What is Quality of Earnings? [2025]
Quick Answer
Quality of Earnings (QoE) is a financial due diligence report that analyzes the accuracy, sustainability, and consistency of a company's reported earnings. Buyers commission QoE reports to validate financial statements, identify risks, and determine appropriate adjustments to EBITDA before finalizing purchase price.
Key Takeaways
- •QoE reports analyze the accuracy, sustainability, and consistency of a company's reported earnings
- •Buyers use QoE to validate financial statements and identify risks before acquisition
- •Common QoE adjustments include one-time expenses, revenue recognition timing, and working capital needs
- •Preparing for QoE involves clean accounting, documented revenue policies, and normalized financials
- •QoE findings directly impact purchase price, deal structure, and transaction certainty
Why Buyers Require QoE Reports
Buyers use QoE reports to validate that the earnings you present accurately reflect the sustainable, ongoing profitability of the business. The report serves multiple purposes:
- Confirms financial statements are accurate and free from material errors
- Identifies non-recurring items that should be added back or excluded
- Analyzes revenue recognition policies and timing differences
- Evaluates working capital requirements and cash flow dynamics
- Uncovers potential risks or liabilities not evident in financial statements
Common QoE Adjustments
QoE reports typically adjust reported EBITDA based on findings during the analysis:
Positive Adjustments (Increase EBITDA)
- One-time legal or professional fees
- Owner compensation above market rates
- Non-recurring consulting or advisory costs
- Expenses related to abandoned projects or initiatives
- Personal expenses run through the business
Negative Adjustments (Decrease EBITDA)
- Deferred maintenance or capital expenditures
- Under-market owner compensation requiring replacement
- Revenue recognized early or pulled forward
- Inadequate reserves or accruals
- Material customer concentration risk
How to Prepare for QoE
Proactive preparation significantly improves QoE outcomes and transaction certainty:
- Ensure accounting policies are consistent and well-documented
- Maintain clean, organized financial records with supporting documentation
- Clearly identify and document all EBITDA adjustments
- Address any accounting irregularities before going to market
- Prepare a detailed QoE request list proactively
- Consider a sell-side QoE to identify issues early
Frequently Asked Questions
The buyer typically pays for and commissions the QoE report as part of their due diligence. However, some sellers proactively commission a QoE before going to market to identify and address issues early, which can streamline the sale process.
Most QoE reports take 3-6 weeks to complete, depending on business complexity, quality of financial records, and responsiveness to information requests. Businesses with clean books and organized documentation experience faster turnaround times.
An audit verifies that financial statements comply with accounting standards and are free from material misstatement. A QoE goes deeper, analyzing the quality and sustainability of earnings, normalizing adjustments, and identifying risks that impact business value.
Yes, significant QoE findings can derail deals if they reveal material misstatements, unsustainable earnings, or hidden liabilities. However, most QoE findings result in price adjustments, earnouts, or escrow provisions rather than deal termination.
Common red flags include aggressive revenue recognition, inconsistent accounting policies, lack of documentation for adjustments, related-party transactions, material customer concentration, and significant working capital needs not reflected in EBITDA.
A sell-side QoE can be valuable if you anticipate complex earnings adjustments or want to address issues proactively. It provides transparency, builds buyer confidence, and can accelerate the sale process. However, it requires upfront investment and may not be necessary for straightforward businesses.