improving EBITDA. The asking price implied a multiple in the high single digits, which the seller justified on growth and on what they described as one-off costs depressing the reported result.

The buyer had limited information at that stage: two years of accounts and a summary management pack.

Whether each adjustment was genuinely non-recurring, and whether the underlying cost would continue after completion.

How much of the reported growth was volume, and how much was a change in customer mix or supplier terms.

Whether cash generation supported the reported profit, given the working capital demands of the business.

Each adjustment was listed and tested against the accounts and the narrative provided, with a judgement recorded on whether it was supportable.

Revenue growth was split between volume, price and mix using the management pack and supplier data.

Operating cash flow was compared with reported EBITDA, and the working capital movement was isolated.

Two of the five adjustments related to costs that had recurred in each of the three years presented, and were therefore ordinary running costs rather than one-offs.

Growth in the most recent year was driven by a single new account at a materially lower gross margin than the existing book, so the profit contribution was much smaller than the revenue increase suggested.

Working capital had absorbed a significant proportion of the additional profit as the new account carried longer payment terms.

On a supportable earnings basis, the implied multiple was materially above the range seen in comparable transactions.

The buyer rebuilt the valuation on a normalised earnings figure and presented the reconciliation rather than a headline number.

The supplier terms behind the growth were treated as a matter to be confirmed before any commitment.

A structure was proposed in which part of the consideration depended on the new account being retained on the terms assumed.

The buyer did not proceed at the asking price. Discussions continued on a revised basis with a clearer earnings definition and a structure linked to the assumptions behind the growth case.

An adjustment that appears in each year presented is not an adjustment, it is a cost.

Revenue growth and profit growth are not the same thing, and the difference is usually found in margin and working capital.

Presenting a reconciled earnings figure is more effective in negotiation than arguing about the multiple.