A global provider of digital transformation solutions that specializes in automating complex, document-heavy workflows through AI-powered content services and process management initiated a sellout as per the decision of the shareholders. This sellout was primarily focused on companies that are under an arrangement of related parties with one of the companies being an offshore company.
The initiation of this sellout required that the company prepares a quality of earnings report which would depict how the company is generating its revenues, what are the cost centers of the company and what is the seasonality of the revenue and costs. Therefore, the company initiated the consolidated quality of earnings report.
For an investor or buyer, the QoE report acts as a safeguard against overpaying for a business that might have "window-dressed" its financials. For a seller, a sell-side QoE can help identify potential "red flags" early, allowing them to address issues before they impact the final sale price or deal structure.
A Quality of Earnings (QoE) report is a detailed financial analysis typically performed during the due diligence phase of a business transaction. Unlike a standard audit, which verifies that financial statements are technically accurate according to accounting rules, a QoE report evaluates the sustainability and repeatability of a company's profits.
The Challenge
The group of companies that are going to be introduced to the market include companies operating in various jurisdictions; however, one offshore company is operating from and in Middle East region. Since the offshore company is engaging in transactions with its sister companies or other subsidiaries of its sister companies outside of its jurisdiction therefore such transactions gave rise to forex exchange gains and losses. In 2022 & 2023, the jurisdiction of offshore company faced a critical economic challenge of hyperinflation where local currency rapidly lost value against dollar. This enormous disruption and currency fluctuations led to US Dollar being traded in open market at a different rate as compared to rate provided by local banks.
Such parallel exchange rates gave rise to forex rate fluctuating on a daily basis and the offshore company was exposed to abnormal forex gains & losses.
At the end of the fiscal year, the company’s financial statements were prepared with an average exchange rate. This inflated the forex losses and misrepresented the true and fair view of the financial performance of the company.
How We Helped
HLB AG LLC was hired by the client with the sole responsibility of facilitating the Financial Due Diligence and to ensure that Quality of Earnings report is prepared in accordance with the applicable standards depicting the true and fair picture of the company’s organic performance.
To ensure the Quality of Earnings report reflected the group's true organic performance, we implemented a technical framework centered on neutralizing the distortions caused by hyperinflationary environment. This involved the extensive application of IAS 21 and IFRIC 22 to govern foreign currency transactions, alongside a specialized accounting approach for hyperinflationary economies. We conducted in-depth research into the prevailing interbank rate and parallel market dynamics to determine the most accurate exchange rates for translation, moving away from the misleading average rates previously utilized. To create a transparent and reconcilable foundation, we established a Tier 4 mapping system for trial balance level reconciliation and performed a comprehensive USD-based reconstruction of all intercompany balances, eliminating "phantom" fluctuations.
Building on this structural integrity, we performed an exhaustive financial consolidation that included the translation of European subsidiary financials and the preparation of both interim and year-end consolidated statements. Our team executed a bifurcation of the income statement, developing detailed subsidiary-level breakdowns for Cost of Services and Revenue. By further classifying these into recurring and non-recurring streams and performing a service-level analysis of both revenues and expenses we provided the depth of data required for a high-stakes due diligence process. The final phase of our intervention focused on delivering maximum clarity through Adjusted EBITDA calculations and account-level financial statements, ensuring that potential investors received a transparent view of the company’s sustainable earnings potential, free from abnormal forex volatility.
Results & Impact
The work done by HLB AG LLC has made it possible for the client to proceed with the sale of the company solving complex problems related to foreign exchange rates, intercompany balances, hyperinflation & normalized EBITDA margins. This highlights the proven experience of the team in providing Financial Due Diligence services and explicitly demonstrates the command over accounting principles. The client has obtained insightful and refined data which accelerates its potential to go for a sellout in the market with a true valuation of the company.
