Quality of Earnings Analysis for Business Sellers

What buyers are really doing when they hire a CPA firm, which adjustments matter most, and how a sell-side QoE protects your price.

What a Quality of Earnings report covers

A QoE is performed by an independent accounting firm — sometimes the Big 4, more often a regional CPA firm specializing in transaction advisory. The buyer typically commissions a buy-side QoE; sellers who commission their own (sell-side QoE) before going to market have a significant negotiating advantage.

The report works through three analytical layers:

1. EBITDA normalization

The buyer's team takes your reported EBITDA and systematically adjusts it — both up and down — to reflect the sustainable earnings a new owner would actually receive.

Common add-backs (increasing adjusted EBITDA):

• Excess owner compensation. If you're paying yourself $900K but a market-rate CEO replacement would cost $350K, the $550K difference is an add-back. Buyers model the management they'd actually need to hire; this can be your largest single adjustment.
• Non-recurring expenses. One-time litigation costs, severance, a major equipment repair, the pandemic-era PPP-funded expenses. Each requires documentation — a QoE preparer will require invoices or board minutes, not just your say-so.
• Personal expenses run through the business. Vehicle, travel, club memberships. Clean these up before the QoE begins if you haven't already.
• Related-party rent at non-market rates. If you own the building your company occupies and charge rent below market, the QoE will normalize it upward. The converse is also true — if you charge above-market rent, the buyer adjusts it down.

Common deductions (decreasing adjusted EBITDA):

• Revenue that won't recur. A large one-time project, a contract that expired, a government-grant-funded initiative. If it's in your trailing twelve months but won't be in the buyer's year one, it comes out.
• Underfunded expenses. If you deferred maintenance, skipped marketing spend, or underinvested in staff to inflate short-term margins, a sophisticated buyer's QoE team will model the normalized cost.
• Pro-forma synergies that don't exist yet. You can't add back costs you haven't actually eliminated. QoE firms distinguish between real historical adjustments and speculative future ones.

2. Revenue quality analysis

Adjusted EBITDA is one number. Revenue quality is the story behind it. Buyers discount businesses where revenue is fragile — even if the trailing EBITDA looks strong.

Customer concentration. If your top customer represents more than 20–25% of revenue, most buyers treat that as a risk premium. They'll either lower the multiple, require a portion of the price to be held in escrow pending that customer's retention, or structure part of the consideration as an earnout tied to that customer's continued business.

Contract vs. at-will revenue. Multi-year contracts with escalation clauses and notice periods are valued more highly than month-to-month service relationships. If you have long-term contracts, make sure they're assignable to a buyer — a contract that can be cancelled on change of control provides no protection.

Recurring vs. project revenue. A SaaS business with 90% recurring subscription revenue commands a different multiple than a consulting firm where every dollar must be re-earned each year. For businesses with a mix, the QoE will typically disaggregate them and the buyer will apply different multiples to each tranche.

Revenue recognition timing. If you recognize revenue on a cash basis or with aggressive accruals, a QoE will often recast the financials on a GAAP-equivalent basis. This can either help or hurt you; it's better to know before the buyer does.

3. Working capital analysis

Most M&A deals include a working capital peg — a target level of current assets minus current liabilities that the seller agrees to deliver at close. If the actual working capital at closing is below the peg, the purchase price adjusts downward dollar-for-dollar. This is one of the most common sources of post-close disputes, and one of the most preventable.

The QoE will establish a normalized working capital baseline — typically a trailing 12-month or 3-month average. The buyer uses this to set the peg in the purchase agreement. Understand the proposed peg calculation before you sign the letter of intent, not after.

Key working capital issues the QoE team examines:

• Accounts receivable aging — old receivables may be excluded from the working capital calculation
• Inventory valuation methodology and obsolescence reserves
• Deferred revenue — recognized on the books but not yet earned (especially for subscription or prepaid businesses)
• Accrued liabilities and bonus obligations that may not appear on your balance sheet at the time of valuation

QoE vs. audit: the key differences

An audited set of financials does not substitute for a QoE. Sophisticated buyers will commission a QoE even if the target has audited statements. The QoE is forward-looking (will these earnings continue?) while the audit is backward-looking (were these numbers recorded correctly?).

The sell-side QoE: why sophisticated sellers do it first

Commissioning your own QoE before launching a sale process has four concrete advantages:

1. No surprises in the data room. You find out about the customer concentration problem, the below-market rent normalization, and the deferred maintenance add-back before a buyer uses them to re-trade your price at closing. Re-trades are nearly always asymmetric — buyers rarely raise a price voluntarily.
2. You control the framing. A buy-side QoE firm works for the buyer. A sell-side QoE firm works for you — their job is to present your adjustments accurately and in the most favorable supportable light. There's often legitimate disagreement about whether an expense is truly non-recurring; having your own analysis shapes the negotiating starting point.
3. It signals seriousness to buyers. A seller who walks into an M&A process with a clean, pre-prepared QoE package is signaling management sophistication. This speeds diligence timelines and can reduce buyer risk discounts in the offer.
4. You can fix problems you didn't know existed. Six months before launch, you can still clean up the chart of accounts, normalize the owner compensation structure, and document one-time items. Six weeks before close, it's too late.

How to prepare your financials for a QoE

You don't have to wait for a QoE firm to identify issues. A year or more before going to market, work through this:

• Recast trailing 36 months of financials on a consistent GAAP-like basis. Monthly detail matters — QoE teams want to see seasonality and trend, not just annual summaries.
• Document every non-recurring item you would argue is an add-back. The standard is contemporaneous documentation — board minutes, invoices, contracts, or a memo at the time the expense occurred. "I remember it was one-time" is not sufficient documentation.
• Set your compensation at market rate well before the sale. If you've been taking $1.2M out of a business that a hired CEO would run for $400K, the QoE team will adjust it. Reduce that gap early so the analysis doesn't create a paper adjustment that surprises a buyer.
• Reconcile your revenue to contract documentation. For each significant customer, know: contract term, renewal provisions, assignment clause (what happens on a change of control?), and pricing trajectory.
• Identify your customer concentration before the buyer does. If you have a 35% customer, either develop a plan to reduce it over 12–24 months or prepare to explain why that relationship is durable — long contract, deep integration, long switching costs.
• Map working capital seasonality. If your business collects heavily in Q4 but closes in Q1, your working capital at close will be low. Understand what a trailing-average peg looks like vs. a spot date and negotiate accordingly.

How QoE findings affect deal structure

QoE adjustments don't just change the headline price — they can change the entire deal structure:

• Customer concentration → buyer adds an earnout tied to that customer's retention (see our earnout guide)
• Low revenue quality (project-heavy, at-will) → buyer lowers the multiple applied or increases escrow hold-backs
• Understated working capital → post-close purchase price adjustment, sometimes six figures
• Underfunded capex or maintenance → buyer carves out a capex reserve from proceeds or negotiates a price reduction
• Deferred revenue → treated as a liability at close, reducing net proceeds

A fee-only exit planning advisor who has seen these adjustments across multiple deals can help you pressure-test your financials, identify which adjustments are legitimate, and model the after-tax impact of different QoE outcomes before you're in a live process. This is part of the exit planning work that happens 2–5 years before a sale, not at LOI.

Finding a QoE firm

For deals under $20M enterprise value, regional CPA firms specializing in transaction advisory work are typically appropriate and cost-effective. For deals above $50M, firms with dedicated transaction advisory practices (including Big 4 advisory arms) are common.

Your investment banker or M&A attorney will have referrals. Your exit planning financial advisor — if they specialize in this niche — will also have a view on which firms are buy-side aggressive vs. more neutral in their adjustments.

The sell-side QoE should be commissioned 3–6 months before launching the process, not 3 weeks before. If the QoE uncovers a problem, you need time to fix it.

Sources

1. AICPA — Transaction Advisory Services: Quality of Earnings Guidance
2. SEC Division of Corporation Finance — Revenue Recognition and Non-GAAP Measures
3. FTC — Due Diligence in M&A Transactions
4. Journal of Accountancy — Quality of Earnings Reports in M&A Transactions

Values in this guide reflect general market practice as of 2026. Cost ranges and timelines vary by deal size, industry, and firm. This page does not constitute financial, tax, or legal advice.