The buyer's Quality of Earnings report is demanding that we include our historical, discretionary year-end performance bonuses as a formal liability in our Net Working Capital peg, which would force us to leave an extra hundred thousand dollars in the business at close. How do we prove these bonuses are discretionary to keep that cash in our pockets?

Question

Tyler Smith · Accepted Answer

Buy-side Quality of Earnings auditors will try to classify discretionary bonuses as accrued liabilities to inflate the Net Working Capital peg. This forces you to leave more cash behind to cover those liabilities. To defeat this, you must prove that these payments are completely discretionary and not a guaranteed operational obligation.

Start by showing the buyer your corporate documents and employee manuals. If your handbook states that year-end bonuses are paid solely at the discretion of management, depend on overall company profitability, and require formal approval by the owners or board of directors, you have a strong legal argument.

Next, show your historical payment records. If the bonus amounts have fluctuated from year to year based on your cash flow, or if there have been years where no bonuses were paid, this historical variance proves they are not fixed operating liabilities.

Additionally, show how these bonuses align with your annual planning. If your EOS V/TO and quarterly Rocks show that bonuses are tied to hitting specific target milestones, they are variable performance incentives rather than guaranteed operating costs. Presenting this clear distinction prevents the buyer from treating discretionary bonuses as recurring liabilities, keeping your cash at close where it belongs.