We maintain our books on a cash basis to optimize our tax liability, but the buyer's Quality of Earnings firm is restating our trailing twelve months to GAAP accrual. How does this accounting conversion typically threaten our reported EBITDA, and how do we prepare for it?

Question

Tyler Smith · Accepted Answer

Operating on a cash or modified-cash basis is standard practice for privately held businesses looking to minimize tax liabilities, but it creates severe friction during transaction diligence. A buy-side Quality of Earnings team will immediately restate your trailing twelve months of performance to GAAP accrual accounting under ASC 606 standards, which can dramatically compress your reported EBITDA.

The primary danger lies in timing mismatches between cash collections and revenue recognition. If you billed large upfront customer deposits or annual contracts toward the end of your trailing twelve-month period, a cash-basis profit and loss statement records that cash as immediate earnings. Under GAAP accrual, the QoE firm will strip out that revenue, reclassifying it as deferred revenue on the balance sheet until the service is actually delivered. At the same time, vendor expenses and subcontractor costs incurred but not yet paid will be pulled forward into your cost of goods sold.

To defend your valuation before diligence begins, engage your financial team to run an internal accrual restatement:
- Match historical labor and material expenses directly to the specific periods in which the associated client revenue was earned.
- Identify prepaid assets and unearned income, calculating the exact net impact on trailing EBITDA so there are no surprises.
- Ensure your billing milestones tie cleanly to deliverable completion records.

Controlling the accrual narrative early prevents the buyer from using GAAP adjustments as an excuse to reduce your purchase price.