Software due diligence and the quality of earnings report belong in the same conversation, because software issues hit the two numbers a buyer cares about most: EBITDA and the forward run rate. A quality of earnings report normalises the target earnings; software due diligence finds the licensing costs, true up exposures, and renewal uplifts that the normalised earnings should reflect but often do not. When software due diligence and the quality of earnings report are run in isolation, a buyer can underwrite a number that quietly understates software cost and overstates sustainable margin.
This guide explains how the two streams connect, so software findings land as adjustments rather than footnotes. It sits within the broader software due diligence method and feeds the same model the investment committee will see.
How software due diligence and the quality of earnings report connect
A quality of earnings report tests whether reported earnings are real, sustainable, and free of one off distortions. Software touches every part of that test. Understated licensing cost inflates margin. A pending true up is an unrecorded liability. A renewal uplift raises the forward run rate above the historical figure. Capitalised software spend can mask operating cost. Each of these is a software finding that belongs in the quality of earnings analysis, and each is invisible to a financial team that does not measure the estate against its entitlements.
Where software issues hit EBITDA
The most direct impact is on operating cost. If the target runs more software than it has paid for, the true cost of running the business is higher than the books show, and the normalised EBITDA should carry that cost. A pending true up is effectively an unrecorded liability that a buyer inherits. Duplicate tools that the combined entity will rationalise are a different kind of adjustment, a sustainable saving rather than a hidden cost. A rigorous quality of earnings analysis should reflect all three, which means the software work has to be done in time to feed it.
Where software issues hit the forward run rate
The quality of earnings report is also the basis for the forward run rate the buyer models. Software is a recurring cost that rarely stays flat. Expiring discounts, usage growth, and price increases all push the forward cost above the trailing figure. A renewal that resets pricing after a change of control can move the run rate sharply. If the software team flags these forward movements, the buyer models a realistic run rate. If not, the buyer models the past and is surprised by the future.
Key takeaways
- Software issues hit both EBITDA and the forward run rate, the two numbers a quality of earnings report is built to protect.
- Under licensing is a hidden cost or liability; expiring discounts and price increases raise the forward run rate.
- Duplicate tools are a synergy, not a normalisation, and should be treated separately from hidden cost.
- The software work has to run in time to feed the quality of earnings analysis, not after it is finalised.
Sequencing the two workstreams
Timing is the practical problem. A quality of earnings report runs on a tight schedule, and software findings that arrive after it is finalised cannot influence the number. The fix is to run the software estate measurement in parallel with the financial diligence and to share findings early, even in draft. The financial team does not need the full effective license position to start; it needs the headline exposures and the forward cost movements as soon as they are visible, so it can build them into the model while the model is still open.
Avoid double counting and false comfort
Two errors recur when software and financial diligence meet. The first is double counting, where the same cost appears as both an EBITDA adjustment and a separate exposure line. The second is false comfort, where a clean reseller invoice is read as proof of compliance when the entitlement actually lives in the underlying agreement and the deployment exceeds it. Avoid both by reconciling the software exposure to the financial adjustments line by line, so each cost appears once and every assumption is traceable, the same discipline that underpins a defensible diligence report.
Carry the adjustments into the deal model and beyond
The purpose of connecting the two streams is a model the buyer can underwrite. Software adjustments should flow into the quality of earnings bridge as named lines, with the exposure expressed as a range where it is uncertain. After close, the same adjustments become the baseline for the integration budget and the license reconciliation plan, so the number the buyer underwrote is the number the integration team manages against. A finding that changes the model but never reaches the people running the estate has changed nothing.
Recommendations for buyers
- Run software estate measurement in parallel with financial diligence and share headline findings early, in draft.
- Reconcile software exposure to the quality of earnings adjustments line by line to avoid double counting.
- Separate hidden cost and liabilities from rationalisation synergies, which belong outside normalised earnings.
- Carry the agreed adjustments into the deal model and then into the post close reconciliation baseline.
Treat software cost as a recurring obligation, not a historical line
A quality of earnings report is most useful when it shows what the business will cost to run, not only what it cost. Software is the line most likely to diverge between the two. Trailing software cost reflects discounts that may be expiring, deployments that may be growing, and prices that publishers raise on a schedule the target does not control. A forward looking view treats software as a recurring obligation with a built in upward drift, and it tests the major contracts for the events that move the number: renewals, true ups, and any repricing tied to a change of control. Building that forward view into the quality of earnings analysis is what stops a buyer from underwriting a software cost base that was only ever true on the day the data was pulled.
Use the same evidence base for both workstreams
The strongest analysis comes from the software and financial teams working off a single evidence base rather than two. When the effective license position, the contract register, and the spend data are shared, the financial team can tie each adjustment to a source the software team has already verified, and the software team can see how its findings land in the model. This shared base prevents the two most common failures: a number that appears in one analysis but not the other, and a disagreement between the teams that surfaces only in front of the committee. A single, reconciled evidence base is also what lets the same figures flow cleanly from the quality of earnings report into the integration budget after close.
Why independence sharpens the analysis
A software cost analysis produced by a party that sells software or support carries a conflict. An independent, buyer side advisor measures the estate and prices the exposure for the buyer alone, then reconciles it honestly with the financial diligence. That neutrality is what lets the quality of earnings report reflect the real cost of the software the buyer is acquiring, rather than the cost the seller would prefer to show.