Quality of Earnings Reports Explained

A quality of earnings report is a third-party financial analysis that verifies whether a company’s reported EBITDA reflects its actual, sustainable earning power. In lower middle market transactions, QoE reports cost between $20,000 and $60,000, take 30 to 45 days to complete, and routinely uncover EBITDA adjustments of 10-25% in either direction. For sellers preparing for an exit, the sell-side QoE has become the single most important pre-market investment you can make.

I have watched more deals stall or reprice during due diligence than at any other stage. The cause is almost always the same: a financial surprise the seller did not see coming. A quality of earnings report eliminates those surprises before they cost you real money.

What a Quality of Earnings Report Actually Analyzes

It is not an audit. It is a deal-focused dissection of your financials through a buyer’s eyes.

Most sellers confuse a QoE with an audit. They are fundamentally different. An audit confirms whether your financials comply with GAAP. A QoE report answers a different question: are these earnings real, recurring, and sustainable enough to justify the purchase price?

The analysis typically covers five areas:

• Adjusted EBITDA: Strips out one-time expenses, owner perks, non-recurring revenue, and normalizes compensation to market rates. This is the number the deal prices off of.
• Revenue quality: Evaluates whether revenue is recurring, contractual, or project-based. Examines customer concentration and churn patterns.
• Working capital: Establishes the normalized level of working capital required to operate the business, which directly affects the closing adjustment.
• Proof of cash: Reconciles reported revenue against bank deposits. This catches aggressive revenue recognition fast.
• Expense trends: Identifies deferred maintenance, below-market contracts, or costs that will increase under new ownership.

The output is typically a 40-80 page report with a bridge from reported EBITDA to adjusted EBITDA, complete with supporting schedules. This becomes the financial backbone of the deal.

Sell-Side vs. Buy-Side: Why Sellers Should Go First

Traditionally, QoE reports were a buyer’s tool. The buyer signed the LOI, hired a CPA firm, and spent 30-45 days picking apart your financials. If they found problems, you lost leverage. If they found upside, they kept quiet.

That dynamic has shifted. Sell-side QoE reports are now standard practice in lower middle market M&A. According to Morgan & Westfield, not having a sell-side QoE puts sellers at a disadvantage in competitive processes.

The logic is straightforward. When you commission your own QoE before going to market, three things happen:

• You find the adjustments first. If there are EBITDA add-backs you missed, your QoE provider finds them. I have seen sell-side reports uncover $200K-$500K in legitimate adjustments that the seller did not even know to claim.
• You fix problems before buyers see them. Revenue recognition issues, customer concentration, deferred maintenance: all of these are better addressed on your timeline than under the pressure of a 60-day exclusivity window.
• You control the narrative. Handing a buyer a polished sell-side QoE report from a reputable firm signals professionalism. It also anchors the EBITDA conversation around your adjusted number, not theirs.

A Deal Where the QoE Changed Everything

We represented a B2B SaaS company with $4.2M in ARR. Clean books. Healthy margins. The owner was confident in a 5.5-6x multiple based on comparable transactions.

I recommended a sell-side QoE before going to market. The owner pushed back on the $28,000 cost. “My books are clean,” he said. “We have a bookkeeper and a CPA.”

He agreed to proceed anyway. The QoE provider found three things:

First, $180,000 in owner compensation above market rate that could be added back to EBITDA. The owner was paying himself well, as he should, but market-rate compensation for a replacement CEO was lower. That is a legitimate add-back most sellers miss.

Second, a one-time consulting project worth $340,000 that the owner had booked as recurring revenue. It inflated trailing twelve-month numbers. The QoE provider flagged it, and we reclassified it before going to market. Had a buyer’s QoE caught this during due diligence, it would have triggered a repricing conversation.

Third, a working capital surplus of $120,000 above normalized levels, which meant the seller would receive that cash back at closing rather than leaving it in the business.

Net result: the sell-side QoE increased defensible EBITDA by $180,000 through the compensation add-back, prevented a $340,000 revenue misclassification from derailing negotiations, and identified $120,000 in excess working capital. The $28,000 report generated over $300,000 in direct value.

When You Need One and When You Might Not

Not every transaction requires a full QoE. But most transactions above $2M in enterprise value do.

A sell-side QoE makes sense when:

• Your business has EBITDA above $500K and the enterprise value justifies the cost
• You have complex revenue streams, multiple entities, or significant add-backs
• You are running a competitive process with multiple buyers
• A PE firm or institutional buyer is involved (they will commission their own regardless)

You can likely skip the sell-side QoE when:

• The business is simple, single-entity, with clean books and under $1M in enterprise value
• You are selling to a known buyer (partner, employee, family member) in a negotiated deal
• The transaction is asset-heavy and the primary value is in tangible assets, not earnings

Even in smaller deals, the buyer will almost certainly commission their own QoE. Understanding what that process looks like helps you prepare. For a deeper look at how different financial analyses affect your valuation, see our guide on how QoE reports, appraisals, and audits compare.

How to Choose a QoE Provider

Not all QoE reports are created equal. The quality of the analysis depends entirely on the firm performing it. Here is what to look for:

• Transaction experience. Pick a firm with a dedicated QoE practice, not a general CPA firm doing its first deal. PE firms and sophisticated buyers want to see a recognized name on the report.
• Industry knowledge. A QoE provider who understands SaaS metrics, recurring revenue, and churn benchmarks will ask better questions and find more relevant adjustments than a generalist.
• Fixed-fee pricing. Most reputable firms offer fixed fees rather than open-ended hourly billing. Get the scope and price in writing before engaging.
• Timeline commitment. The standard is 30-45 days. If a firm cannot commit to that timeline, they may not have the capacity to prioritize your engagement.

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