Key Takeaways
- A quality of earnings report reveals the true earning power of your business by excluding one-time gains, accounting anomalies, and non-recurring income.
- This report is crucial for owners planning to sell, helping to support a confident and successful ownership transition.
- Understanding and preparing a quality of earnings report positions your company for smoother transactions and informed decision-making during the sale process.
Whether you know it or not, you have been preparing for a sale for years. And a key component of that preparation is a quality of earnings report. This report is invaluable for business owners during a sale because it provides a clear picture of the company's true earning power — stripped of any one-time gains, accounting anomalies, or non-recurring income.
Here's why it's so impactful.
What is a quality of earnings report?
A Quality of Earnings (QofE) report is a comprehensive analysis of a company’s financial health. It analyzes precisely how your business accumulates revenue.
Unlike a traditional audit, which focuses on compliance with accounting standards, a QofE digs deeper into the sustainability and reliability of earnings.
An audit is not sufficient for due diligence because:
- Audits focus on verifying if financials are GAAP-compliant, while due diligence provides insight into revenue and cost drivers, operational efficiency, cash flow stability, customer and supplier relationships, and potential risk factors.
- Audits focus on material misstatements that could affect the financials. Potential liabilities that fall below these thresholds could be missed even if they are significant in the context of a transaction.
- Audits will not always call attention to one-time events that may impact your financial results.
How does a quality of earnings report help during a transaction?
Conducting a sell-side QofE helps you:
- Gain insight into how buyers will assess your earnings and key financial areas.
- Demonstrate to potential buyers that you’re committed to selling and have taken steps to make your company sale-ready.
- Address and resolve past financial issues to potentially enhance your company’s value.
- Ensure all necessary add-backs and adjustments are properly documented.
- Tackle challenging questions and concerns before buyer discussions begin.
- Prepare documents in advance, reducing pressure on your team during the sale process.
Depending on the results, waiting to sell for another year after the QofE is completed could return significant value, as management would have time to focus on improving key performance indicators and value drivers.
What does the quality of earnings process look like?
The process for a QofE report begins when you are considering selling your company or a segment of your company. Typically, the timeframe is within six to 12 months after you decide to sell.
After you’ve selected a third-party advisor to conduct the QofE report, you can expect the following:
Introductory Consultation
The initial meeting is designed to discuss the objectives of the engagement, provide an overview of your business operations, and share key financial information.
Information Gathering
The QofE team will gather all relevant data from your business, including financial statements, tax returns, and customer contracts.
It’s essential to appoint a key individual within your organization to communicate with the QofE team throughout the engagement. This person will assist with data requests and ensure confidentiality throughout the process.
Initial Analysis
The QofE advisors will begin analyzing the collected data to identify key areas of focus. Preliminary findings, questions, or clarifications will be communicated to your internal team.
Deep Dive Analysis
Upon collecting all necessary data and clarifying goals, the QofE team will conduct a detailed analysis of your financial data to assess the quality of your earnings. This stage includes:
- A thorough examination of revenue, expenses, and key financial metrics.
- Identification of one-time items, unusual trends, or adjustments.
- Requests for additional data or explanations as needed.
Discussion of Findings
An initial QofE report will outline the findings of the engagement, including any adjustments or key issues. A meeting will be scheduled with your advisors to discuss the report, gather your feedback, and address any questions.
Final Report
After incorporating your feedback and clarifications, the advisors will finalize the report.
Follow Up
Based on the engagement results and your organizational goals, the QofE advisors may provide ongoing support or schedule a follow-up review once adjustments and improvements have been implemented.
As the QofE process proceeds, stay involved. This allows you to better understand not only the due diligence process but also deal options, value points, and the final deliverable.
What information is included in a quality of earnings report?
The quality of earnings report highlights the key aspects of your business, including:
- Normalized level of EBITDA and the addbacks to bridge from reported EBITDA to adjusted EBITDA
- Fluctuations in annual and monthly financial information
- Revenue and gross margin by product, customer, or distribution segments
- Operating expenses and employee analysis
- Key balance sheet highlights
- Normalized levels of working capital needed to operate the business
It also enables leadership to consider:
- Have we had any significant one-time events, infused significant growth, or added process improvement capital that affected our financial performance?
- Have we prudently managed our working capital and cash flow?
- Do we have discretionary expenses affecting EBITDA?
- How do our compensation packages compare to the market?
- Have we reasonably forecasted our growth?
- Have we outgrown our current technologies?
- What is the outlook for our organization?
Although primarily focused on financials, the QofE report may also explore your IT landscape, finance team composition, accounting processes, and other operational details to assess the overall quality and reliability of financial data.
How to Move Forward
Whether you’re actively working toward a transaction or simply planning, a QofE gives you the information you need to navigate the process strategically.
Our M&A advisors can help you prioritize improvements, reduce surprises, and prepare for a smoother, more valuable exit — on your terms.
Frequently Asked Questions
What is a quality of earnings report?
A QofE report is a detailed analysis of a company’s true earnings, adjusted for onetime events, accounting anomalies, and nonrecurring income, giving buyers and sellers an accurate picture of sustainable financial performance. A Quality of Earnings report digs deeper into the financial data than a traditional audit. It looks at the sustainability and reliability of your earnings — not just compliance with accounting standards.
How is a QofE different from an audit?
Audits focus on GAAP compliance and material misstatements, while a QofE digs deeper into revenue drivers, cash flow stability, margins, working capital needs, and risk factors that impact valuation during a transaction.
How does a QoE help you sell your business?
A sell-side QoE gives you bargaining power. It shows buyers you’re prepared, identifies issues early, and documents add-backs that increase adjusted EBITDA. In some cases, waiting a year to go to market after completing a sell-side QoE can add significant value by showing improvements in key metrics.
When should a business complete a QofE report?
Six to twelve months before going to market is ideal, giving owners time to address issues, optimize performance, and strengthen value drivers before buyers begin their evaluations.
How long does a QofE process take?
Most QofE engagements take several weeks, depending on the complexity of your business, availability of documentation, and depth of analysis required.
What documents are required for a QofE?
Typical requests include financial statements, general ledger data, tax returns, customer contracts, AR/AP reports, payroll records, revenue schedules, and other operational documentation needed to validate earnings.
How does a QofE impact valuation?
A QofE strengthens your valuation by identifying add backs, validating EBITDA, highlighting growth drivers, and resolving issues before negotiations begin.
What happens if the QofE uncovers issues?
Most findings can be corrected or improved before a sale. Addressing issues in advance can strengthen your valuation, reduce buyer pushback, and create a smoother due diligence process.
What if I'm not planning to sell soon?
A QofE can still be valuable for operational improvement, succession planning, financing, or earlystage exit readiness.
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