Every business acquisition eventually comes down to one question: what does the target company actually earn? A quality of earnings report, or QoE, is the diligence tool built to answer that question with numbers a buyer can defend.
So, what is a quality of earnings report in practice? This piece walks through what it covers, which documents are pulled into the review, which adjustments come up most often, and how the findings reshape the purchase price, deal terms, and risk allocation before closing.
Defining a Quality of Earnings Report
A quality of earnings report is the financial analysis of a target company prepared during due diligence. Independent accountants or advisory professionals examine the target’s books to determine whether reported earnings reflect what the business generates on a repeatable basis.
The result is a clean, simplified view of the acquisition’s profitability, and buyers use this report to finalize pricing before signing the definitive agreement.
How a QoE Report Fits Into the Acquisition Process
Most QoE engagements begin after both parties sign a letter of intent and enter the financial due diligence phase. The seller opens the books, and the buyer’s advisory team begins reviewing several years of financial records. The completed report arrives before the buyer negotiates the definitive purchase agreement.
The buyer typically pays independent accounting or advisory firms to handle the technical work. Some sellers commission their own version before listing the business, which lets them address issues on their own timeline.
What a QoE Report Looks At
The centerpiece of any QoE is adjusted EBITDA, a measure of earnings that removes one-time items, non-operating expenses, and owner-specific costs. Buyers use this figure as the basis for valuation, applying a multiple to reach the purchase price.
Beyond EBITDA, the review examines revenue quality, cost structure, and cash flow patterns. Reviewers check whether income comes from recurring customers or from one-off contracts. They also dig into discretionary spending, working capital cycles, and other patterns that suggest earnings might not hold up under new ownership.
What Documents Are Reviewed in a QoE Report
During a QoE engagement, the reviewing firm requests a wide range of financial and operational records to test whether reported numbers hold up under scrutiny. The exact list varies by deal size and industry, but most reviews cover the same core categories.
Financial Statements and Ledgers
Reviewers request three to five years of profit and loss statements, balance sheets, and general ledger detail. Monthly trial balances allow the team to spot seasonal trends and unusual entries. Bank statements and reconciliations confirm that the reported numbers align with actual cash activity.
Revenue and Customer Records
Sales reports broken down by customer, product, and service line give reviewers the raw material for revenue quality analysis. Customer contracts, recurring revenue schedules, and accounts receivable aging reports show whether income streams are stable. Data on customer concentration helps the team quantify risk exposure.
Cost, Payroll, and Tax Records
Payroll registers reveal compensation for owners, related parties, and key employees. Tax returns, inventory records, and debt agreements further clarify and confirm what the business owes and owns.
Why Buyers Rely on a Quality of Earnings Report
A QoE report gives buyers an independent view of the numbers before they invest capital.
The report serves as a working document that guides negotiations and legal drafting for the remainder of the deal. Its findings show up in valuation math, purchase agreement schedules, and indemnity provisions applied after closing.
A QoE report serves several concrete purposes for buyers:
- Confirms whether reported earnings reflect true operating performance rather than accounting choices or timing effects.
- Surfaces one-time gains, unusual expenses, and revenue recognition issues that distort reported profit.
- Produces the adjusted EBITDA figure that determines purchase price and valuation multiples.
- Creates documented findings that the buyer can reference when raising concerns with the seller.
For most middle-market acquisitions, a QoE has become a standard step in the diligence process. The U.S. Small Business Administration guidance on buying a business recommends buyers review financial statements, tax returns, and cash flow, all of which fall within the scope of a standard QoE engagement.
5 Common Adjustments Made in a QoE Report
Every QoE includes adjustments that convert the seller’s reported earnings into a normalized figure. These adjustments show what earnings would look like under new ownership, without unusual events, and on a going-forward basis.
These five categories come up in nearly every review.
1. Discretionary Owner Expenses
Owner-operated businesses often run personal or lifestyle costs through the company. This includes personal vehicles, family members on payroll, country club memberships, and personal travel.
A QoE identifies these items and adds them back to earnings, producing a cleaner picture of what the business would generate under professional management.
2. Nonrecurring Revenue or Costs
One-time events distort earnings in both directions. A large legal settlement, an insurance payout, a canceled contract, or a project that will not repeat all qualify as one-time events. Reviewers remove these items so earnings trends reflect normal operations rather than isolated spikes or dips.
3. Timing and Accounting Policy Adjustments
Some sellers accelerate revenue recognition or defer expenses in the months leading up to a sale. These choices usually fall within accounting rules, but they can make the business look stronger than it is over time. QoE reviewers apply consistent accounting policies across the review period and correct for timing differences.
4. Customer Concentration Adjustments
When a large share of revenue comes from a small group of customers, buyers face real concentration risk. A QoE flags this risk and often models what earnings would look like without the top one, three, or five customers. Some reports also adjust EBITDA downward to reflect the ongoing risk of losing a major account after closing.
5. Pro Forma Adjustments for Recent Business Changes
If the target opened a new location, launched a product line, or completed a small acquisition during the review period, historical earnings understate the current run rate. Pro forma adjustments extend the impact of those changes across the full period. The result is a normalized view of the business as it operates today.
How QoE Findings Affect the Deal
The value of a QoE report extends beyond the analysis itself. Its findings routinely reset the terms of the transaction, from headline purchase price to the fine print of the definitive agreement. Buyers who overlook the report face both financial and legal risk.
Purchase Price Renegotiation
Adjusted EBITDA is the number buyers use to negotiate the deal. When the QoE comes in lower than the seller represented, buyers push for a corresponding cut in the purchase price.
On a deal priced at a 5x multiple, a $300,000 drop in EBITDA translates to a $1.5 million reduction in what the buyer pays.
Deal Structure Changes
Findings often prompt buyers to restructure the transaction itself. Concerns about customer concentration or revenue sustainability can lead to earnouts, where a portion of the price gets tied to future performance.
Working capital targets often get reset as well. Escrow amounts and holdback periods sometimes get extended to protect the buyer if issues surface after the deal closes.
Representations, Warranties, and Indemnities
QoE findings are directly connected to legal documents. Items flagged by the review are typically disclosed in the purchase agreement schedules and covered by specific indemnification provisions.
An experienced M&A attorney uses the QoE as a roadmap for what to negotiate on the buyer’s behalf. That includes which risks stay with the seller after closing and what triggers a claim under the indemnity provisions.
Buy-Side Versus Sell-Side Quality of Earnings Reports
QoE reports come in two forms, depending on who commissions them. The technical work is similar, but the audience, purpose, and use case differ.
What a Buy-Side Report Focuses On
Buy-side reports are commissioned by the buyer and built around the buyer’s specific investment thesis. Reviewers probe assumptions, test the seller’s numbers against source documents, and flag anything the buyer needs to know before writing the check. The report becomes the buyer’s private working file and stays under NDA throughout the transaction.
Why Some Sellers Commission a QoE Before Going to Market
Sellers who want to control the narrative sometimes order their own QoE before listing the business. A clean sell-side report speeds up buyer diligence, reduces the chance of surprises during negotiation, and strengthens the seller’s negotiating position when buyers commission their own review.
How Each Type Influences the Negotiation
Buy-side and sell-side reports move the conversation in different directions. Buy-side findings usually justify a lower price and stronger buyer protections in the purchase agreement.
Sell-side findings support the seller’s asking price, accelerating negotiations when both parties bring QoE work to the table.
What a Quality of Earnings Report Costs and How Long It Takes
Cost and timeline for a QoE report depend on deal size, business complexity, and the state of the seller’s financial records. Buyers should build both into their diligence budget and closing schedule from the start of the process. Rushing the process usually adds cost without improving quality.
Typical Cost Range
For small and midsize transactions, a full QoE report generally runs between $10,000 and $75,000. Larger and more complex deals routinely cost above $100,000.
For smaller acquisitions where a full QoE is out of scope, Legal Dealmakers offers a QoE Lite Report through its CPA partnership, a scaled-down version that covers the essentials at a lower price point and shorter turnaround. This makes independent earnings analysis accessible on deal sizes that would not otherwise support a full engagement.
Standard Timeline for Completion
Most QoE reports take two to six weeks from kickoff to final delivery. The timeline depends heavily on how quickly the seller produces the requested documents and how many follow-up questions the review generates. Buyers who want a smooth close should build the QoE window into the LOI timeline rather than treat it as an afterthought.
Factors That Add Cost or Time
Several factors can extend the process. Businesses with multiple entities or locations, weak internal controls, heavy inventory, or industry-specific accounting practices all take longer to review.
Deals involving cross-border operations or recent acquisitions add another layer of complexity. A QoE serves a different purpose from a traditional financial audit, and buyers weighing both can read more on the quality of earnings versus the audit.
A QoE and Legal Team Working From the Same File
Buyers who commission a QoE from one firm and a legal review from another often find the two reviews don’t inform each other. The financial findings are in one report, the legal review is in another, and the asset purchase agreement is drafted without the financial and legal work connecting.
Legal Dealmakers has partnered with an experienced CPA team so that buyers can commission the QoE and the legal review as a single coordinated engagement.
Working capital targets, EBITDA adjustments, and revenue quality concerns feed directly into the drafting of the asset purchase agreement, rather than sitting in a separate PDF that the legal team reads too late in the process.
Reading the Numbers the Way a Buyer Should
A quality of earnings report gives buyers a defensible read on what a target business actually earns, and its findings routinely influence purchase price, deal structure, and the protections written into the definitive agreement.
Legal Dealmakers is a Vermont- and Texas-based M&A firm built by attorneys who have bought and sold businesses themselves, working with buyers on SMB acquisitions from six figures to eight figures across SaaS, eCommerce, healthcare, and manufacturing.
Buyers can call 844-332-5657 or reach the team through the Contact Us page to talk through a specific deal.
