Quality of Earnings Report: What Business Buyers and Sellers Should Know
A quality of earnings report, commonly called a QoE report, examines the financial drivers behind a company’s reported earnings. It helps transaction participants evaluate recurring performance, proposed earnings adjustments, and financial risks. Depending on the agreed scope, the engagement may also address working capital, cash conversion, and related financial matters.
A business can report a profit while leaving important questions unanswered. Did a one-time payment increase earnings? Was a necessary position left vacant? Are customers paying their invoices? Would the buyer need to replace work performed by the owner?
A QoE engagement investigates questions like these. Baker Tilly describes it as a consulting engagement with a scope tailored to the transaction, distinct from a financial statement audit. Baker Tilly
This guide explains how buyers and sellers can prepare for that process. Consult a qualified accountant for financial diligence and accounting advice, and an attorney for transaction documents and legal matters.
What Does a Quality of Earnings Report Examine?
The starting point is understanding how the business produced its reported earnings and whether adjustments are appropriate.
A useful review connects financial summaries with supporting records and explanations. Areas to discuss when defining the engagement include:
| Area | Questions to address |
| Revenue | What generated sales, and were transactions recorded in the appropriate periods? |
| Expenses | Are normal operating costs fully reflected? |
| Earnings adjustments | Which proposed adjustments have supporting documentation? |
| Concentration | How dependent is performance on particular customers, products, or locations? |
| Working capital | What operating assets and obligations would transfer? |
| Cash conversion | How do reported earnings relate to collections and operating cash needs? |
Eide Bailly identifies earnings sustainability, nonrecurring events, revenue and margin concentrations, working capital, and EBITDA adjustments among the financial matters considered during acquisition diligence. eidebailly.com
Confirm the actual scope before hiring a provider. Do not assume that every report bearing the QoE label includes the same procedures.
Quality of Earnings vs. an Audit or Business Valuation
These services answer different questions.
| Service | Main purpose |
| Quality of earnings analysis | Examine earnings quality and transaction-relevant financial adjustments |
| Financial statement audit | Express an opinion on the financial statements under the applicable reporting framework |
| Business valuation | Develop a value conclusion using the relevant purpose, assumptions, methods, and evidence |
An audit provides assurance concerning financial statements. A QoE engagement investigates the economic earnings relevant to a transaction and does not replace an audit. Bennett Thrasher explains how their objectives and procedures differ. btcpa.net
A QoE report is also not a promise of future results. Historical analysis can inform a buyer’s assumptions, but customer behavior, staffing, competition, and operating conditions may change after closing.
For owners considering an asking price, a business valuation addresses a related but separate question. Earnings are one input into that discussion.
Example of Quality of Earnings Adjustments
The following hypothetical example illustrates how a provider might organize an earnings discussion. It is not a KMF client transaction or a recommendation that these adjustments apply to another business.
Assume a service company presents $600,000 of historical EBITDA. The review identifies several items requiring investigation.
| Item | Illustrative adjustment | Supporting evidence to examine |
| Historical EBITDA presented | $600,000 | Reconciliation to financial statements and underlying accounts |
| Isolated legal expense included in operating costs | +$25,000 | Invoice, nature of the matter, and explanation of why it will not recur |
| Documented personal expense included in operating costs | +$20,000 | Ledger entries and evidence that no replacement business cost is necessary |
| Necessary management position left vacant during the period | −$60,000 | Duties, staffing plan, and support for compensation and related costs |
| Nonrecurring insurance gain included in starting EBITDA | −$35,000 | Accounting entries and insurance documentation |
| Illustrative adjusted EBITDA | $550,000 | Supported reconciliation of all accepted adjustments |
The calculation is:
$600,000 + $25,000 + $20,000 − $60,000 − $35,000 = $550,000.
Now assume the seller also proposes adding back $30,000 of recurring advertising. If that spending remains necessary and there is no supportable adjustment, it stays in operating expenses. It contributes zero to the adjustment bridge.
Every item requires judgment. An insurance recovery may need to be considered alongside related losses or expenses. A cost described as “one-time” may recur in another form.
CLA emphasizes that unsupported or inconsistent add-backs can create differences between seller-presented earnings and the earnings a buyer’s diligence team supports. claconnect.com
Why the Adjustment Matters
Using a purely illustrative 4.0-times multiple:
- $600,000 × 4.0 = $2,400,000.
- $550,000 × 4.0 = $2,200,000.
That produces a $200,000 difference in illustrative enterprise value. The multiple is an assumption for this example, not a Florida market benchmark.
Enterprise value is not necessarily the seller’s proceeds. Debt, cash, working capital, transaction expenses, taxes, and negotiated terms require separate consideration.
Buyer-Side vs. Seller-Side Quality of Earnings
The commissioning party and timing differ, even when the financial subjects overlap.
Seller-Side Review
A seller commissions the work to understand financial questions before or during marketing.
For a seller, useful preparation questions include:
- Can the proposed earnings adjustments be supported?
- Do monthly reports reconcile with annual results?
- Are there unexplained changes the buyer will discover?
- Is the supporting information organized and accessible?
A seller-side engagement can identify issues early and help prepare documentation. It does not prevent the buyer from conducting additional diligence. CLA discusses seller-side preparation as a way to address financial concerns before they become transaction obstacles. claconnect.com
Buyer-Side Review
The buyer commissions work suited to the acquisition and its unresolved financial questions.
Before relying on an existing seller report, the buyer should ask its advisers about the report’s period, scope, limitations, permitted use, and whether additional work is necessary.
Agree on access to management and supporting records early. A polished report cannot resolve questions that its underlying scope did not address.
Why Working Capital Needs Separate Attention
Earnings and working capital affect different parts of a transaction.
Working capital generally means current assets minus current liabilities. In an acquisition, however, the purchase agreement defines which accounts are included or excluded. A headline balance-sheet calculation may not match the negotiated transaction calculation.
BDO explains that working capital analysis can inform an agreed target, often called a peg, and that differences at closing may affect the amount paid. BDO
Consider this separate hypothetical calculation:
| Included operating account | Amount |
| Accounts receivable | $180,000 |
| Inventory | $90,000 |
| Less accounts payable | −$110,000 |
| Less accrued operating expenses | −$40,000 |
| Illustrative operating working capital | $120,000 |
This example excludes cash, financing balances, and other accounts solely for illustration. Actual inclusions, exclusions, reserves, and adjustments must follow the agreement.
Ask your accountant to review the methodology and your attorney to document it clearly. Avoid counting the same obligation in both working capital and debt adjustments.
Does Every Small Business Need a Full QoE Report?
The decision should follow the transaction’s risks and requirements.
Before commissioning work, discuss:
- How reliable and organized the records are.
- Whether the business has multiple entities or locations.
- How much the proposed price depends on adjusted earnings.
- Which concerns the buyer or lender needs addressed.
- Whether a focused engagement would answer the relevant questions.
- Who needs to receive or rely on the findings.
A seller’s discretionary earnings calculation, broker recast, or review of tax returns should not automatically be described as a formal QoE report.
Ask the proposed provider to explain what its work would establish and what would remain outside scope. Confirm financing requirements directly with the lender.
Who Prepares a Quality of Earnings Report?
Look for an accounting or transaction advisory provider with relevant financial diligence experience.
Questions to ask include:
- Who will lead the engagement and perform the analysis?
- What experience does the team have with this business model?
- What procedures and reporting periods are included?
- How are proposed adjustments tested and documented?
- What conflicts, limitations, or reliance restrictions apply?
- Will the team discuss findings with the transaction participants?
Warren Averett explains that a QoE engagement does not issue a formal audit opinion and that deliverables may include an Excel data pack and a written report. Ask to see an anonymized example of the proposed deliverable. warrenaverett.com
How Much Does a Quality of Earnings Report Cost?
Request a written quote for a defined engagement rather than assuming a universal price range.
Give each prospective provider the same information so the proposals are comparable:
- Business activities, entities, and locations.
- Available accounting records and reporting periods.
- Known accounting or reconciliation issues.
- Requested analyses and deliverables.
- Intended recipients and transaction deadline.
Ask whether the quoted fee includes management discussions, revisions, updated financial periods, and support answering buyer questions.
A lower fee may cover a narrower assignment. Compare what the provider will actually do before choosing.
How Long Does a QoE Review Take?
Ask the provider for a timetable based on the records available and the agreed scope.
Before scheduling the work, confirm when the team can start, what information it needs, who will answer questions, and how unresolved items affect completion.
If closing is delayed, discuss whether the analysis needs to be updated for a later reporting period. Make that responsibility clear before the original engagement concludes.
Documents to Prepare Before the Review
Use the following list as a preparation aid. Your provider should issue a request list tailored to the assignment.
| Document group | Examples |
| Financial reporting | Monthly profit-and-loss statements, balance sheets, trial balances, and general ledger |
| Reconciliations | Bank reconciliations and explanations of differences between financial records |
| Revenue | Sales by customer, service, product, or location; relevant contracts and credits |
| Operating obligations | Accounts payable, payroll accruals, leases, and financing schedules |
| Operating assets | Receivables aging, inventory records, and equipment information |
| Proposed adjustments | Amount, date, ledger account, explanation, and supporting document for each item |
Maintain one organized adjustment schedule. Identify whether each amount is already reflected in the starting earnings figure so it is not counted again.
Use our seller due diligence checklist to organize the broader sale preparation process.
How to Respond to Findings
Treat findings as matters to investigate and resolve.
Ask the provider to distinguish a supported adjustment from an unresolved question or a limitation caused by unavailable information.
For each material issue, record:
- What the provider identified.
- Which records support or contradict it.
- Whether it affects earnings, working capital, another transaction calculation, or several areas.
- Who will resolve it and by when.
Discuss commercial implications with your broker and legal implications with your attorney. Do not assume every proposed financial adjustment must automatically change the purchase price in the same way.
KMF’s Role in Preparing for Financial Due Diligence
KMF Business Advisors helps owners prepare for a sale, discuss business value, organize transaction information, and coordinate commercial negotiations.
A formal QoE engagement should be separately scoped with a qualified accounting or transaction advisory provider. Your accountant advises on accounting and tax matters; your attorney advises on legal rights, agreements, and obligations.
If you are considering selling your business in Florida, begin by organizing your records and identifying the questions a prospective buyer will need answered.
Frequently Asked Questions
Is a QoE report the same as an audit?
No. An audit and a QoE engagement have different objectives and deliverables. Ask your provider which service meets the transaction’s needs rather than treating either as an automatic substitute.
Does a QoE report establish the business’s value?
No. Its findings can inform valuation assumptions and negotiations, but a value conclusion requires additional analysis.
Can adjustments reduce earnings?
Yes. A review may identify costs omitted from the historical period or income that should not be treated as recurring. The hypothetical example above shows both increases and decreases.
Who pays for the report?
Clarify payment responsibility with the party commissioning the work and document it in the engagement arrangements. Do not assume the buyer and seller will share the expense.
Can a buyer rely on the seller’s report?
Ask the provider and the buyer’s advisers. Access to a report does not automatically establish permission to rely on it or eliminate the need for additional procedures.
Will a QoE report guarantee a successful sale?
No. Financial findings are one part of the transaction. Financing, legal diligence, approvals, negotiations, and other conditions may still affect completion.
About the Author
John C. Bucher is Broker and President of KMF Business Advisors LLC in Boca Raton, Florida. He works with business owners and buyers on business sales, acquisitions, and business valuation discussions.
This article provides general education. Consult a qualified accountant and attorney about your specific transaction.