What Is a Quality of Earnings Report and Why Does Every Buyer Require One?

A Quality of Earnings (QoE) report is an independent analysis of a company's financial statements that goes deeper than standard audited accounts. An accounting firm (hired by the buyer, sometimes the seller) examines whether the reported earnings reflect the true, repeatable financial performance of the business.

In any M&A transaction above $5M, a QoE is standard. Above $15M, it is nearly universal.

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What the Report Actually Examines

Revenue recognition. Are customers actually committed to the revenue on the books, or did the company pull forward bookings, count signed LOIs as revenue, or recognize annual contracts upfront in ways that inflate the current year?

One-time vs. recurring items. Did the company have a one-time settlement, a government grant, or a consulting project that boosted revenue this year but will not repeat? QoE adjusts EBITDA to remove non-recurring items.

Customer concentration and churn. What percentage of revenue comes from the top customers? What is the actual renewal rate by cohort, not the average rate?

Working capital normalization. Is the balance sheet showing working capital that reflects normal operations, or is it temporarily inflated (or deflated) by timing of payments?

Related-party transactions. Are there transactions between the company and founders, family members, or related entities that would not continue post-acquisition?

Add-backs. What expenses should be added back to EBITDA because they are not normal operating costs? Owner compensation above market rate, personal expenses run through the company, one-time legal fees.

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Why Buyers Require It

Buyers are paying a multiple of EBITDA or ARR. They need confidence that the number they are multiplying against is real and repeatable.

A seller presenting $10M EBITDA and a buyer agreeing to a 7x multiple is a $70M deal. If the QoE reveals $3M of that EBITDA was one-time items, the real multiple is 10x on $7M — and the deal either reprices to $49M or falls apart.

QoE protects buyers from acquiring a business that looks better than it is. It also creates a negotiation lever: any number the QoE firm can challenge becomes a reason to lower the price.

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Why Sellers Should Run It Themselves First

Sophisticated sellers run a sell-side QoE before starting a process. This costs $30-80K depending on the size and complexity of the business.

The value: you learn what a buyer will find before they find it. You can fix legitimate issues, prepare clear explanations for items that look unusual but are not problematic, and avoid the worst outcome — a late-stage deal renegotiation when you are already committed to one buyer.

Founders who go into a process without understanding their own QoE exposure often get surprised when the buyer's accountants come back with an adjusted EBITDA number 20-30% below what the seller expected. At that point, you are renegotiating from a weak position.

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What Triggers Large Adjustments

The most common items that get adjusted out of EBITDA in SaaS company QoEs:

1. Capitalized R&D that should be expensed 2. Deferred revenue recognition that inflated current period revenue 3. Founder/owner compensation significantly below what a market-rate replacement would cost (this gets added back, but buyers want to understand it) 4. Customer contracts with unusual terms that affect renewal probability 5. One-time professional fees for a prior legal matter

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Timeline

A QoE typically takes 4-8 weeks from engagement to final report. In a competitive process, buyers sometimes request a 2-week turnaround on a preliminary QoE. This is where clean financial records and a finance team that knows the business becomes a competitive advantage.

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Prepare Before the Process

ExitBoard helps founders understand which financial metrics buyers will scrutinize in diligence. Know your exposure before the QoE begins.

[Run Your Exit Readiness Score on ExitBoard]