What Is a Quality of Earnings Report? A Founder’s Guide Before You Sell

The letter of intent is signed. The price is agreed, the champagne is open, and then the buyer’s diligence team shows up and starts rebuilding your P&L line by line. Your EBITDA says $3 million. Theirs says $2.4 million. At the 5x multiple written into the LOI, that difference just cost you $3 million of purchase price, and you are still expected to close.

That rebuild is the quality of earnings analysis. A quality of earnings report is an independent, detailed examination of your company’s earnings, prepared by a transaction advisory team, that tells a buyer how sustainable and repeatable your profits really are. It typically takes four to eight weeks to complete, and it has become standard practice in nearly every private-market deal of consequence. Global M&A reached $4.8 trillion in 2025, the second-highest total on record according to Bain & Company, and the diligence machinery behind those deals has professionalized accordingly. The QoE sits at the center of it.

What Is a Quality of Earnings Report?

A QoE report is usually prepared by the transaction advisory practice of a CPA firm. It issues no opinion and provides no assurance; it is an analytical tool built for one audience, the party writing the check. A typical report contains:

• An adjusted EBITDA schedule, walking from reported net income to a normalized EBITDA figure through a documented list of add-backs and adjustments.
• A revenue analysis covering customer concentration, recurring versus one-off revenue, churn, pricing, and how revenue is recognized.
• Margin analysis by product, service line, or customer, showing where the profit actually comes from and whether it is stable.
• A proof of cash, which reconciles reported revenue and earnings to actual bank activity, month by month.
• A net working capital analysis that establishes the normal level of working capital the business needs to operate.

Reports come in two flavors. A buy-side QoE is commissioned by the acquirer after a letter of intent, during exclusivity. A sell-side QoE is commissioned by you, before going to market, so you learn what a buyer will find while there is still time to fix it.

Who Orders a QoE, and When?

Buyers, almost always. Private equity firms treat a QoE as a non-negotiable condition of closing, strategic acquirers order one for any deal of size, and lenders financing the transaction frequently require it before committing debt. Since PE buyers typically hold companies for years before their own exit, they underwrite your earnings the way they will one day defend them to their own buyer.

There will be plenty of them to face. In Deloitte’s survey of 1,500 dealmakers, 79% of corporate leaders and 87% of private equity leaders expected deal volume to grow in the year ahead. An active market does not mean a forgiving one; diligence standards have tightened even as volume has recovered.

Sellers order QoE reports too, and the timing matters. A sell-side QoE commissioned 6–12 months before you go to market gives you a dry run of buyer diligence with time to act on the findings. Walking in without one means the buyer’s advisors define your EBITDA for you.

How Is a QoE Different From an Audit?

An audit is conducted under AICPA auditing standards and provides reasonable assurance that your historical financial statements, taken as a whole, are free of material misstatement. It answers a compliance question: do these statements fairly present what happened, under GAAP (Generally Accepted Accounting Principles)? A QoE answers an economic question: of the earnings those statements report, how much will keep showing up after the wire clears?

A company can pass its audit cleanly and still show poor earnings quality: one customer at 40% of revenue, a one-time windfall sitting in the run rate, owner expenses buried in cost of goods sold. The audit was never designed to catch any of that, because none of it is a misstatement.

The Four Areas a QoE Adjusts

Nearly everything in a QoE rolls up into four categories of adjustment.

1. Add-backs

Expenses that ran through the business but will not continue under a new owner: owner compensation above or below market rate, family members on payroll, personal vehicles and travel, the country club membership, one-off professional fees. Legitimate add-backs raise adjusted EBITDA and therefore your price, but every one must be documented to the invoice. Buyers discount the entire schedule when the first sloppy item appears.

2. One-time items

Revenue or costs that will not recur: a litigation settlement, an insurance recovery, pandemic-era government funds, a single unusually large project, the year a flood shut down the plant. These get stripped out in both directions, and sellers are consistently surprised at how many of their good years contain items a buyer refuses to count.

3. Revenue quality

Two companies with identical revenue can deserve very different multiples. The QoE examines how much revenue is recurring or contracted versus one-off, how concentrated it is among top customers, how much churns each year, and whether revenue is recognized in the right periods. Companies keeping cash-basis books face a particular reckoning here, because converting to accrual accounting re-times revenue and can reshape the growth story a seller thought they had.

4. Net working capital

Working capital (receivables plus inventory, minus payables, roughly) is the fuel a business runs on, and buyers expect a normal tank of it to convey with the company. The QoE establishes that normal level, which becomes the working capital peg in the purchase agreement; deliver less at close and the price adjusts against you, dollar for dollar. Founders systematically underestimate what is at stake here. PwC’s working capital study estimates €1.84 trillion of excess working capital is trapped on company balance sheets worldwide, and a seller who cannot explain their own working capital cycle will have the peg set for them.

What Buyers Look For, and Where Deals Get Re-traded

Retrading is the polite word for a buyer lowering the agreed price during diligence, and the QoE is where the ammunition comes from. The recurring targets:

• The proof of cash. If reported revenue does not tie to bank deposits, the conversation changes from price to trust, and few deals recover from that.
• Customer concentration. Any customer above 10–20% of revenue draws scrutiny, and buyers will call those customers before closing.
• Margin durability. Declining gross margins beneath growing revenue is a pattern diligence teams are specifically trained to find.
• Cash-to-accrual gaps. Timing differences that flattered recent results get unwound, and the restated trend is what gets priced.
• Aggressive add-backs. Half-documented adjustments get struck from the schedule, and each strike multiplies: at 5x, a $200,000 add-back that fails review is $1 million off the price.

Harvard Business Review pegs the M&A failure rate at 70% to 90%, against more than $2 trillion companies spend on acquisitions every year. In the lower middle market, failure usually starts in diligence, at the moment the numbers stop matching the story. Sellers who have already found their own weak spots keep control of that moment.

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If a sale is even two years out, the financial statements a buyer will one day scrutinize are being written right now, month by month. Our CFOs get founders’ books, add-back schedules, and working capital analysis deal-ready long before a banker or buyer sees them. Book a CFO strategy call with Ascent CFO Solutions.

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How to Prepare Before You Go to Market

The QoE rewards preparation more than any other step in a sale process, because every finding is cheaper to fix before a buyer is watching:

• Move to accrual-basis, GAAP-compliant financials at least 12–24 months before a sale, so the restatement happens on your schedule instead of during exclusivity.
• Run a disciplined monthly close, so revenue, cost, and margin land in the right periods and the trend line a buyer sees is real.
• Build the add-back schedule now, with an invoice or agreement behind every line, instead of reconstructing it from memory under deadline.
• Normalize owner compensation and separate personal expenses from the business well before diligence starts.
• Study your working capital cycle by month, so you can argue for a fair peg instead of accepting the buyer’s.
• Commission a sell-side QoE once you are within a year of going to market, and treat its findings as a punch list.

On cost: a sell-side QoE for a lower-middle-market company typically runs well into five figures. For comparison, a full year of fractional CFO support starts at $60,000 and covers the sustained preparation that determines what the QoE finds in the first place.

For the broader picture, start with our guide to preparing for the sale of your company and the financial questions to answer before you are acquired. If EBITDA still gets debated in your management meetings, our EBITDA explainer is the place to begin, our walkthrough of the M&A lifecycle shows where the QoE sits in the sequence, and our piece on a CFO’s role in exit planning covers the years before the process starts.

Frequently Asked Questions

How much does a quality of earnings report cost?

Most sell-side QoE engagements for lower-middle-market companies land in the low to mid five figures, with complex, multi-entity businesses running higher. Scope drives price: number of entities, quality of the underlying records, and whether a cash-to-accrual conversion is needed. Buy-side reports are paid for by the buyer.

How long does a quality of earnings analysis take?

Four to eight weeks is typical once the advisory team has your data. Messy records stretch the timeline, and in a live deal a stretched timeline is a cost in itself, since exclusivity periods are finite and buyer enthusiasm decays.

Do I need a QoE if my financials are audited?

Yes. Buyers commission a QoE on audited companies as a matter of course, because the audit addresses misstatement, and the QoE addresses sustainability. An audit strengthens your starting position and shortens the work, but it does not answer the buyer’s question.

What is an add-back in a QoE report?

An add-back is an expense added back to earnings because it will not continue under new ownership: above-market owner salary, personal expenses run through the business, or true one-time costs. Each documented, defensible add-back raises adjusted EBITDA, and at typical multiples each dollar of accepted add-back is worth several dollars of purchase price.

Should I get a sell-side QoE before going to market?

For most companies above a few million dollars in revenue, yes. It surfaces problems while you can still fix them, anchors negotiations on your numbers rather than the buyer’s, and signals to bidders that the process will be professionally run, which itself supports price.

What is a working capital peg?

The peg is the normalized level of net working capital the parties agree must be in the business at close, usually based on a trailing twelve-month average. Deliver more and the price adjusts up; deliver less and it adjusts down. The QoE’s working capital analysis is where that number gets established, which is why sellers should understand theirs first.

Know Your Number Before the Buyer Does

Sellers who walk into diligence with a defensible adjusted EBITDA keep their price; sellers who wait to be told their number rarely do. We help founders and CEOs in Boulder, Denver, and across the country prepare for exits, with clean accrual financials, documented add-backs, working capital analysis, and M&A support from CFOs who have sat on both sides of the table. Book a CFO strategy call with Ascent CFO Solutions.