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Quality of earnings report.

Aka. QoE report · quality of earnings · earnings quality analysis
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What is a quality of earnings report?

A quality of earnings report is a financial diligence study that examines whether a company's reported profits are real, recurring, and sustainable — or inflated by one-time items, aggressive accounting, and timing tricks. Commissioned by a buyer (or by a seller as vendor diligence), it is the single most influential document in most M&A financial diligence.

Its central output is an adjusted, or "normalized," EBITDA: reported earnings recalculated to remove the noise. The QoE strips out non-recurring gains, adds back genuinely one-off costs, and corrects for accounting policies that flatter the numbers, arriving at the run-rate profitability the buyer is actually paying a multiple of.

A QoE is not an audit. An audit confirms the financials comply with accounting standards; a QoE asks a different question — how much of this reported profit will persist for the new owner? Two companies with identical audited earnings can have very different earnings quality, and the QoE is how a buyer tells them apart.

What a QoE actually examines

The analysis works methodically from reported numbers toward a defensible run-rate.

  1. EBITDA adjustments. Removing one-time gains and adding back genuine non-recurring expenses — owner perks, legal settlements, restructuring — to find normalized earnings.
  2. Revenue quality. Testing whether revenue is recurring or one-off, properly recognized, and free of channel-stuffing or pulled-forward sales.
  3. Working capital. Establishing a normal working-capital level, which sets the peg used in the purchase price adjustment at close.
  4. Customer and margin trends. Concentration, churn, and whether margins are stable or being propped up temporarily.

Each adjustment can move the price directly, because most deals are struck as a multiple of adjusted EBITDA. A QoE that knocks a few points off normalized EBITDA reduces the purchase price by that amount times the multiple — which is why the adjustments are negotiated as hard as the multiple itself.

Why earnings quality, not just earnings, drives price

Buyers pay multiples of earnings, so the durability of those earnings is what they are really buying. A dollar of profit that recurs reliably is worth far more than a dollar that came from a one-time contract or a deferred maintenance cut — and the QoE exists to separate the two.

The report also re-anchors the negotiation. A seller markets the business on reported or management-adjusted EBITDA; the buyer's QoE produces its own normalized figure, and the gap between them becomes the battleground. The buyer who can defend each adjustment with evidence from the data room negotiates from a position of strength.

Frequently asked.

5 questions
01 What's the difference between a QoE and an audit?

An audit verifies that financial statements comply with accounting standards and are free of material misstatement — a backward-looking compliance check. A quality of earnings report asks whether the reported profits are sustainable and recurring for a future owner — a forward-looking economic assessment.

A company can have a clean audit and still have poor earnings quality, if much of its profit is non-recurring or propped up by accounting choices. Buyers commission a QoE precisely because the audit, while necessary, doesn't answer the question that drives the price.

02 What is adjusted EBITDA in a QoE?

Adjusted, or normalized, EBITDA is reported EBITDA recalculated to reflect sustainable run-rate profitability. The QoE removes one-time gains, adds back genuinely non-recurring costs (such as owner-specific expenses or one-off legal fees), and corrects for accounting distortions.

It matters because the purchase price is usually a multiple of adjusted EBITDA. Every dollar of adjustment, multiplied by the deal multiple, moves the price — so which add-backs are legitimate and which are not is one of the most contested elements of financial diligence.

03 Who pays for a quality of earnings report?

Usually the buyer, as part of its confirmatory diligence, hiring an accounting or transaction advisory firm to perform it. The cost is borne by the buyer and is generally unrecoverable if the deal does not close.

Sellers increasingly commission their own QoE as part of vendor due diligence, to control the narrative and reduce surprises. Even so, buyers typically run or scrutinize their own analysis rather than relying solely on the seller's, given how directly the conclusions affect price.

04 How does a QoE affect the purchase price?

Directly and substantially. Because deals are priced as a multiple of adjusted EBITDA, any change to that normalized figure flows through to the price at the full multiple. A QoE that lowers normalized EBITDA gives the buyer grounds to reduce its offer.

The QoE also drives the working-capital peg used in the closing adjustment, and surfaces issues — revenue recognition problems, customer concentration — that lead to structural protections like larger escrows or specific indemnities. It is the analytical backbone of the price negotiation.

05 How does a QoE stay useful after the deal closes?

The QoE produces the most rigorous, normalized view of the company's economics that exists at the moment of purchase — the very baseline the buyer underwrote against. After close, the buyer needs to know whether actual performance lives up to that normalized picture.

When the QoE's adjustments and conclusions remain queryable alongside post-close results, the buyer can test its underwriting in real time — confirming the add-backs held, the margins persisted, and the run-rate was real — rather than letting the report disappear into the closing binder.

Related terms

Ddiligence

Data tape

A single granular file — one row per loan, account, or customer — listing every position in a portfolio so a buyer can model it <em>line by line</em>.

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Sdiligence

Site visit

An on-the-ground inspection of a target's physical operations — plants, warehouses, stores — to verify in person what the data room describes on <em>paper</em>.

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Cdiligence

Carve-out financials

Financial statements constructed for a business unit being sold out of a larger parent — an estimate of how the unit would perform <em>standalone</em>.

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Sdiligence

Sell-side diligence

Diligence a seller runs on its own business before a sale — finding and fixing problems early so buyers can't use them to <em>re-trade</em> the price.

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Cdiligence

Customer reference call

A diligence conversation with a target's actual customers to test whether the revenue story holds up — the closest a buyer gets to ground <em>truth</em> on demand.

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Bdiligence

Buy-side diligence

The investigation a buyer runs on a target before close — testing the seller's claims so the buyer knows <em>exactly what it is paying for</em>.

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