Valuation fundamentals
What Is a Quality of Earnings Report?
The short answer
A quality of earnings report, often shortened to QoE, is an independent financial review that tests whether a business's reported profit is real, repeatable, and accurately presented. Buyers commission it during due diligence, usually paid for by the buyer, though sellers increasingly commission their own sell-side QoE in advance to catch problems before a buyer finds them. A QoE can change the final price of a deal, sometimes significantly, because it often surfaces adjustments to earnings that were not visible in the seller's own bookkeeping.
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What a QoE report actually does
Most small business financials are prepared for tax purposes, not for a buyer trying to decide what to pay. Tax returns are built to minimize taxable income, which means expenses get maximized and revenue timing can be shifted in ways that make sense for the IRS but distort the true earning power of the business. A QoE report exists to undo that distortion.
An accountant, usually from a firm that specializes in transaction advisory work, goes through the company's financial records, bank statements, contracts, and underlying transactions and asks a simple question: what does this business actually earn, on a normalized and recurring basis, if you strip out one-time items, accounting quirks, and owner-specific expenses? The output is a set of adjusted earnings figures, along with an explanation of every adjustment made.
This is different from an audit. A QoE report does not certify that the financial statements are correct according to accounting standards. Instead, it focuses narrowly on the earnings figure that will drive the valuation, typically EBITDA or seller's discretionary earnings, and it tests whether that figure holds up under scrutiny.
Who pays for it, and why that matters
In most small and mid-sized business deals, the buyer pays for the QoE, because the buyer is the one relying on it to decide whether the deal makes sense and at what price. Buyer-side QoE reports typically run from a few thousand dollars for a very small deal to well over $50,000 for a larger, more complex business, and the cost is usually built into the buyer's overall diligence budget.
A growing number of sellers now commission their own sell-side QoE before they go to market. The logic is straightforward: if you know in advance what a buyer's accountant is going to find, you can fix it, explain it, or price it in ahead of time, rather than being surprised by a renegotiation two weeks before closing. A sell-side QoE also signals to buyers that the seller has nothing to hide, which can speed up the process and reduce the buyer's own diligence costs.
Sell-side QoE reports are more common in deals above roughly $2 million to $3 million in value, where the cost of the report is small relative to the risk of a late-stage price cut. Below that range, many sellers skip it and rely instead on having clean, well-organized books going into the process.
Sell-side vs buy-side QoE
A sell-side QoE is prepared for the seller, before the business goes to market or early in the process, and its purpose is to get ahead of problems. It gives the seller a defensible, independently prepared earnings number to present to buyers, and it often becomes the starting point for negotiation rather than the buyer's own adjustments.
A buy-side QoE is prepared for the buyer, usually after a letter of intent has been signed, and its purpose is to verify the numbers the seller has represented and to look for anything the seller's materials did not disclose. Buy-side QoE reports tend to be more adversarial in tone, simply because the buyer's accountant is actively looking for reasons the price should be lower or the terms should change.
In many deals both happen: the seller prepares a sell-side report to support their asking price, and the buyer still commissions their own buy-side review because they are not willing to rely entirely on a report the seller paid for. The two reports usually land close to each other if the seller's numbers were accurate, but gaps between them are where real negotiation happens.
What a QoE report examines
The core of a QoE report is earnings normalization: identifying add-backs (owner salary above market rate, personal expenses run through the business, one-time legal fees, and similar items) and testing whether each one is legitimate and properly documented. Add-backs that cannot be tied to a bank statement or invoice tend to get rejected, which lowers the adjusted earnings figure.
It also examines revenue quality: how much revenue is recurring versus one-time, how concentrated it is among a small number of customers, and whether any recent growth was driven by something unlikely to continue, such as a temporary contract or a pandemic-era demand spike. A business with revenue that looks strong on paper but depends heavily on one customer will often see that flagged prominently.
Working capital, deferred liabilities, unrecorded expenses, and the timing of revenue recognition all get reviewed as well. A QoE will often uncover things like unpaid vendor bills sitting off the books, vacation pay that has accrued but was never recorded as a liability, or revenue booked before the work was actually completed. Each of these can shift the adjusted earnings number, sometimes in the seller's favor and sometimes against it.
How a QoE can change the price
Because most small business deals are priced as a multiple of earnings, any change to the earnings figure moves the price directly, and the effect is magnified by the multiple. If a buyer's QoE knocks $100,000 off adjusted EBITDA and the deal is priced at a 4x multiple, that single adjustment can reduce the offer by $400,000.
This is the main reason QoE reports matter so much to sellers, even though the seller usually is not the one paying for the buy-side version. An owner who has been mentally spending a certain sale price for months can be genuinely blindsided when a QoE report trims the earnings number and the buyer comes back wanting to renegotiate, or worse, walks away.
The best defense is preparation: keeping clean books throughout the years leading up to a sale, documenting every add-back with real records as they happen rather than reconstructing them later, and being conservative and honest about what counts as a legitimate adjustment. Sellers who inflate their add-backs going into a deal are the ones most likely to see a painful downward adjustment once a QoE is done.
When a small business actually needs one
Not every deal involves a formal QoE. For very small transactions, often under $1 million or so, many buyers rely on a simpler review of tax returns and bank statements rather than paying for a full QoE engagement, since the cost of the report can be disproportionate to the size of the deal.
A QoE becomes more likely, and more valuable to both sides, once a deal involves outside financing, private equity or search fund buyers, or a purchase price above roughly $2 million to $3 million. Lenders in particular often require some form of independent earnings verification before they will fund an acquisition loan, which effectively forces a QoE into the process regardless of what either party would otherwise prefer.
Even where it is not required, a seller who suspects their books have some messiness, personal expenses mixed into the business, inconsistent bookkeeping, or thin documentation for add-backs, may benefit from commissioning a sell-side QoE simply to find out what a buyer would find, on their own terms and their own timeline, rather than in the middle of a live negotiation.
A hypothetical example
Imagine a hypothetical owner, Dana, who runs a specialty manufacturing company and has verbally agreed to sell for $4.5 million based on adjusted EBITDA of $1 million and a 4.5x multiple. Dana's own bookkeeper had added back $150,000 for a family member's salary, calling it a non-working relative. During buy-side QoE, the buyer's accountant finds that the relative did, in fact, perform real administrative work several days a week, and only $60,000 of the $150,000 add-back is supportable. That single finding reduces adjusted EBITDA by $90,000, which at the agreed 4.5x multiple lowers the implied price by roughly $405,000. Dana and the buyer end up renegotiating to a price closer to $4.1 million rather than losing the deal entirely. This example is illustrative only and not based on a real transaction.
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Common questions
How much does a quality of earnings report cost?
Costs vary widely by deal size and complexity, but small business QoE engagements often run from around $10,000 to $25,000, while larger or more complex businesses can see fees well above that. Buyers usually build this cost into their overall diligence budget.
Is a QoE the same as an audit?
No. An audit certifies that financial statements comply with accounting standards. A QoE focuses specifically on normalizing earnings to reflect the true, recurring profitability of the business, and it does not provide the same formal assurance an audit does.
Who typically pays for the QoE report?
In most deals, the buyer pays for their own buy-side QoE, since it is prepared for their benefit. Sellers who choose to commission a sell-side QoE in advance pay for that themselves, as a way of getting ahead of issues before marketing the business.
Can a QoE report kill a deal?
Yes. If a QoE uncovers significant, unexplained gaps between reported and normalized earnings, or reveals issues like revenue that was recognized improperly, a buyer may walk away entirely rather than renegotiate, particularly if trust in the seller's numbers has been damaged.
How long does a QoE take to complete?
A typical small to mid-sized business QoE takes anywhere from two to six weeks, depending on how organized the seller's records are and how complex the business is. Poor recordkeeping is the most common cause of delay.
Do I need a QoE if I am selling a very small business?
Not necessarily. Many transactions under roughly $1 million rely on simpler reviews of tax returns and bank statements rather than a full QoE, since the cost may not be justified relative to the deal size. Larger deals and those involving outside financing are far more likely to require one.
What happens if the seller and buyer's QoE numbers disagree?
Disagreements are normal and usually become the basis for negotiation. The two sides, or their accountants, typically work through the specific adjustments in dispute to reach a number both can support, sometimes resulting in a revised price or additional deal terms.