What Is a Quality of Earnings (QoE) Report? The Operator's and Seller's Guide to What Happens to Your Numbers
A QoE report rebuilds EBITDA line by line and sets the price. Written for the management team and the seller who live through it, not the firm that sells it.
A quality of earnings (QoE) report is a due-diligence analysis, usually commissioned by a buyer after a letter of intent, that tests whether a company's reported earnings are sustainable, recurring and real in cash terms. It rebuilds EBITDA line by line and is the number the purchase price is actually set on.
A QoE is not an audit. An audit asks whether the books are accurate. A QoE asks whether the earnings will still be there after you buy the company. A business can pass one and fail the other.
Almost every page that explains a QoE is written by a firm that produces them. This one is written for the two parties who live through it: the management team whose EBITDA gets rebuilt line by line over three to six weeks, and the founder who learns in week three that "adjusted" cuts both ways.
Who commissions a QoE, and when
Buy-side. The sponsor commissions a QoE after the letter of intent is signed and before close. It takes 3 to 6 weeks and is produced by the transaction advisory practice of an accounting firm, not by the company's own auditor. The buyer pays, the buyer owns the findings, and the buyer uses them to confirm, reprice or walk.
Sell-side. Increasingly, the seller commissions its own QoE before going to market, to find the problems first and present a defended number rather than an aspirational one. For platforms above roughly $5M of EBITDA this is now market practice; sponsors expect it, and its absence reads as a signal.
Lender. A QoE is usually a condition of the debt financing. The bank reads it before the buyer signs, because the leverage is sized on the adjusted number, not the reported one.
What a QoE report actually contains
The report is long, but it is built from six pieces, and the price moves on two of them.
- Adjusted EBITDA bridge. Reported EBITDA at one end, adjusted EBITDA at the other, every step between them named and quantified. The bridge is the report's spine; our guide to what an EBITDA bridge is covers how to read one.
- Add-backs and their credibility spectrum. Owner compensation normalised to a market salary, true one-off costs, and pro-forma adjustments for actions not yet taken. This is the fight zone. Our EBITDA add-backs guide ranks the claims from routinely accepted to routinely rejected.
- Revenue quality. Customer concentration, recurring versus re-occurring versus one-time revenue, cohort views and churn. A report will happily accept $2M of EBITDA and then note that 40 percent of it comes from one contract up for renewal in month seven.
- Net working capital and the peg. The paragraph no provider page writes plainly: the working capital peg is the level of net working capital the buyer expects to be delivered at close, and the purchase price adjusts dollar for dollar against it. It is negotiated, not measured, and it is where a deal quietly gains or loses a turn of value.
- Proof of cash. Reported revenue and earnings tied back to bank statements. It is the test that catches what the P&L hides, and it is the reason the data request asks for 36 months of statements rather than a trial balance.
- Run-rate and pro-forma. What the buyer will and will not pay for on a promise. A price rise announced in month eleven counts for one month of history and eleven months of argument.
Buy-side vs sell-side QoE
| Buy-side QoE | Sell-side QoE | |
|---|---|---|
| Who pays | The buyer, usually a sponsor | The seller or its sponsor |
| When | After LOI, before close; 3 to 6 weeks | Before going to market; often longer, because it doubles as clean-up |
| What it is for | Confirm, reprice or walk | Find the problems first and defend the number |
| Who sees it | Buyer, its lenders and its investment committee | Every bidder in the process, then the winning buyer's own QoE team |
| Typical scope | Full: bridge, add-backs, revenue quality, NWC, proof of cash, run-rate | Same scope, but the add-back list is the seller's opening position |
A sell-side report does not replace the buyer's. The buyer's accountants will re-perform the work, and their job is to find what the seller's team accepted too easily.
A worked example, with units
A company reports $10.0M of EBITDA. The CIM shows $12.4M, because management has claimed $2.4M of add-backs: owner compensation, a lawsuit settlement, a rebrand, a bad-debt write-off and the run-rate effect of a price increase. The QoE team accepts $1.1M of that, rejects the run-rate and most of the "one-off" costs that recur every two or three years, and lands at $11.1M of adjusted EBITDA. At the 9.0x multiple in the LOI, the $1.3M gap between claimed and accepted add-backs is $11.7M of enterprise value that was in the CIM and is not in the closing statement.
The difference between claimed and accepted add-backs is the single most common reason a price moves between LOI and close. It is rarely fraud. It is almost always optimism, met by a team paid to be unimpressed.
What a QoE does to the management team
The report is a document. The process is three to six weeks of data requests landing on a finance function that was built to close the month, not to defend three years of it. The controller who runs a clean close will still be asked, in week two, for a customer-level revenue file that has never existed.
What the team should have ready before the QoE firm arrives: monthly P&L by entity for 36 months, customer-level revenue for the same period, bank statements to match, a fixed-asset and capex register, and a written list of every add-back with the invoice, contract or board minute that supports it. A team that turns up with these has taken two weeks and a great deal of argument out of the process.
Adjusted EBITDA cuts both ways. Sellers think of add-backs as things that increase the number. The QoE team also removes earnings the seller counted: pricing that will not hold, a lost customer not yet out of the run-rate, deferred maintenance capex that has been flattering cash flow, and revenue recognised early. A report that adds $1.1M and removes $0.8M has done its job on both sides.
The behavioural point is the one nobody puts in the engagement letter. Management that argues every add-back loses credibility on the ones that matter. Pick the five that move the number, support them to the invoice, and concede the rest early. The QoE team is grading the finance function as much as the earnings, and the buyer reads that grade too.
Where a QoE sits next to the other diligence workstreams
A QoE is the financial workstream in a set of five. Commercial due diligence (CDD) tests the market and the customers. Marketing due diligence (MDD) tests the demand engine: whether the pipeline the company reports is owned, rented or borrowed. Legal diligence tests what the company has signed. Tax diligence tests what it owes and what the structure will owe. In one line each: the QoE tests whether the earnings are real, CDD tests whether the market will keep producing them, and MDD tests whether the engine that produces them belongs to the company or to a channel it pays for. Our comparison of commercial versus marketing due diligence draws the line between the second and third.
The one variant worth naming separately is the carve-out QoE, where the earnings have to be rebuilt on a stand-alone basis with the parent's shared services priced back in; our guide to private equity carve-outs covers why those stand-alone cost adjustments are usually the largest number in the bridge.
Frequently asked questions
What is a quality of earnings report?
A quality of earnings (QoE) report is a due-diligence analysis, usually commissioned by a buyer after a letter of intent, that tests whether a company's reported earnings are sustainable, recurring and real in cash terms. It rebuilds EBITDA line by line and is the number the purchase price is actually set on.
Is a QoE the same as an audit?
No. An audit tests whether the financial statements are accurate against an accounting standard and is signed by the company's auditor. A QoE tests whether the earnings are sustainable and will still be there after the deal, is produced by a separate transaction advisory team, and answers a different question. A business can pass an audit cleanly and still lose a third of its adjusted EBITDA in a QoE.
Who pays for a quality of earnings report?
The buyer pays for a buy-side QoE and the seller pays for a sell-side one. Fees scale with the number of entities, the state of the data and the scope agreed, and the buyer's report is usually the more expensive because it is broader. Neither party's fee is refundable if the deal does not close, which is one reason sellers now commission their own before a process starts.
How long does a QoE take?
A buy-side QoE typically runs 3 to 6 weeks from kick-off to final report, starting after the letter of intent. A sell-side QoE starts earlier and often runs longer, because it doubles as a clean-up exercise. In both cases the timeline is driven by data readiness rather than by the firm: a company that can produce 36 months of monthly financials and customer-level revenue on day one finishes weeks ahead of one that cannot.
What are add-backs in a QoE?
Add-backs are adjustments that increase reported EBITDA to reflect what the business would earn under the new owner: owner compensation normalised to market, true one-off costs, and pro-forma savings. They sit on a credibility spectrum from routinely accepted to routinely rejected, and the gap between what management claims and what the QoE team accepts is usually the largest single movement in the price. Our EBITDA add-backs guide sets out which claims hold.
Why did my EBITDA go down after the QoE?
Because the QoE team rejected add-backs you claimed, applied haircuts to run-rate revenue, normalised working capital, or removed one-time revenue that was counted as recurring. Any of these lowers adjusted EBITDA, and the purchase price follows the adjusted number at the agreed multiple. The gap is rarely a dispute about the books; it is a dispute about what will still be true after close.
