Quality of Earnings Report: What Sellers Need to Know Before a Buyer Orders One
A PE firm signs an LOI for your business at 6.5x EBITDA. Two weeks later, their accounting team delivers a quality of earnings report that reclassifies $400,000 of your add-backs as "non-recurring optimism." Suddenly that 6.5x offer is sitting on a lower earnings base, and the effective purchase price just dropped by $2.6 million. This is not a hypothetical. According to GF Data, nearly 50% of middle-market deals now include a sell-side QoE, and the sellers who commission one before going to market are closing at 7.4x TEV/EBITDA compared to 7.0x for those who skip it. That 0.4x gap, on a business generating $3 million in EBITDA, is $1.2 million left on the table.
This article breaks down what a quality of earnings report actually examines, how buyers weaponize findings during negotiations, and why the best defense is ordering your own report before a buyer ever gets the chance.
What Is a Quality of Earnings Report?
A quality of earnings report is a financial analysis performed by an independent accounting firm that digs beneath the surface of a company's reported EBITDA. Where standard financial statements follow GAAP rules and present a historical record, a QoE report asks a harder question: are these earnings real, repeatable, and transferable to a new owner?
The analysis typically runs 40 to 80 pages and covers everything from revenue recognition policies to one-time expense adjustments to working capital trends. For a business generating $2 million to $20 million in EBITDA, the QoE report is the single most influential document in determining what a buyer actually pays. It is the financial bedrock of every serious offer.
QoE Reports vs. Audited Financials: What's the Difference
An audited financial statement confirms that your books follow GAAP. It tells a reader, "these numbers were prepared according to accepted accounting rules." A QoE report goes further. It asks whether those GAAP-compliant numbers accurately reflect the ongoing earning power of the business under new ownership. An audit might accept that you booked $500,000 in revenue from a one-time government contract. A QoE analyst will strip that revenue out because it is not repeatable. An audit will report your rent expense at the below-market rate your uncle charges. A QoE report will normalize it to fair market value, because the buyer will not have your uncle as a landlord.
The American Institute of CPAs (AICPA) sets the standards for audits. QoE reports follow no single standard. They are performed as agreed-upon procedures engagements, meaning the scope is tailored to what the buyer (or seller) wants examined.
Who Orders a QoE Report and Why
In most transactions, the buyer orders the QoE report. PE firms order them on virtually every acquisition. According to GF Data, more than 90% of PE-backed transactions include a QoE. For founder-led businesses selling for the first time, that number drops to roughly 50%, which often means those sellers walk into diligence unprepared for what a buyer's accounting team will find. Strategic buyers, including competitors and vertical integrators, also commission QoE reports, though their focus may lean more toward revenue quality and customer overlap than pure earnings adjustments.
Increasingly, sophisticated sellers are ordering their own QoE before going to market. This sell-side QoE lets the owner identify and address problems before a buyer uses them as ammunition to lower the price.
What a QoE Report Examines
A QoE report touches every line item that affects EBITDA, but five areas draw the most scrutiny. Understanding each one tells you where a buyer's accounting firm will spend its time and where your deal is most exposed.
Revenue Quality and Sustainability
The QoE analyst starts by asking whether your revenue is real, recurring, and likely to continue under a new owner. They will segment revenue by customer, product line, and contract type. One-time project revenue gets separated from recurring subscription or contract revenue. Revenue recognized under aggressive accounting policies, for example booking a two-year contract entirely in year one, gets restated on a normalized basis.
A business showing $10 million in top-line revenue might have $7 million that a QoE analyst considers "quality" revenue. That $3 million gap flows directly into the adjusted EBITDA calculation and, by extension, into the purchase price.
EBITDA Adjustments: Add-Backs, Normalizations, and Recasts
This is the section where deals are made or broken. Sellers typically present an "adjusted EBITDA" that adds back one-time expenses, owner compensation above market rate, and discretionary spending. The QoE analyst pressure-tests every single add-back.
Common adjustments include normalizing owner compensation to market-rate salary (a $600,000 owner draw adjusted to a $250,000 replacement cost adds $350,000 to EBITDA), removing litigation settlements, stripping out one-time moving or relocation costs, and reclassifying personal expenses run through the business. The QoE team will also look for expenses that should have been capitalized and revenue that was pulled forward. Every dollar they remove from adjusted EBITDA reduces the purchase price by that dollar times the deal multiple.
Working Capital Analysis
Working capital, defined as current assets minus current liabilities, is one of the most contested areas in any transaction. The SRS Acquiom 2026 Deal Terms Study found that purchase price adjustments are present in more than 90% of private-target deals, up from roughly 50% a decade ago. Over 75% of those deals include a special-purpose escrow specifically for working capital true-ups.
The QoE report establishes a "normalized" working capital figure, typically a trailing 12-month average. If the business is delivered at closing with working capital below that target, the seller owes the difference. A seasonal business with $500,000 swings in working capital can see a six-figure adjustment if closing falls at the wrong point in the cycle.
Customer Concentration and Revenue Durability
If one customer accounts for more than 15% of revenue, expect the QoE report to flag it. If one customer accounts for more than 25%, expect the buyer to ask for a price reduction or an earnout tied to that customer's retention. The QoE analyst will examine customer tenure, contract terms, renewal rates, and whether key relationships are tied to the departing owner.
A manufacturing business with 40% of revenue coming from two automotive OEMs will receive a very different QoE assessment than a services firm with 200 clients, none exceeding 3% of revenue. Buyers price concentration risk directly into the multiple.
Off-Balance Sheet Items and Contingencies
The QoE report will search for liabilities that do not appear on your balance sheet: pending litigation, unfunded pension obligations, deferred maintenance on equipment, environmental remediation costs, and warranty claims. These items reduce deal value dollar-for-dollar because buyers will either demand indemnification, escrow holdbacks, or a straight price reduction. As Bain's 2026 Global M&A Report notes, "the bar for diligence is rising fast" as deal activity rebounds from $4.9 trillion in 2025 volume.
Why Sellers Should Care: Every Finding Is a Price Lever
A QoE report is not an academic exercise. It is a negotiation tool. Every finding in that report gives the buyer a data-backed reason to adjust the purchase price downward. Understanding how buyers use these findings is the difference between holding your price and watching it erode.
How Buyers Use QoE Findings to Retrade
Retrading, the practice of renegotiating the purchase price after signing an LOI, is the most common consequence of QoE findings. A buyer who offered 7x your stated $4 million EBITDA ($28 million) may come back after the QoE and argue that true adjusted EBITDA is $3.4 million. At the same 7x multiple, the price drops to $23.8 million, a $4.2 million reduction. Some buyers use this tactic strategically, bidding aggressively to win the LOI and then using diligence findings to walk the price back to where they wanted it all along.
Adjustments That Are Legitimate vs. Aggressive Buyer Tactics
Not every QoE adjustment is fair. Legitimate adjustments include removing a one-time insurance settlement, normalizing below-market rent to fair market value, and reclassifying a family member's above-market salary. Aggressive tactics include treating recurring expenses as one-time (arguing that your annual trade show spend is "discretionary"), applying an unreasonably low market-rate salary for the owner replacement, or cherry-picking the lowest trailing months for working capital normalization.
An experienced M&A advisor can distinguish between the two and push back with supporting data. Sellers without representation often accept aggressive adjustments because they lack the context to challenge them. ACP works with sellers to review every QoE finding line by line and build a documented response that separates legitimate adjustments from buyer overreach. For more on what to expect from an advisor during this process, see our guide on what to expect when working with an M&A advisor.
How to Respond to QoE Findings Without Killing the Deal
The worst response to a QoE report is silence. The second worst is outrage. The best approach is a point-by-point rebuttal supported by documentation. If the buyer's QoE team reclassified $200,000 in owner travel as personal, show the business purpose for each trip. If they normalized working capital using a three-month window instead of twelve, present the full-year data. If they stripped out a recurring revenue stream, provide the contract and renewal history.
Responding with facts keeps the deal alive and protects the price. Responding with emotion signals to the buyer that there may be more problems beneath the surface.
The Case for a Sell-Side Quality of Earnings Report
The strongest sellers do not wait for a buyer to order a QoE. They commission their own before the process begins.
Why Proactive Sellers Commission Their Own QoE
A sell-side QoE gives the owner a chance to identify problems, fix what can be fixed, and prepare explanations for what cannot. GF Data's research shows that only about 50% of founder-led businesses commission a sell-side QoE, compared to more than 90% of PE-backed companies. PE firms understand that controlling the narrative around earnings quality is worth the upfront investment. First-time sellers rarely have that institutional knowledge, which is why working with an advisor who insists on a sell-side QoE is so important.
The data supports the investment: sellers who commission a sell-side QoE achieve an average TEV/EBITDA multiple of 7.4x, compared to 7.0x for those who do not. On a business with $5 million in EBITDA, that 0.4x difference is $2 million in additional proceeds.
How a Sell-Side QoE Accelerates the Sale and Protects Price
Beyond protecting the multiple, a sell-side QoE speeds up the deal. Buyers who receive a credible third-party earnings analysis at the start of diligence spend less time and money on their own review. Their accounting firm still performs independent work, but the scope narrows significantly when a reputable sell-side report is already on the table.
Speed matters because time kills deals. Every additional week in diligence is another week for interest rates to move, a key employee to resign, a customer to churn, or the buyer's board to get cold feet. A sell-side QoE compresses the diligence timeline by two to four weeks in most cases. For a deeper look at how sellers can prepare for the diligence process, read our overview of M&A due diligence preparation.
What a QoE Report Costs and How Long It Takes
Cost and timeline depend on the size and complexity of the business. Owners should budget appropriately and build the QoE timeline into their overall sale process.
Typical Fees by Deal Size
For businesses with $1 million to $5 million in EBITDA, a QoE report typically costs $30,000 to $60,000. Businesses in the $5 million to $15 million EBITDA range should expect fees of $50,000 to $100,000. Larger or more complex businesses, those with multiple entities, international operations, or significant inventory, can see fees exceed $150,000. Buy-side QoE reports tend to run 10% to 20% higher than sell-side reports because the buyer's accounting firm is starting from scratch rather than building on an existing relationship with the company.
Timeline and What to Expect During the Process
A typical QoE engagement takes four to eight weeks from kickoff to final report. The first two weeks involve data collection: the accounting firm will request three to five years of financial statements, tax returns, general ledger detail, customer lists, vendor contracts, and payroll records. Weeks three through five are analysis, during which the QoE team will ask follow-up questions and request supporting documentation for specific transactions. The final one to two weeks produce the draft and final report.
Sellers should expect to dedicate 15 to 25 hours of management time to the process, primarily answering questions from the QoE team. Having organized financial records, which ACP helps clients assemble during the preparation phase, can reduce that time significantly.
How to Prepare for a Quality of Earnings Review
Preparation is the single best way to protect your sale price. The sellers who perform worst in QoE reviews are those who hand over a box of disorganized records and hope for the best.
The Financial Cleanup Checklist
Before a QoE engagement begins, sellers should complete these steps. First, reconcile all balance sheet accounts. Unexplained balances in intercompany accounts, related-party receivables, or "miscellaneous" line items will draw immediate scrutiny. Second, document every add-back with supporting evidence. If you added back $150,000 for a one-time legal settlement, have the settlement agreement ready. Third, normalize owner compensation and benefits. Calculate the market-rate cost of replacing yourself and document the difference. Fourth, clean up any personal expenses running through the business. Remove them from the current year and restate prior periods. Fifth, prepare a working capital schedule showing monthly balances for the trailing 24 months. Understanding your business valuation starts with clean numbers that a buyer's team can verify quickly.
Common Adjustments Sellers Should Anticipate
Experienced Deloitte practitioners and regional QoE firms consistently flag the same categories. Owner compensation above market rate is the most common add-back, typically ranging from $100,000 to $500,000 for businesses in the $2 million to $10 million EBITDA range. One-time professional fees related to the transaction itself are legitimate add-backs. Rent adjustments for owner-occupied or related-party real estate almost always appear. Discretionary expenses like luxury vehicles, club memberships, and personal travel need documentation showing business purpose or they will be removed.
The Exit Planning Institute recommends that business owners begin financial cleanup at least 12 to 18 months before going to market. That lead time allows owners to run one or two clean fiscal years, which dramatically strengthens the earnings story a QoE report tells.
