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Quality of earnings.

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

A quality of earnings analysis — universally shortened to QoE — is a financial diligence study that interrogates whether a target's reported earnings reflect the true, sustainable economics of the business. It is not an audit. An audit asks whether the financials comply with accounting standards; a QoE asks whether the earnings are real, recurring, and likely to repeat.

The output is a QoE report, typically prepared by a transaction advisory team at an accounting or specialist firm, commissioned by the buyer (buy-side QoE) or, increasingly, by the seller to get ahead of the process (sell-side QoE). Its centerpiece is a bridge from reported EBITDA to an adjusted, "normalized" EBITDA that a buyer can actually underwrite.

Because price in most private deals is a multiple of EBITDA, the QoE-adjusted EBITDA number is frequently the single most consequential figure in the transaction. A dollar moved on or off that line moves the purchase price by the full multiple.

What a QoE actually tests

A QoE works through the income statement and the underlying ledgers looking for the gap between what was reported and what is durable.

  1. Revenue quality. Is revenue recognized appropriately, concentrated in a few customers, contracted versus one-time, and free of channel-stuffing or pull-forwards near period-end?
  2. Normalizing adjustments. Add-backs for one-time, non-recurring, and owner-specific items — and, just as importantly, deductions for understated run-rate costs the business will carry post-close.
  3. Run-rate and pro-forma effects. The full-year impact of recent price changes, lost or won customers, headcount changes, and acquisitions, so EBITDA reflects the go-forward business rather than a blended historical year.
  4. Working capital and cash conversion. Whether reported profit actually turns into cash, and what a normal level of working capital looks like — which feeds the closing mechanism, not just the price.
  5. Proof of cash. Tying reported earnings back to bank statements to confirm the profit was genuinely collected.

Why buyers and sellers both commission it

For a buyer, the QoE is the basis for the price they are willing to pay and the protections they negotiate. A finding that EBITDA is overstated by add-backs that won't survive ownership is direct leverage on price or structure.

For a seller, a sell-side QoE prepared before launch removes surprises. It lets the seller defend the EBITDA number with a credible third-party analysis already in the room, compressing the time a buyer's own QoE can take to chip away at value. Either way, the report becomes a core document in the data room and a reference point through closing.

Frequently asked.

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

An audit provides assurance that financial statements are presented fairly under accounting standards, looking backward at a fiscal period. A QoE is a transaction-specific analysis that asks whether earnings are sustainable and what a buyer should pay for them — it is forward-looking and unconstrained by audit scope.

A company can have clean audited financials and still receive a QoE that materially reduces underwritable EBITDA, because the two answer different questions.

02 Who pays for the quality of earnings report?

Whoever commissions it. A buy-side QoE is paid for by the buyer and serves their diligence; a sell-side QoE is paid for by the seller to pre-empt buyer findings. In competitive processes a sell-side QoE has become close to standard, with buyers then performing a lighter confirmatory review on top.

03 How does a QoE affect the purchase price?

Directly and with leverage. Price is typically a multiple of adjusted EBITDA, so any adjustment the QoE makes to that EBITDA number is amplified by the multiple. Removing a one million dollar add-back at a 10x multiple takes ten million dollars off enterprise value.

This is why the EBITDA bridge in a QoE is negotiated line by line by both sides' advisors.

04 What are EBITDA add-backs in a QoE?

Add-backs are adjustments that restore reported EBITDA to a normalized run-rate by removing items a new owner won't bear — one-time legal costs, owner's above-market compensation, discontinued lines, transaction expenses. A credible QoE scrutinizes each one for whether it is genuinely non-recurring.

The discipline cuts both ways: a rigorous QoE also adds costs the target has been under-spending on, which reduce EBITDA rather than inflate it.

05 Does the QoE stay relevant after close?

It should. The QoE's adjusted EBITDA, its add-back schedule, and its working-capital normal become the baseline the new owner manages against — yet the report is often filed away and forgotten once the deal signs.

Keeping the QoE bridge live and cross-referenced to the company's actuals — so the post-close team can see whether the normalized earnings the price was built on are holding — is part of what VectorShift keeps queryable after the room closes.

Related terms

Avaluation

ARR multiple

Enterprise value divided by <em>annual recurring revenue</em> — the headline multiple for subscription software, where ARR is the durable revenue base.

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Pvaluation

Purchase price allocation

The post-close exercise of <em>spreading the purchase price</em> across a target's assets and liabilities at fair value — with the residual booked as goodwill.

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Evaluation

EBITDA multiple

Enterprise value divided by EBITDA — the headline multiple in private markets, expressing <em>price as a count of operating-earnings years</em>.

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Rvaluation

Revenue multiple

Enterprise value divided by revenue — a top-line valuation yardstick used when a business is <em>unprofitable or pre-EBITDA</em>, common in high-growth software.

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Ivaluation

Implied multiple

The valuation multiple <em>backed out</em> from a known price and metric — what a deal price or model output implies in turns of EBITDA or revenue.

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Evaluation

Enterprise value

The value of a business to <em>all</em> capital providers — equity and debt — independent of how the company happens to be financed.

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