A complete guide to Quality of Earnings reports — what they are, what they cover, how much they cost, and why every serious seller should get one before going to market.
A Quality of Earnings report is the single most impactful document you can produce before going to market. It validates your adjusted EBITDA, identifies issues before buyers find them, and signals to buyers that you are a serious, prepared seller. Yet most business owners have never heard of it until a buyer's accountant starts tearing apart their financials in due diligence.
This guide explains what a QoE is, what it covers, how much it costs, and why getting a sell-side QoE before going to market is one of the best investments a seller can make.
A Quality of Earnings report is an analysis of a company's financial performance conducted by an independent accounting firm. It goes deeper than a financial audit — rather than verifying that financial statements comply with accounting standards, a QoE analyzes the quality, sustainability, and predictability of the company's earnings.
The primary output of a QoE is a validated adjusted EBITDA — the starting point for every business valuation. The QoE firm reviews every line item in the income statement, evaluates every add-back, and produces a defensible, documented adjusted EBITDA that buyers can rely on.
Buy-side QoE: Conducted by the buyer's accounting firm to validate the seller's financial representations. This is standard practice in most lower middle market transactions.
Sell-side QoE: Conducted by the seller's accounting firm before going to market. The seller commissions and pays for the report, but shares it with buyers as part of the due diligence package.
The sell-side QoE is what this guide focuses on. It is proactive — you identify and address issues before buyers find them.
A comprehensive QoE report typically covers:
This is the core of the QoE. The accounting firm:
Common add-backs that QoE firms validate:
Common add-backs that QoE firms reject:
Working capital is the amount of current assets minus current liabilities required to run the business. The QoE firm:
The working capital analysis is critical because the working capital peg is one of the most common sources of post-close disputes. A well-documented working capital analysis prevents surprises.
QoE costs vary by firm, deal size, and complexity:
| Deal Size | Typical QoE Cost | As % of Deal Value |
|---|---|---|
| $2M-$5M | $15,000-$35,000 | 0.3-1.75% |
| $5M-$15M | $35,000-$75,000 | 0.25-1.5% |
| $15M-$30M | $75,000-$150,000 | 0.25-1.0% |
| $30M+ | $150,000+ | <0.5% |
The cost of a sell-side QoE is typically recovered many times over through:
The most valuable aspect of a sell-side QoE is that it identifies issues before buyers find them in due diligence. Common issues that QoE firms identify:
Finding these issues before going to market gives you time to address them or adjust your expectations. Finding them during buyer due diligence creates delays, price reductions, and deal failures.
When you share a sell-side QoE with buyers, you dramatically reduce the time and cost of their due diligence process. Instead of spending 4-8 weeks having their accountants rebuild your adjusted EBITDA from scratch, buyers can review your QoE, ask questions, and move forward.
This matters for two reasons:
A sell-side QoE signals to buyers that you are a serious, prepared seller. It says: "I've had my financials independently reviewed, I'm confident in my numbers, and I'm not going to waste your time."
This credibility translates into:
Without a sell-side QoE, the adjusted EBITDA negotiation happens during due diligence — after you've already agreed on a purchase price in the LOI. Buyers use the due diligence process to chip away at your adjusted EBITDA, reducing the effective purchase price.
With a sell-side QoE, you establish your adjusted EBITDA before negotiations begin. The LOI is negotiated based on a validated, documented number. There is less room for buyers to reduce the purchase price during due diligence.
Not all accounting firms are equal in their QoE capabilities. When choosing a QoE firm:
Look for M&A transaction experience. The firm should have specific experience conducting QoE reports for M&A transactions, not just general accounting experience.
Look for industry experience. A firm that has done QoE work in your industry will understand your business model, your revenue recognition practices, and your key metrics.
Consider firm size. Large accounting firms (Big 4, national firms) have deep resources and credibility with buyers. Regional firms may have more flexibility on cost and timeline.
Get references. Ask for references from sellers who have used the firm for QoE work. Ask about the quality of the report, the timeline, and the firm's responsiveness.
Understand the process. Ask the firm to walk you through their QoE process. How many weeks will it take? What information will they need? Who will be doing the work?
A typical sell-side QoE takes 4-8 weeks and involves:
Week 1-2: Information gathering. The QoE firm will request extensive financial information:
Week 2-4: Analysis. The QoE firm analyzes the financial information, builds the adjusted EBITDA bridge, and identifies issues.
Week 4-6: Management interviews. The QoE firm interviews you and your CFO/controller to understand the business model, revenue recognition practices, and the rationale for each add-back.
Week 6-8: Report preparation. The QoE firm prepares the report, which typically includes:
Final review. You review the report with the QoE firm, address any questions, and finalize the document.
If you're planning to sell your business and want guidance on whether a sell-side QoE makes sense for your situation, Deal Flow's team can help. Start the conversation here.