A quality of earnings report, often called a QoE, is an independent review of a company’s books that tests whether its reported profit is real, recurring and likely to hold up under a new owner. Buyers rely on it to decide how much to pay, and sellers can order one before going to market so they find problems while there is still time to fix them.
For owners of small and mid-sized companies, this review often decides whether the price in a signed offer survives due diligence. This guide explains what the analysis covers, how it differs from an audit, what it usually turns up and how to get your records ready.
Key Takeaways
- A QoE review asks whether earnings will continue after the sale, not whether the statements follow accounting rules.
- Buyers often commission their own analysis after a letter of intent, and the findings can change the price or the terms.
- A sell-side review shows you your numbers the way a buyer will see them and lets you document add-backs early.
- Typical findings include unsupported add-backs, personal expenses, customer concentration and working capital swings.
- Monthly closes, a written add-back schedule and one internal point of contact make any review faster and calmer.
What Is a Quality of Earnings Report?
A QoE is a financial due diligence analysis, usually prepared by the transaction advisory group of an accounting firm. The team starts with the profit shown in your statements and then rebuilds it, removing items that will not repeat and adding back costs a new owner will not carry. The result is a normalized earnings figure, most often adjusted EBITDA, that a buyer can price against.
That figure matters because most offers are built as a multiple of earnings. If you have read our guide on how to value a small business, you know that a small change in the earnings base moves the price far more than a small change in the multiple. The review is where that base gets tested line by line.
Buy-side and sell-side reviews
A buy-side review is ordered and paid for by the buyer, or by the lender or investor backing the buyer, once an offer has been accepted. Its job is to protect the buyer from overpaying. A sell-side review is ordered by the owner before the business is marketed. Its job is to show the owner what a buyer’s accountants will find and to put documented support behind the earnings figure the owner plans to present.
Both reviews follow similar steps. The difference is who controls the timing and who sees the results first.
How a QoE Differs From an Audit
Owners with audited statements sometimes assume they can skip this step. They usually cannot, because the two exercises answer different questions. An audit looks backward at whether the statements are presented fairly under an accounting framework. A quality of earnings analysis looks at whether the profit those statements show is a sound basis for a purchase price.
| Point of comparison | Financial audit | Quality of earnings review |
|---|---|---|
| Main question | Are the financial statements fairly presented under the accounting framework? | Is the reported profit sustainable for a new owner? |
| Output | A formal audit opinion | A written analysis with adjusted earnings, working capital and risk findings |
| Typical trigger | Lender, investor or regulatory requirement | A planned sale, purchase, recapitalization or acquisition loan |
| Focus | Accuracy and compliance of historical figures | Recurring profit, cash conversion, customer risk and one-time items |
| Adjusts earnings? | No | Yes, through a bridge from reported to adjusted EBITDA |
| Who reads it | Owners, lenders and investors | Buyers, sellers, lenders and their advisors in the deal |
A QoE is generally performed as an advisory engagement, so it does not carry an audit opinion. Audited statements still help, because the reviewers can rely on figures that have already been tested and spend more of their time on the adjustments.
What the Review Examines
Every engagement is scoped to the business, but most cover the same core areas. Knowing them in advance tells you where to tidy up first.
Adjusted EBITDA and add-backs
This is the center of the work. The reviewers list each adjustment you claim, such as above-market owner pay, a one-time legal bill or personal travel run through the company, and ask for proof. Adjustments with invoices, payroll records and a clear business reason tend to survive. Adjustments based on memory tend not to.
Revenue quality
Reviewers break sales down by customer, product, location and month. They look for concentration, where one or two accounts produce a large share of revenue, and for revenue recognized before the work was delivered. Recurring contract revenue is usually viewed as stronger than one-off project income.
Net working capital
Buyers expect a business to come with enough receivables, inventory and payables to keep operating. The review measures what a normal month looks like so the parties can agree on a working capital target in the purchase agreement. A target set too high can quietly reduce what the seller receives at closing.
Proof of cash
The team ties reported revenue and expenses to actual bank deposits and withdrawals. Gaps between the books and the bank are one of the fastest ways to lose a buyer’s trust.
Debt-like items and the balance sheet
Customer deposits, deferred revenue, unpaid bonuses, accrued taxes and equipment leases can all be treated as obligations that reduce the price. Reviewers flag them early so they do not surprise anyone at the closing table.
Common Adjustments and How to Support Them
The table below shows the adjustments that come up most often in small and mid-sized deals, with hypothetical examples. Your own list will depend on how the business has been run.
| Adjustment | Hypothetical example | Usual effect on earnings | Support reviewers ask for |
|---|---|---|---|
| Owner compensation | Owner pays themself well above what a hired general manager would earn | Increases adjusted earnings by the excess | Payroll records and a market salary estimate for the role |
| Personal expenses | Family vehicle and phone plans paid by the company | Increases adjusted earnings | Statements showing the charge and that it is not needed to operate |
| One-time costs | A lawsuit settlement or a website rebuild | Increases adjusted earnings | Invoices and evidence the cost will not recur |
| Non-operating income | Interest income or a one-time insurance payout | Decreases adjusted earnings | Bank and insurance documents |
| Related-party rent | Owner’s property leased to the business below market rent | Decreases adjusted earnings if a buyer must pay market rent | Lease terms and a local rent comparison |
| Revenue timing | Annual contracts billed and booked up front | Can move earnings between periods | Contracts, billing schedules and deferred revenue workpapers |
Notice that some adjustments cut the other way. A careful review removes favorable items as readily as it accepts helpful ones, which is why a seller is better off finding them first.
Why a Sell-Side Quality of Earnings Report Can Help
No law or standard requires a seller to commission one. Many owners of smaller companies sell without it, especially when the buyer is an individual using a bank loan. Still, there are good reasons to consider it once earnings reach a level where institutional buyers, private equity groups or larger strategic acquirers are likely to bid.
- You see the adjustments a buyer will challenge and can fix records or drop weak add-backs before they become negotiating points.
- Your marketing materials can rest on a figure that has already been tested by an outside firm.
- Buyers may move faster when they can review a prepared analysis instead of starting from scratch.
- You keep control of the timing, so problems surface on your schedule rather than in the middle of diligence.
- Your team handles the heaviest document requests once, before the pressure of a live deal.
Firms that offer this service commonly suggest starting six to twelve months before going to market. That window leaves time to clean up reporting, sort out related-party arrangements and let a few more months of improved results build up.
A hypothetical example
Suppose an owner plans to market a distribution company on adjusted EBITDA of $1.2 million, including $180,000 of add-backs. A sell-side review supports $110,000 of those add-backs and finds that a customer rebate was booked in the wrong year. Adjusted EBITDA lands at about $1.1 million. If buyers were pricing the company at a hypothetical multiple of four times earnings, the owner has learned about a potential $400,000 gap before any buyer saw the numbers, and can decide whether to fix it, explain it or wait.
When the Buyer Orders the Review
Most buy-side reviews start after both parties sign a letter of intent and the buyer enters exclusivity. Accounting firms often quote roughly four to six weeks from engagement to a draft report, though slow document turnaround can stretch that. The review runs alongside legal and operational diligence, which is one reason the time it takes to sell a business can grow late in the process.
If the findings show lower earnings than the offer assumed, the buyer may ask to cut the price, move part of the payment into an escrow or holdback, or shift some value into an earnout tied to future results. Sellers who already know their numbers are in a much stronger position to push back on adjustments they believe are wrong.
How to Prepare for a Quality of Earnings Review
Whether the review is yours or the buyer’s, the same habits make it smoother and cheaper.
- Close the books every month and reconcile every bank and credit card account.
- Gather at least three years of financial statements and tax returns, plus the most recent trailing twelve months.
- Write an add-back schedule that lists each adjustment, the amount, the reason and the supporting document.
- Stop running personal expenses through the company, or at least tag them clearly in the ledger.
- Prepare a revenue report by customer and by month so concentration and seasonality are easy to see.
- Put related-party leases and agreements in writing at terms you can defend.
- Choose one person inside the company to handle document requests and keep the process confidential.
None of these steps requires a large budget. They mostly require starting early and being consistent.
What Does a QoE Cost and How Long Does It Take?
Fees vary with company size, the number of entities and locations, the condition of the records and how much the engagement covers. A narrowly scoped review of a clean, single-location company will cost far less than a full analysis of a multi-entity business with inventory and several revenue streams. Ask two or three firms for written proposals that spell out the scope, the deliverables and whether the fee is fixed.
Timing depends on the same factors. Owners who can hand over a complete general ledger, reconciliations and an add-back schedule in the first week usually see the fastest turnaround. Delays most often come from missing documents, not from the analysis itself.
When to Talk to a Broker
A broker can help you decide whether a sell-side review makes sense for your company and buyer pool, and can help you organize the records reviewers will request. SellerForce works on a 100% success-based model, and its advisors work with owners before the business goes to market, at no upfront cost, to find ways to raise its market value. You can read more about that approach on our service and process page or start on the sell your business page.
It is worth having that conversation if you expect offers from private equity or larger strategic buyers, if your add-backs are large relative to profit, or if one customer accounts for a big share of revenue.
Buyers will test your earnings one way or another, so the safest move is to know the result first. If you are thinking about selling in the next year or two, request a free business valuation or contact our team to talk through where your numbers stand today.
