What Is a Quality of Earnings (QoE) Report?

What a quality of earnings report checks

A quality of earnings report answers a specific question: is the profit this business reports the profit a new owner can actually expect to earn, on a repeatable basis, once the sale completes? It is prepared by an accountant, usually engaged by the buyer, working from the target's management accounts, general ledger, bank statements and supporting schedules rather than from the summary numbers in a memorandum.

That is a narrower and more useful question than "are the accounts accurate", which is what an audit answers. A set of accounts can be entirely accurate and still misleading about what a buyer is actually paying for — a one-off insurance payout recorded as trading income, an owner drawing a below-market salary, a customer contract that ends the month after completion. None of these makes the accounts wrong. All of them make the reported EBITDA a poor guide to next year's cash.

Quality of earnings vs an audit

The two are frequently confused because both involve an accountant reviewing financial records, and sellers sometimes assume audited accounts make a QoE unnecessary. An audit tests whether the financial statements are free from material misstatement against an accounting framework, on a sample basis, looking backward at what happened. A QoE tests whether reported earnings are a reasonable base for a forward-looking price, examining the composition of revenue and costs in far more granular detail than an audit typically reaches, and it says nothing about statutory compliance.

How adjusted EBITDA is built in a QoE

The centrepiece of most quality of earnings reports is a bridge from reported EBITDA to an adjusted figure, built up add-back by add-back with a stated reason and, ideally, supporting evidence for each one. See how to calculate EBITDA for the underlying formula this bridge starts from.

Not every adjustment moves in the seller's favour. A one-off cost the seller called non-recurring but which recurs every year should be added back into a lower adjusted figure, and a contract ending at completion should reduce it too. A QoE that only ever increases the seller's number is not independent.

Who commissions a QoE, and when

A buyer almost always commissions and pays for the QoE, because it is the buyer relying on the figure to set the price and the funding. It typically runs after an offer has been accepted — once there is a letter of intent or heads of terms — and before the sale and purchase agreement is finalised, because a material finding can still move the price or the structure at that point. See how to structure a business acquisition for where this sits in the wider process.

A seller sometimes commissions their own quality of earnings report before going to market, to identify and be ready to explain the adjustments in advance. This does not replace the buyer's own report — a buyer relying entirely on a seller-commissioned QoE is relying on an analysis paid for by the other side of the negotiation — but it can shorten the buyer's process by pre-empting the obvious questions.

Fees vary with the size and complexity of the target and the scope agreed with the accountant; get a quote directly from a firm that does this work rather than assuming a figure from another deal applies to yours.

What a QoE typically uncovers

Beyond the add-back bridge, a QoE usually reports on working capital normalisation, revenue quality (how much is recurring versus one-off), and the trend across several periods rather than a single year. It often surfaces the same kind of findings covered in red flags when buying a business — customer concentration, related-party transactions and add-backs that grow between drafts of the same figure — but with a named accountant standing behind the finding rather than a buyer's own read of the memorandum.

• Revenue recognised before cash or the underlying work is complete
• Costs allocated inconsistently across periods, flattering the most recent year
• Related-party transactions priced away from market rates
• Working capital that has been run down ahead of a sale, overstating the cash the business normally throws off
• A pattern of "one-off" costs that recur every year

What a QoE does not tell you

A quality of earnings report is bounded by its brief. It says nothing about whether the company's intellectual property is actually owned by the company, whether material contracts survive a change of control, or whether the business is compliant with the regulations that apply to its sector — those are legal and commercial diligence questions, covered by different specialists working from different documents. It also does not value the business: it produces an adjusted earnings figure that a valuation can then be built on, using the methods described in business valuation methods used in M&A, but the multiple applied to that figure is a separate judgement.

Common mistakes buyers make with a QoE

• Treating a seller-commissioned QoE as sufficient. It answers a real question, but it was commissioned and paid for by the other side of the table.
• Accepting an adjusted figure with no supporting schedule. Every add-back should be traceable to a ledger entry, a contract or a bank statement, not asserted as a round number.
• Confusing a QoE with an audit, and skipping it because audited accounts exist. The two tests are different questions, and audited accounts say nothing about whether an add-back is defensible.
• Commissioning it too late to change anything. A QoE run after the sale and purchase agreement is signed has no leverage left in the negotiation.
• Reading only the headline adjusted number. The bridge and the findings behind it are where the real information is; the top-line figure alone tells you almost nothing you did not already know from the CIM.

How TrueValue helps read the numbers behind a QoE

TrueValue does not replace the independent accountant who prepares a formal quality of earnings report, but the CIM Analyzer does the same kind of first-pass reading on a memorandum or a set of filed accounts: it extracts the income statement, balance sheet and working capital position, lists every stated add-back and flags a concentration or a related-party pattern worth raising with the accountant doing the formal QoE. Findings from that first pass, or from the QoE report itself once it lands, become items on the due diligence checklist, with the evidence linked and a red flag able to move the price the deal is actually priced on — the same valuation engine that runs the five methods can be re-run on the QoE's adjusted EBITDA once it is agreed.