What Is a Quality of Earnings (QoE) Report — And Why Buyers Require One

What a Quality of Earnings Report Is

A Quality of Earnings (QoE) report is a detailed financial analysis performed by an independent accounting firm that examines the sustainability, accuracy, and reliability of a company's reported earnings. It is the financial X-ray of your business — a rigorous investigation that goes far beyond what standard audited financial statements reveal.

In modern M&A transactions, the QoE has become the single most influential due diligence workstream. It determines whether the buyer's offer — which was based on the seller's represented EBITDA — is supported by the underlying financial reality. According to a 2025 survey by the Association for Corporate Growth (ACG), 89% of private equity buyers now require a QoE report before proceeding to a definitive purchase agreement, up from 72% in 2020. For strategic acquirers and search fund buyers, QoE adoption is growing rapidly as well.

The QoE is not an audit. Audits verify that financial statements comply with accounting standards. A QoE goes deeper — it analyzes the quality, composition, and durability of earnings to determine what the business will actually earn on a go-forward basis under new ownership. For sellers, understanding what a QoE examines and how to prepare for one can mean the difference between a smooth closing and a deal that falls apart.

Who Orders the QoE — And Who Pays for It

In the vast majority of transactions, the buyer commissions and pays for the QoE report. The buyer's accounting firm — typically a mid-market advisory firm specializing in transaction services rather than the buyer's audit firm — conducts the analysis independently. The cost ranges from $30,000 to $100,000 or more, depending on the complexity of the business and the scope of the engagement.

However, an increasingly common practice is for sellers to commission their own QoE — known as a sell-side QoE — before going to market. A sell-side QoE identifies potential issues early, allows the seller to address them proactively, and provides a credible financial narrative that the buyer's QoE firm can validate rather than construct from scratch. Deloitte's 2025 Transaction Advisory report found that transactions where the seller provided a sell-side QoE closed 28% faster and experienced 40% fewer post-LOI price adjustments than those without one.

The decision to invest in a sell-side QoE depends on deal size, complexity, and the seller's confidence in their financial reporting. For businesses with Adjusted EBITDA above $1.5 million, the cost of a sell-side QoE is typically a fraction of the value it protects. Discuss the decision with your advisor during exit planning.

What the QoE Examines

A comprehensive QoE report examines five core areas of the business's financial profile. Understanding each area helps sellers anticipate what the buyer's team will focus on and prepare accordingly.

1. Revenue Quality. The QoE firm analyzes the composition, predictability, and sustainability of revenue. They examine revenue quality through multiple lenses: recurring vs. non-recurring revenue mix, customer concentration ratios, contract terms and renewal rates, historical retention and churn metrics, revenue recognition policies, and the consistency of revenue growth. Revenue that is recurring, diversified, and growing commands higher multiples. Revenue that is project-based, concentrated in a few customers, or declining triggers deeper scrutiny and valuation discounts.

2. EBITDA Adjustments. This is the most contentious section of any QoE. The buyer's team will evaluate every add-back the seller has made to arrive at Adjusted EBITDA. They will determine which adjustments are legitimate (above-market owner compensation, documented one-time expenses), which are aggressive (expenses characterized as one-time that recur annually), and which are unsupported (adjustments without adequate documentation). The QoE firm will also identify adjustments the seller missed — both positive and negative. The result is the QoE-adjusted EBITDA, which becomes the basis for the buyer's final valuation.

3. Working Capital Analysis. The QoE includes a detailed analysis of net working capital — the amount of current assets minus current liabilities needed to operate the business on a day-to-day basis. The QoE firm calculates a normalized working capital level (typically a trailing 12-month average) and compares it to the working capital that will be delivered at closing. Most purchase agreements include a working capital peg, and deviations at closing result in dollar-for-dollar price adjustments. Understanding your working capital dynamics is critical to avoiding surprises at the closing table.

4. One-Time and Non-Recurring Items. The QoE firm scrutinizes every item characterized as one-time or non-recurring. Their test is simple: has the expense actually occurred only once, and is there a reasonable basis to believe it will not recur? Litigation settlements, severance payments, natural disaster costs, and one-time consulting engagements typically pass this test. However, items like annual bonuses labeled as discretionary, recurring system upgrades classified as one-time, or customer acquisition costs treated as non-recurring will be challenged.

5. Cash Flow and Capex Analysis. Beyond earnings quality, the QoE examines how effectively earnings convert to cash. The analysis distinguishes between maintenance capex (spending required to sustain current operations) and growth capex (spending on expansion). A business with $2 million in EBITDA but $1.5 million in required maintenance capex has very different value than one with the same EBITDA and only $200,000 in maintenance capex. The QoE firm also analyzes cash conversion cycles, inventory turns, and the relationship between reported earnings and actual bank deposits.

Common QoE Findings That Kill Deals

Not every QoE finding results in a deal-killing event, but certain patterns consistently cause buyers to walk away or demand significant price reductions. Based on ACG and AM&AA data, the following are the most common QoE issues that derail transactions:

• Material EBITDA shortfall. When the QoE-adjusted EBITDA is more than 15-20% below the seller's represented EBITDA, most buyers will either renegotiate aggressively or terminate the LOI. The most common causes are unsupported add-backs, aggressive revenue recognition, and expenses that the seller characterized as one-time but the QoE firm determined are recurring.
• Revenue concentration risk. If the QoE reveals that a single customer accounts for 25% or more of revenue — particularly if the customer's contract is short-term or at risk — buyers will either demand a price reduction, require the seller to obtain a long-term contract from the customer, or walk away. Customer concentration is one of the most frequently cited reasons for post-LOI price adjustments.
• Revenue recognition issues. Aggressive or inconsistent revenue recognition policies — booking revenue before delivery, recognizing multi-year contracts upfront, or changing recognition methods between periods — destroy credibility and raise questions about management integrity.
• Undisclosed liabilities. Outstanding tax obligations, pending litigation, environmental remediation requirements, or product warranty claims that were not disclosed during the pre-LOI phase. Discovery of undisclosed liabilities during QoE is one of the fastest paths to deal termination.
• Working capital manipulation. Evidence that the seller has been managing working capital to present an artificially favorable picture — delaying vendor payments, accelerating customer collections, or drawing down inventory before the measurement period. QoE firms routinely analyze working capital trends for signs of manipulation.
• Related-party transactions. Undisclosed or inadequately documented transactions between the company and entities owned by the seller or the seller's family. Below-market rent, above-market service agreements, and revenue from captive customers all raise concerns about the sustainability of reported earnings.

The common thread in deal-killing QoE findings is surprise. Buyers can often work through financial issues if they are disclosed early, explained clearly, and reflected in the offer price. What they cannot tolerate is discovering material issues during diligence that the seller either concealed or failed to address.

How to Prepare for a Quality of Earnings

Preparation is the seller's most powerful tool for navigating a QoE successfully. The businesses that emerge from QoE analysis with their valuation intact — or even enhanced — are those that prepared thoroughly and presented clean, well-documented financials.

• Clean up your books 12-18 months before going to market. Ensure your accounting is consistent, your chart of accounts is clean, and your financial statements reconcile to your tax returns and bank statements. If you are using cash-basis accounting, consider converting to accrual basis, which is the standard that QoE firms analyze.
• Document every add-back meticulously. For each adjustment to EBITDA, prepare a written explanation of what the expense was, why it is non-recurring or owner-specific, and supporting documentation (invoices, contracts, board minutes). If you cannot defend an add-back with documentation, do not include it.
• Prepare a working capital analysis. Calculate your trailing 12-month average net working capital and understand the seasonal fluctuations. If your working capital is unusually high or low at any point, be prepared to explain why.
• Address customer concentration proactively. If you have a concentrated customer base, prepare documentation showing the relationship history, contract terms, renewal likelihood, and any diversification efforts underway. A buyer who understands and accepts the concentration risk during the LOI phase is less likely to renegotiate during QoE.
• Organize your data room with QoE in mind. The QoE firm will request specific documents in a specific format. Having monthly financial statements, bank statements, revenue detail by customer, and AR/AP aging reports organized and accessible accelerates the QoE process and signals professionalism.
• Consider a sell-side QoE. For deals above $3-5 million in enterprise value, a sell-side QoE report provides the seller with an independent validation of their financial narrative. It identifies issues before the buyer does, allows time for correction, and creates a credible foundation that the buyer's QoE firm can verify rather than construct independently.

How to Survive a QoE — And Close the Deal

Even with thorough preparation, the QoE process will surface questions, clarifications, and potential adjustments. How you handle these findings determines whether the deal stays on track.

Respond quickly and transparently. The QoE firm will submit detailed information requests and follow-up questions. Responding within 24-48 hours keeps the process moving and demonstrates that you have nothing to hide. Slow or evasive responses trigger deeper scrutiny and buyer concern.

Engage your own advisors. Your CPA and M&A advisor should review the QoE firm's findings and preliminary conclusions before they are finalized. This is not adversarial — it is collaborative. Your advisors can provide context, correct misunderstandings, and ensure that legitimate add-backs are not improperly rejected. For more on how legal and financial advisors protect your interests, see our guide on due diligence preparation.

Do not panic over individual findings. QoE reports routinely identify adjustments — both positive and negative. The relevant question is the net impact on Adjusted EBITDA. A finding that reduces one add-back by $50,000 but is offset by another legitimate adjustment the seller missed is not a crisis. Focus on the total picture, not individual line items.

Understand the buyer's perspective. The buyer invested in the QoE because they want to close the deal — they just want to close it at a price supported by the financial reality. If the QoE confirms your represented EBITDA within a reasonable margin (typically 5-10%), the deal will almost certainly proceed on the original terms. If the QoE reveals a significant shortfall, be prepared for a constructive conversation about price adjustment rather than deal termination.

Keep running the business. The worst thing a seller can do during QoE is let business performance slip. A decline in trailing results during the QoE period gives the buyer ammunition to argue that the business is deteriorating and that a lower price is justified. Maintain your focus on operations, sales, and customer retention throughout the diligence period.

The Quality of Earnings report is the financial proving ground of your transaction. Sellers who understand what it examines, prepare their documentation thoroughly, and engage experienced advisors consistently achieve better outcomes — faster closings, fewer price adjustments, and higher deal certainty. The QoE is not something to fear. It is something to prepare for.