What information is included in a quality of earnings report?

A scope of due diligence procedures is customized to each client and transaction depending on factors like industry, market size, deal size, accounting complexities, and areas of special concern. Reports typically include an analysis of adjusted EBITDA, and net working capital, net debt, a balance sheet and income statement, among others. Trend analysis, key performance indicator (KPI) analysis, customer analysis, vendor analysis, and headcount analysis are also common.

What is the process of a quality of earnings report in the sale of a business?

Every transaction and every company is unique. Advisors adapt strategies and processes to reflect the goals and requirements of the deal team. A QOE typically takes four to six weeks to complete. The sell-side advisors typically advise how the timing that the QOE should be completed to fit into the overall deal timeline. The process begins with the aggregation of source information, such as monthly financial statements. Then, the analysis and supporting schedules are built, which takes one to two weeks. Next, meetings are held to review findings, areas of concern, and required adjustments, which takes one to two weeks, and then the report is drafted, which usually takes an additional one to two weeks. Should the process extend beyond a few months and the numbers become stale, the advisors can elect to roll forward all or part of the report to reflect the most recent financial activity of the business.

What could be identified in a quality of earnings report?

Types of common issues identified in a QOE report examination during pre-sale due diligence include: Non-recurring events and expenses that are unlikely to repeat can be removed from the financial statements, such as a lawsuit with substantial legal fees or judgments. Non-operational expenses, such as the owner purchasing personal vehicles or vacations through the business Accounting errors, such as misstated financials, in which auditors compare to U.S. generally accepted accounting principles (GAAP) Pro forma, such as an investment or purchase of equipment that improves efficiency that doesn’t impact the financial statements Assessment of recurring earnings and historical trends Adjustments to revenue and cost drivers Quality of balance sheet accounts Key risk areas such as customers, vendors, or key employees Financial terms and conditions of key contracts Normalized working capital needs In-depth explanation of accounting policies and procedures for complex transactions or critical estimates Summary of accounting software, financial reporting process, closing process, and IT systems

What is a quality of earnings report versus an audit?

Audits serve a different purpose than transaction due diligence. Items that are correct based on GAAP may still create deal issues or adjustments. The traditional auditor isn’t an M&A specialist that will represent the seller through the close of a transaction. Audits don’t focus on all issues that may be important to a buyer such as customer sales trends, cost structure, vendor, and relationships. Audits cover an annual period and don’t show recent trends. Buyers rely on the most recent information, specifically the trailing 12 month (TTM) period for setting value and for debt financing underwriting, if applicable. Auditors look at the numbers on an annual basis, while a QOE looks at adjusted numbers on a monthly basis and provides a more refined accuracy.

Article

What to know about a quality of earnings report in pre-sale due diligence

July 18, 2023 · Updated March 12, 2025 · Authored by Bradley Porter, Brett Sproul

Pre-sale due diligence can help increase the valuation of the enterprise and eliminate surprises for the seller in a business transaction. The preparation of a quality of earnings (QOE) report will assist in making an efficient and effective due diligence process.

Understand the enterprise value

The enterprise value of the business typically is based on:

Earnings before interest, taxes, depreciation, and amortization (EBITDA)
Free cash flow (FCF)
Revenue
Some other driver which is known based on financial statements, and some multiplier of that value that’s specific to the industry and market conditions

Other factors specific to the individual business can contribute to the value of the business. Third-party QOE providers can get granular in analyzing the adjusted EBITDA during a QOE evaluation.

What is a quality of earnings report?

A QOE report is used to demonstrate the adjusted or normalized cash flow of a business.

QOE providers can identify issues that can affect the value of the business, make recommendations to fix or mitigate those issues, or, if they can’t be fixed or mitigated, explain in clear terms how they’ll affect the value of the business.

Signs it’s time for a sell-side QOE

Here are some key indicators that it may be time to explore selling your company.

Rapid Growth. If your business has transitioned from stability to rapid growth, this could be an opportune moment to consider a sale. A strong growth trajectory makes your company an attractive candidate for private equity investors who are actively seeking optimal businesses to invest in. Engaging in discussions about valuation and current market conditions can help you explore your exit options effectively.

Bradley Porter

Principal

The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.

What to know about a quality of earnings report in pre-sale due diligence

Understand the enterprise value

A QOE report is used to demonstrate the adjusted or normalized cash flow of a business.

Signs it’s time for a sell-side QOE

Bradley Porter

Benefits of a quality of earnings report

What information is included in a quality of earnings report?

What is the process of a quality of earnings report in the sale of a business?

What could be identified in a quality of earnings report?

What is a quality of earnings report versus an audit?

Indicators of overall earnings quality

The report is complete; now what?

Next steps

Have questions? Baker Tilly can help.