Quality of Earnings Report: What It Is and When a Buyer Needs One

A quality of earnings (QoE) report is an independent analysis, usually prepared by a CPA or transaction advisory firm, of whether a business’s reported earnings are real and sustainable. It tests adjusted EBITDA or SDE, revenue quality, working capital and debt-like items. Buyers commission a full QoE for larger acquisitions; for smaller deals, rebuilding the P&L from bank statements provides a proportionate level of verification.

The question a QoE answers is narrow but decisive: is the earnings figure the price is based on one you can actually rely on after closing?

What is a quality of earnings report?

When you buy a business at a multiple of earnings, every dollar of overstated earnings costs you several dollars of price. A QoE report rebuilds the earnings from source records, challenges the seller’s adjustments, and produces an adjusted EBITDA (or SDE for owner-operated businesses) that the buyer can use in the valuation and the purchase agreement.

It is a buyer-side document. The seller’s broker may present adjusted figures in the marketing package, but those numbers are prepared to support the asking price. A QoE is prepared for the person taking the risk. Sellers of larger companies sometimes commission a sell-side QoE in advance; buyers usually still review it independently.

What does a QoE report cover?

The scope varies by deal, but a typical engagement includes:

• Adjusted EBITDA or SDE. Review of each add-back and normalization adjustment, with supporting documents.
• Proof of cash. Matching reported revenue and expenses to bank deposits and withdrawals for the period.
• Revenue quality. Customer concentration, recurring versus one-time revenue, pricing changes, cut-off at period end.
• Margin and cost analysis. Trends in gross margin, payroll and key expense lines.
• Net working capital. Normal working capital levels and a proposed peg for the purchase agreement.
• Debt and debt-like items. Unpaid taxes, deferred revenue, customer deposits, accrued bonuses, equipment leases.
• Reconciliations. Financial statements against tax returns and the general ledger.

The findings feed directly into the price, the letter of intent terms on working capital and holdbacks, and the representations in the purchase agreement.

How does a QoE differ from an audit?

Most small businesses have never been audited at all. Their financial statements are internally prepared or compiled by a bookkeeper, which is exactly why independent verification matters before a purchase.

What drives the cost of a QoE?

Fees for a QoE range widely and are often five figures in the lower middle market. Rather than relying on a quoted average, look at what drives the scope:

• Deal size and complexity. More revenue streams, entities and locations mean more work.
• Quality of records. Clean accrual accounting is faster to analyze than cash-basis books with gaps.
• Inventory. Businesses with significant inventory need counts and costing reviews.
• Period covered. Three years plus year-to-date costs more than a trailing twelve months.
• Timeline. A compressed exclusivity window may require a larger team.
• Add-ons. Tax due diligence, IT or operational reviews are usually priced separately.

Ask several firms for a scoped proposal, and confirm what is in and out of scope before the engagement starts.

What documents does a QoE need from the seller?

Whether you commission a full QoE or a lighter review, the analysis is only as good as the records behind it. Build the document request into the LOI so the seller knows what to prepare. A typical list:

• Monthly financial statements (P&L and balance sheet) for the last three years and the current year to date.
• Federal and state tax returns for the same period.
• Bank and credit card statements for every business account.
• The general ledger and the chart of accounts.
• Payroll reports and payroll tax filings.
• Sales tax returns, where applicable.
• Accounts receivable and payable agings, and an inventory listing.
• Customer revenue by month for the largest customers.
• The lease, loan agreements, equipment leases and key contracts.
• Support for each proposed add-back.

Delays in delivering these documents are themselves informative. A seller who cannot produce bank statements or reconcile tax returns to the P&L is telling you something about the reliability of the earnings.

When does a buyer need a full QoE?

A full QoE from a CPA firm is common, and often expected by lenders and investors, when:

• the purchase price is in the millions and based on an EBITDA multiple;
• the business has several entities, locations or revenue streams;
• earnings rely on many adjustments or on a recent spike;
• the purchase agreement will include a working capital peg, earnout or significant indemnities.

For a smaller owner-operated business, a full QoE can cost a meaningful share of the price. That does not mean skipping verification; it means choosing a proportionate method.

How do smaller deals verify earnings without a full QoE?

For many acquisitions in the $500,000 to low millions range, the most useful test is also the hardest for a seller to adjust: the bank statements. TealBridge’s due diligence rebuilds the P&L from three years of bank statements, matches deposits to reported revenue (a proof of cash), and reconciles the result with tax returns and the seller’s financial statements.

The output is a verified P&L, balance sheet and cash flow view, a list of add-backs with the documents behind them, and a valuation opinion based on the verified figures. Where the numbers diverge, we bring the differences back to the negotiating table.

This work is part of buyer-side advisory, not an attestation. TealBridge is not a CPA firm. When a deal’s size or complexity calls for a formal QoE, we recommend engaging an independent CPA firm and coordinate with it, so the two pieces of work do not duplicate each other.

How do QoE findings affect the deal?

Findings usually lead to one of four outcomes. The price is confirmed and the deal proceeds. The price is adjusted because adjusted earnings came in lower than presented. The structure changes, for example with a larger holdback, seller note or earnout to share the risk of uncertain earnings. Or the buyer walks away, which is far cheaper during due diligence than after closing. See how to value a business for how a change in earnings flows through to price.

For E-2 investors there is one more reason to verify. The business must be real, operating and able to generate more than a minimal living, and your immigration attorney will rely on its financials. Verified earnings make that case more credible.

Next step

TealBridge verifies earnings on the buyer side: a P&L rebuilt from bank statements, proof of cash, add-back review, valuation opinion, and coordination with a CPA firm when a full QoE is warranted. See how we work and our fees, or contact us with the business you are reviewing.