The buy-side Quality of Earnings firm is attempting to recategorize our internal software development costs as recurring cost of goods sold instead of operating expenses to artificially shrink our EBITDA and drive down our multiple. How do we use our documented core processes and Accountability Chart to defend our categorization?

Question

Tyler Smith · Accepted Answer

A buy-side Quality of Earnings firm has one job: find reasons to adjust your earnings downward so their client can pay a lower multiple. Recategorizing internal software development costs from operating expenses to cost of goods sold is a common tactic, as it directly reduces your gross margin and lowers your enterprise valuation. To defeat this adjustment, you must provide objective proof of how your team operates.

This is where your Accountability Chart and documented core processes become your strongest financial shield. Show the auditors exactly how your software development team is structured. If your developers are focused on building new features and scaling the platform, rather than performing routine maintenance or customer support, their compensation is capitalizable or categorized as an operating expense under standard accounting rules.

Present your core processes to demonstrate that maintenance and customer delivery are handled by entirely separate seats on the Accountability Chart. By showing a clear division of labor, you prove that development costs are strategic investments in long-term enterprise value, not recurring costs required to deliver today's service.

Additionally, align your weekly Level 10 Meeting scorecard data with your financial records. When you can show that your development team's weekly measurables are tied to product milestones rather than daily customer tickets, the buy-side firm will have a difficult time justifying their downward adjustment. Clean, process-driven documentation is the only way to win a Quality of Earnings debate.