An earnings quality adjustments tab – EQA tab – is a single worksheet that reconciles reported earnings to the decision EBITDA you use to price deals and set leverage. Decision EBITDA is the denominator of valuation and the anchor for credit metrics and covenants. LTM means last twelve months; LQA means last quarter annualized. When the tab is clean, lender-ready, and audit-friendly, you compress diligence timelines and reduce amendment risk while keeping the story consistent across all materials.
What the EQA Tab Delivers and Why It Matters
The EQA tab bridges reported operating profit or EBITDA to adjusted, run-rate, and pro forma EBITDA across LTM, LQA, and forward views used in the model. It focuses on earnings quality, not cash conversion – working capital and cash taxes live on separate schedules. It aligns to the company’s reporting basis under US GAAP or IFRS and to the credit agreement’s Consolidated EBITDA definition. Where the credit definition diverges from the sponsor viewpoint, the tab produces both views in parallel so you can satisfy lenders without losing analytical nuance.
Design Rules That Keep Your Tab Audit-Ready
- Auditability: Every line links to a source file, GL account, or contract and carries an ID, preparer, reviewer, and date. That chain of custody makes the tab audit-ready and lender-friendly.
- Minimalism: Use one line per economic event and aggregate only in outputs. Fewer lines reduce reconciliation mistakes.
- Reversibility: Status flags identify cash, non-cash, policy, reclass, run-rate, and pro forma items. You can include or exclude any class without breaking arithmetic, enabling clean sensitivities.
- Period integrity: Each line has start and end dates so weighting into LTM and LQA is formulaic. No hand edits means better comparability.
- Signs and labels: Expenses are negative and revenues positive; add-backs are positive. Pro forma-only items never bleed into historical adjusted figures, preserving covenant certainty.
- Materiality: A threshold drives display and testing intensity. Small items roll into “other,” but nothing disappears.
Core Layout and Calculation Flow
- Header: Show entity, GAAP/IFRS, currency, consolidation scope, and audit/interim review status by year to align context.
- Periodization: Use monthly columns for at least 24 months – quarterly if needed – with LTM and LQA calculated mechanically for straight-through updates.
- Inputs: Pipe totals for revenue, gross profit, operating expenses, D&A, interest, taxes, and standard EBITDA. Add cross-checks to annual and interim financials for zero-defect tie-out. If you need structure, build a simple, audit-ready inputs tab first.
- Adjustments: Maintain granular lines with categories, dates, GL anchors, and documentation links for traceability.
- Calculation engine: Implement LTM/LQA weighting, annualization, run-rate conversion for partial-period items, and pro forma logic aligned to deal timing.
- Output summaries: Provide bridges by category and class – one-time, run-rate, pro forma, policy – and alternate outputs for sponsor vs. credit agreement definitions. A concise earnings bridge clarifies the story.
- Validation panel: Add tie-outs, zero-sum tests for reclasses, duplicate flags, credit caps and “window” checks, and a change log for early error detection.
Adjustment Types That Actually Count
- One-time or unusual: Asset sale gains or losses, restructuring with plans and completion evidence, disaster costs, and litigation settlements. Require contemporaneous support and pattern testing to confirm non-recurrence.
- Policy and estimate changes: ASC 842/IFRS 16 leases, ASC 606 transitions, or capitalized development policy changes. Restate comparatives or show a comparability bridge when restatement is impractical.
- Owner and related-party normalization: Replace related-party rent or management fees with market levels and insert missing charges with third-party support.
- Recurring reclassifications: Move freight into COGS or remove pass-through revenue. These should be zero-sum inside EBITDA unless prior misclassification distorted EBITDA.
- Stock-based compensation: Report both including and excluding SBC. Tie to plan terms and vesting type, and note cash tax effects elsewhere. For modeling, see stock-based compensation techniques.
- Leases: IFRS 16 shifts rent to D&A and interest; ASC 842 leaves operating lease rent in EBITDA. Reconcile frameworks so peers and covenants line up.
- FX and translation: Fix FX rates for LTM/run-rate views per policy. Keep FX gains or losses below operating profit unless the credit definition requires otherwise.
- Revenue recognition: For long-term contracts, normalize change orders and cumulative catch-ups that distort LTM. Exclude purchase accounting deferred revenue impacts from adjusted operating metrics.
- M&A and carve-outs: Time-align inclusions and exclusions, eliminate intercompany, and map customers and products. Include dis-synergies if observable in TSAs, supplier notices, or purchase agreements.
- Cost savings and run-rate: Include only with executed actions: headcount lists, signed rent changes, or vendor term sheets. Items not yet implemented belong in forward views or within the credit agreement’s caps and windows.
- Other: Pension curtailments, discontinued operations, and inventory policy shifts. Watch for “repeat one-offs” that signal structure rather than noise.
Mechanics, Ownership, and Waterfall Outputs
Data sources should cover audited financials, interim reviews, trial balances, GL extracts, lease rollforwards, payroll, customer revenue, top vendor spend, legal settlement letters, and MSAs or TSAs. The preparer is typically the modeling lead, the reviewer is the deal finance lead, a QoE advisor corroborates, and counsel validates credit definition mapping. The tab outputs a three-stop waterfall: Reported EBITDA to Adjusted EBITDA, to Run-Rate EBITDA, to Pro Forma EBITDA with a status flag that controls inclusion.
Fields Every Line Should Carry
- Line ID and description: For example, “Plant consolidation severance; plant ID” using consistent naming.
- Category and class: One-time, run-rate, pro forma, or policy – classes drive inclusion logic.
- P&L anchor: Revenue, COGS, SG&A, D&A, or other – this blocks below-the-line add-backs from creeping into EBITDA.
- Dates and amount basis: Start/end dates drive LTM/LQA weighting; capture both gross and any offsets, plus cash/non-cash status.
- GL reference: Account and department codes enable replicability and reviewer spot checks to source.
- Support link: Use stable data room paths or document IDs.
- Credit mapping: Caps, time limits, currency, and eligibility aligned to the loan documentation.
- Tax note: Deductibility and timing, kept off EBITDA lines to avoid mixing earnings with cash effects.
LTM, LQA, and Run-Rate Conventions
Completed one-time events inside the LTM window enter fully; cross-period items allocate by GL date stamps. For partial-period cost-outs, convert to run-rate by multiplying monthly savings by 12, then subtract realized in-period savings to avoid double counting. LQA is useful for seasonality diagnostics or when LTM is biased; label it as diagnostic, not the covenant base.
Run-Rate Cost Savings Example
Facts: A supplier renegotiation cuts direct material by 2.0 per unit effective May 1. Average monthly volume is 50,000 units. LTM ends September 30; five months are realized. Mechanics: Monthly savings are 2.0 × 50,000 = 100,000. LTM realized equals 5 × 100,000 = 500,000. Run-rate equals 12 × 100,000 = 1,200,000. The adjustment is a run-rate add-back of +700,000, which is 1,200,000 less 500,000 realized. Outputs: Adjusted EBITDA excludes +700,000; Run-Rate EBITDA includes it; Credit Agreement EBITDA includes it only if permitted within caps and windows. For perspective on what lenders accept, see this overview of EBITDA add-backs.
Lease and Revenue Alignment Across Frameworks
Under IFRS 16, EBITDA rises because rent shifts to D&A and interest while cash remains unchanged. Under ASC 842, operating lease rent remains in EBITDA. Provide a toggle:
- Option A: Show “EBITDA pre-IFRS 16” by subtracting IFRS 16 depreciation and adding lease expense as if operating lease accounting applied.
- Option B: Keep the actual standard and normalize peers instead.
For percentage-of-completion revenue, adjust LTM for unusual change orders and discrete catch-ups that skew comparability. Reverse revenue pulled forward by a new measure of progress and reclass it to when it would have been recognized without the change. For subscriptions, recognize churn and executed price changes in run-rate only when billing data supports them.
FX Treatment Without the Noise
Fix an FX rate table and translate non-functional currency adjustments using the same rates applied to the underlying P&L. Isolate FX gains or losses below operating profit unless local GAAP embeds them in COGS. For hyperinflationary economies, apply IAS 29 or local guidance and segregate those effects. The one-line rule of thumb: keep operating performance and translation mechanics separate.
Pro Forma M&A and Carve-Outs That Lenders Trust
- Acquisitions: Include the target’s LTM EBITDA normalized to your policies. Strip discontinued operations and transaction costs. Add only synergies tied to executed actions and within loan document caps and windows. For modeling the broader statements, review how to build pro forma financial statements.
- Divestitures: Remove the unit’s results, reverse corporate allocations, and include TSA effects. Attach allocation rules and a stranded cost plan with timing.
- Financing: Keep financing costs in interest. Include EBITDA-level adjustments only if the credit definition permits them.
Governance, Kill Tests, and Duplicate Control
- Support packs: Each line carries its source file, author, date, GL cross-reference, reviewer signoff, and a cash-observed statement. The tab fails closed if support links are blank.
- Change log: Track prior value, new value, reason, difference, timestamp, and user ID. This audit trail is mandatory for lender or public materials.
- QoE tie-out: Maintain a static copy of QoE exhibits with a map from QoE line IDs to tab line IDs. Reconcile differences by scope, timing, or refresh status. For background, see a practical primer on a quality of earnings report.
- Segregation of duties: The originator does not approve their own items; reviewers sample back to source by category.
- Kill tests: Reject add-backs without executed contracts, repeat “non-recurring” items that appear more than once in three years, revenue normalizations without customer-level cohorts, inventory write-down reversals with unchanged policies, and double counting of IFRS 16 under US GAAP. Downgrade SBC add-backs if the plan is essential to retention.
- Caps and windows: Code checks for cost-savings caps as a percentage of EBITDA and realization windows defined in the credit agreement.
- Duplicate detection: Flag when two lines hit the same GL and period with the same sign.
A Modern Twist: Data Lineage and AI Checks
To add resilience, tag each adjustment line with a data lineage hash that reflects the exact source file and version. Then run lightweight AI screens that cluster similar descriptions and spot duplicates or “near-duplicate” adjustments across periods. Pair this with automated invoice or payroll joins for recurring items. The result is faster reviewer sampling and fewer late-stage surprises.
SEC Compliance and Credit Agreement Alignment
Public-facing materials must follow SEC guidance on non-GAAP measures. GAAP figures must have equal or greater prominence, labels should be clear, and you should avoid individually tailored principles that change recognition or measurement. Present gross adjustments with rationale and include a GAAP-to-non-GAAP reconciliation that a third party can recalculate. In parallel, create a separate logic block for Credit Agreement EBITDA that applies defined pro forma adjustments, enforces caps and baskets, and excludes items that do not qualify even if they make analytical sense. To monitor leverage and headroom, tie your outputs to your covenant modeling page.
Build Timeline and Practical Tips
- Week 0–1: Gather financials, trial balances, GL, payroll, leases, top customers and vendors, legal and TSA documents, and credit definitions. Freeze the calendar and currency.
- Week 1–2: Build the shell with header, periodization, and inputs. Populate base financials and validated lists for categories and classes.
- Week 2–3: Load adjustments with links. Implement LTM/LQA weighting, toggles for run-rate and pro forma, duplication checks, and cap tests.
- Week 3–4: Reconcile to QoE drafts, run tie-outs, and obtain signoffs. Prepare lender and sponsor views and back-test prior-year adjustments for recurrence.
- Week 4–5: Lock and static for IC and external use. Archive the change log and version stamp. Push outputs into valuation and credit models.
- Anchor to the GL: Statements can hide reclasses. GL anchors allow fast sampling and pass-through of audit evidence.
- Favor transparency: Avoid black-box macros. If code is needed, comment with version stamps and expose the logic.
- Keep categories simple: Mirror diligence workflows: restructuring, legal, owner costs, M&A, revenue timing, policy change, FX, leases, SBC, other.
- Present side-by-side: Show Reported, Adjusted, Run-Rate, and Pro Forma EBITDA with drivers fit for a one-slide bridge. For a case-style walkthrough, study an earnings bridge case study.
- Respect confidentiality: Use data room references that avoid privileged content leakage and link to redacted contracts when needed.
- Archive properly: Index versions of the tab, support, Q&A, users, and audit logs; hash the final package; apply retention policies; and document vendor deletion on closure.
Common Pitfalls and What Good Looks Like
Teams overreach on run-rate without executed changes or mix revenue normalization with growth initiatives. Unexecuted price increases belong in forecasts. Failing to reconcile IFRS 16 vs. ASC 842 can derail comparability. Misaligned policies across targets and acquirer pollute pro forma outputs. Double counting restructuring charges and cost-out add-backs tied to the same plan erodes credibility and triggers lender pushback.
A clean tab ties base figures exactly to audited financials. Each adjustment has a clear rationale, source, and GL anchor. LTM, LQA, run-rate, and pro forma outputs match the CIM, lender deck, and model. A reviewer can trace any number to source in under a minute. Alternate sponsor and credit views are driven by toggles, not manual edits.
Key Takeaway
An EQA tab earns trust when it is simple, sourced, and switchable between analytical and credit views. Build it with audit-grade lineage, enforce kill tests and caps, and keep SEC-compliant reconciliations. Do that, and your adjustments will withstand diligence – and your deal math will hold up under covenant scrutiny.