Tom Grupa
October 21, 2026
Fact checked by the Dealflow team
The content of this site is for educational purposes only and does not constitute legal, tax, or financial advice. Always consult with a licensed professional for advice about your specific situation.
What is a quality of earnings report?
A quality of earnings report is a transaction-focused financial diligence analysis that determines how reported earnings translate into sustainable, lender-reliable cash flow after closing. Unlike an audit that tests GAAP compliance, a QoE evaluates earnings drivers and risks that directly impact valuation, financing, and purchase agreement terms. For buyers, it is the bridge between historical financials and a defendable, forward-looking cash flow that lenders can underwrite.
| Topic | Key point | Why it matters to buyers |
|---|---|---|
| QoE purpose | Focuses on sustainability and cash conversion of earnings | Anchors valuation, lender DSCR, and deal protections |
| Audit vs QoE | Audit tests GAAP; QoE normalizes EBITDA and risks | Explains price renegotiations and lender reliance |
| Deliverable | Adjusted EBITDA bridge, revenue and margin analysis, working capital, proof of cash, data quality | Supports LOI updates, APA definitions, and lender underwriting |
Why buyers need a QoE in M&A due diligence
Buyers use a QoE to validate adjusted EBITDA, size debt safely, and set working capital targets and true-ups. The report translates historical statements into forward-looking cash flow that supports your valuation model and lender case. It also surfaces hidden liabilities and concentration risks that should shape structure, covenants, and protections.
| Buyer objective | QoE answer | Deal impact |
|---|---|---|
| Is EBITDA real and repeatable? | Normalization and add-back testing with evidence | Price adjustments, earnouts, or walk-away decisions |
| Can earnings service debt? | Proof-of-cash and cash conversion analysis | Loan sizing, DSCR, equity check |
| What working capital is required? | Seasonality and target setting | Close payments and post-close liquidity |
| What hidden liabilities exist? | Debt-like and off-balance sheet items | Purchase price reductions and escrows |
| Where are the key risks? | Customer concentration, churn, data quality | R&W protections, covenants, and integration focus |
What a buyer-focused QoE includes
A buyer-focused quality of earnings report leads with an adjusted EBITDA bridge, then unpacks revenue quality, margins, working capital, cash conversion, concentration risks, debt-like items, and data reliability. Each workstream ties back to valuation, financing, and APA mechanics so findings translate directly into deal terms.
| Workstream | Primary deliverable | Deal decision supported |
|---|---|---|
| Adjusted EBITDA | Reported-to-adjusted bridge with evidence | Valuation and lender case |
| Revenue quality | Recognition testing, recurring vs non-recurring, seasonality | Forecast and earnout design |
| Margin analysis | Product, customer, and location profitability | Pricing, mix, and cost initiatives |
| Working capital | Normalized target and true-up mechanics | Closing funds flow and liquidity |
| Proof of cash | Bank-to-book reconciliation | Lender reliance and fraud detection |
| Concentration | Top customers and suppliers, churn/retention | Consents and post-close revenue risk |
| Debt-like items | Deferred revenue, taxes, accrued comp, leases | Purchase price and escrows |
| Data quality | Systems, reconciliations, policy consistency | Scope limits and reliance language |
Adjusted EBITDA and normalization
The QoE starts by reconciling reported EBITDA to adjusted EBITDA with documented add-backs and normalizations. Buyers and lenders scrutinize these adjustments, so the bridge and evidence must withstand seller and credit review.
- Owner compensation normalization and related-party rent.
- One-time legal, COVID grants, system implementations.
- Non-operating income and expenses, discontinued lines.
- Under or over-accruals that distort period margins.
Revenue quality and recognition
Revenue testing focuses on cutoffs, contract terms, and recurring versus project revenue. The goal is to surface timing errors and sustainability issues that affect forecasts and earnouts.
- Cash vs accrual gaps, deferred revenue, and backlog quality.
- Renewal rates, price escalators, termination rights, and discounts.
- Channel mix and returns, credit memos, and write-offs.
Margin analysis by driver
Margin analysis isolates structural versus one-time cost drivers. By product, customer, and location views reveal mix effects and underpriced accounts that require post-close action.
- COGS completeness, inventory costing method, and capitalization practices.
- SG&A normalization and owner discretionary spend.
Working capital and debt-like items
Working capital analysis determines a normalized target and the rules to measure it at close. The QoE also identifies debt-like items that reduce cash paid at closing.
- AR, AP, inventory, and deferred revenue seasonality.
- Accrued payroll, bonuses, commissions, sales/use tax, warranties, leases.
Cash conversion and proof of cash
Proof of cash ties recorded revenues and expenses to bank activity to validate cash generation. This step underpins lender DSCR sizing and can uncover timing or completeness gaps.
- Monthly bank-to-book reconciliation coverage with exceptions logged.
- Collections timing, chargebacks, refunds, and cash leakage.
Customer and supplier concentration
Concentration testing quantifies reliance on top customers and key suppliers. The QoE links contract assignability and required consents to closing conditions and pricing.
- Top 10 customers by revenue, logo churn, and net revenue retention.
- Supplier terms, sole-source risks, and inflation pass-through.
Data quality and accounting policies
Data reliability determines how much lenders and buyers can rely on the numbers. The QoE flags system limitations, missing reconciliations, and aggressive policies that require protections.
- Close process maturity, manual workarounds, and finance team turnover.
- Policy consistency for revenue, capitalization, and reserves.
SBA and lender requirements for QoE
If you plan to use SBA 7(a) financing for an acquisition or expansion with a purchase price of $3,000,000 or more, lenders must obtain a QoE that includes a cash proof under SBA SOP 50 10 version 8.1, effective October 1, 2026. Lenders size DSCR using QoE-adjusted earnings; owner-occupied special purpose property is excluded.
| Requirement | What lenders expect | Buyer takeaway |
|---|---|---|
| SOP 50 10 v8.1 threshold | QoE required at purchase price ≥ $3,000,000 | Budget time and cost for QoE in your closing plan |
| Cash proof | Bank-to-book reconciliations over diligence periods | Provide complete bank statements and reconciliations |
| DSCR sizing | Underwrite off QoE-adjusted EBITDA, not seller’s claims | Expect proceeds to flex with QoE findings |
| Exceptions | Owner-occupied special purpose property | Confirm applicability with your lender early |
Process and timeline
Most buy-side QoE engagements take 4 to 6 weeks to draft, then another 1 to 2 weeks to finalize. Complexity, data quality, industry nuances, and response times can lengthen the schedule. Share interim readouts with your lender to keep underwriting aligned.
| Stage | Primary activities | Typical duration |
|---|---|---|
| Kickoff | Objectives, scope, timeline, data room setup | 2 to 4 days |
| Information request | Monthly financials, GL, bank statements, contracts | 1 to 2 weeks |
| Initial analysis | Trend reviews, proof-of-cash start, EBITDA bridge draft | 1 week |
| Deep dive | Revenue cutoffs, margin drivers, WC seasonality, debt-like | 1 to 2 weeks |
| Preliminary findings | Buyer readout and open items | 2 to 3 days |
| Management Q&A | Evidence testing and follow-ups | 3 to 5 days |
| Final report | Revisions, lender package, unresolved-items log | 3 to 7 days |
Pricing and how to compare providers
QoE pricing has no national benchmark; fees vary by scope, complexity, data quality, deadlines, industry, and number of entities. Standardize your scope and compare written proposals side by side to avoid apples-to-oranges decisions.
| Deal profile | Typical fee | Price range | Scope notes |
|---|---|---|---|
| Micro to small LMM, single entity, clean books | $25,000 to $45,000 | $20,000 to $60,000 | Core QoE with proof-of-cash and WC target |
| Lower middle market, multi-entity or inventory heavy | $45,000 to $85,000 | $35,000 to $120,000 | Deeper revenue, margin, and inventory procedures |
| Complex carve-out or multi-location with poor data | $85,000+ | $75,000 to $200,000+ | Heavy reconstruction and reliance limitations |
| Targeted procedures only | $10,000 to $25,000 | $7,500 to $35,000 | Limited scope on defined risks; lender acceptance varies |
Expect fixed fees for defined scopes and hourly overruns for scope creep. Insist on a clear change-order process and caps tied to documented assumptions. The table below highlights the main cost drivers and how to control them.
| Cost driver | Effect on fee | Buyer control |
|---|---|---|
| Number of entities and locations | Increases data volume and tie-outs | Define entities and carve-outs precisely in LOI |
| Industry complexity | Specialized testing needed | Select a provider with industry experience |
| Accounting basis and data quality | Rebuilds add hours and limit reliance | Push early for complete monthly closes and reconciliations |
| Deadline compression | Rush premiums and staffing costs | Start QoE immediately after LOI |
How QoE findings change valuation, financing, and the purchase agreement
QoE findings reset adjusted EBITDA, working capital targets, and debt-like items, which shift price, structure, loan proceeds, and APA protections. Buyers should translate each finding into a specific valuation or contract lever so there is a direct path from diligence to terms.
| Finding | Valuation impact | Financing and APA impact |
|---|---|---|
| Owner comp normalization of $250,000 | EBITDA increases by $250,000; at 5x, value +$1,250,000 | Higher DSCR; validate tax and payroll effects |
| Remove one-time income of $250,000 (e.g., grant) | EBITDA decreases by $250,000; at 5x, value −$1,250,000 | Lower proceeds; consider earnout for uncertain items |
| Deferred revenue of $400,000 reclassified as debt-like | Reduces enterprise value at close by $400,000 | Net cash at close down; consider escrow for delivery risk |
| Normalized working capital target up by $300,000 | Purchase price effectively offset by $300,000 at true-up | Requires more cash at close or seller note adjustment |
Illustrative adjusted EBITDA swing and enterprise value
Even a 5 to 15 percent normalization swing can add or subtract millions at common EBITDA multiples. Use the QoE bridge as the negotiated base, not seller-presented numbers.
| Scenario | Reported EBITDA | Adjustment | Adjusted EBITDA | EV at 4x | EV at 6x |
|---|---|---|---|---|---|
| No change | $2,000,000 | $0 | $2,000,000 | $8,000,000 | $12,000,000 |
| +10 percent normalization | $2,000,000 | +$200,000 | $2,200,000 | $8,800,000 | $13,200,000 |
| −10 percent normalization | $2,000,000 | −$200,000 | $1,800,000 | $7,200,000 | $10,800,000 |
Working capital target and true-up
Set the working capital target using monthly trends, seasonality, and clear definitions of included accounts. The APA should specify measurement rules, a dispute process, and a post-close true-up window to reduce friction and protect liquidity.
| Element | Target approach | Deal effect |
|---|---|---|
| Reference period | Last 12 months median or seasonally adjusted average | Reduces gamesmanship at close |
| Definition | Explicit included AR, AP, inventory, accruals, and exclusions | Fewer disputes and faster true-up |
| Shortfall or excess | Dollar-for-dollar purchase price adjustment | Protects buyer liquidity post-close |
Deal structure levers
Map each QoE risk to a contract protection. Use escrows, earnouts, special indemnities, or price credits where evidence or sustainability is weak.
- Customer churn or consent risk: earnout on retained revenue.
- Tax exposure or sales tax nexus: tax escrow or special indemnity.
- Data reliability limits: holdback or R&W insurance with higher retention.
How to scope a QoE and compare provider proposals
Define scope based on exposure, evidence quality, financing needs, and APA decisions, not just a percentage of add-backs. Standardize your RFP so quotes are comparable and aligned with lender expectations; this prevents shortcuts that look cheaper but miss critical testing.
| Scope element | Must-have details | Quote risk if omitted |
|---|---|---|
| Periods and entities | Trailing 24 to 36 months, all entities and locations | Missed trends and carve-out surprises |
| Workstreams | EBITDA bridge, revenue, margins, WC, proof-of-cash, concentration, debt-like, data quality | Low quotes that skip critical testing |
| Deliverables | Report, exhibits, unresolved-items log, lender package | Rework and delays for underwriting |
| Access | Management interviews and customer calls if needed | Shallow conclusions and higher risk |
| Reliance language | Buyer and lender reliance terms, if available | Reduced financing proceeds or more equity |
| Timing and fees | Milestones, assumptions, change-order triggers | Overruns and missed close dates |
Ask who will do the work, not just who will sign it. Senior attention on revenue recognition, working capital, and proof of cash drives quality and lender acceptance.
Buyer document request checklist
Send a focused evidence list on day one to keep the QoE on schedule. Prioritize monthly financials, bank proofs, revenue detail, contracts, and inventory data to start testing fast and maintain momentum with your lender.
| Category | Documents | Why needed |
|---|---|---|
| Financial statements | Monthly P&L, balance sheet, cash flow; GL detail | Core trends and tie-outs |
| Bank and cash | All bank statements and reconciliations | Proof-of-cash coverage |
| Tax | Federal and state returns | Reconciliation and exposure checks |
| Revenue | By customer and product; contracts; backlog; price lists | Recognition and concentration testing |
| Working capital | AR and AP agings; inventory listings and counts; costing method | Target setting and reserves |
| Payroll | Payroll registers; org chart; owner comp detail | Add-back and normalization support |
| Add-backs | Invoices, contracts, and explanations | Evidence for adjustments |
| Obligations | Debt schedules; leases; contingent liabilities | Debt-like classification |
| Capex and assets | Fixed asset register; capex history | Capitalization policies and maintenance vs growth |
| Planning and KPIs | Budgets, forecasts, and key metrics | Forward view and lender case |
| Related parties | All related-party agreements | Normalization and conflicts |
| Compliance | Insurance, permits, licenses | Operating continuity and risk |
Industry spotlights
Tailor your QoE scope to the business model. Industry nuances change how revenue, margins, and working capital are tested and how findings flow to valuation and APA terms. The focus areas below help prioritize time where it moves value and risk most.
| Industry | High-impact focus | Common adjustments |
|---|---|---|
| SaaS | Deferred revenue, churn, net revenue retention, ARR vs cash | Revenue deferrals, implementation revenue timing |
| E-commerce | Returns, chargebacks, fulfillment fees, ad spend attribution | Inventory obsolescence, shipping accruals |
| Home services | Crew payroll completeness, seasonality, dispatch systems | Owner labor normalization, warranty accruals |
| Healthcare | Payer mix, credentialing, denials, revenue lag | Adjustments for write-offs and provider comp |
| Manufacturing | Standard costing accuracy, backlog, scrap and yields | Inventory reserves, capitalization policies |
Common pitfalls and how to avoid them
Avoid treating the QoE as an audit or a checklist. Make it a decision tool tied to your LOI, valuation model, lender package, and APA mechanics to reduce retrade risk and closing friction. Start early, align scope to risks, and require evidence for every material add-back.
| Pitfall | Result | Prevention |
|---|---|---|
| Starting QoE late | Compressed lender review and surprises | Engage immediately post-LOI and share draft with lender |
| Scope not aligned to risks | Missed issues in revenue, WC, or contracts | Customize by model and concentration profile |
| Accepting add-backs without evidence | Overstated EBITDA and proceeds | Require invoices, contracts, and payroll proofs |
| Ignoring WC seasonality | Liquidity squeeze post-close | Use 12 to 24 month trends and clear definitions |
| Overlooking consents and assignment | Revenue loss at or after closing | Tie QoE findings to APA closing conditions |
| Data reliability not addressed | Lower lender reliance and more escrows | Document limitations and negotiate protections |
Frequently asked questions
Buyers often ask how a QoE differs from an audit, when SBA lenders require it, how long it takes, what it costs, and how adjustments affect valuation, DSCR, and working capital. The answers below will help you plan scope, timing, and lender conversations.
| Question | Short answer |
|---|---|
| Is a QoE the same as an audit? | No. An audit checks GAAP presentation; a QoE evaluates sustainability, normalized EBITDA, and cash conversion for deals. |
| When do I need a QoE for SBA 7(a)? | For acquisitions or expansions with purchase price ≥ $3,000,000 under SOP 50 10 v8.1, excluding owner-occupied special purpose property. Lenders also commonly request QoE below that level. |
| How long does it take? | Typically 4 to 6 weeks to draft, plus 1 to 2 weeks to finalize and underwrite, longer if data is weak. |
| What does it cost? | See the Pricing and how to compare providers section for detailed fee ranges by deal profile and scope. |
| Which add-backs are valid? | Evidence-backed owner comp normalization, one-time legal or systems costs, non-operating items, and related-party adjustments. Lenders need documentation. |
| How does QoE affect DSCR? | Lenders size DSCR on QoE-adjusted EBITDA and proof of cash. Lower adjusted EBITDA reduces proceeds or raises required equity. |
| What debt-like items reduce cash at close? | Deferred revenue, accrued taxes, accrued payroll and bonuses, customer deposits, capital leases, and gift card or credit liabilities. |
| How is the working capital target set? | From 12 to 24 month trends with clear definitions and a post-close true-up. A $300,000 swing can offset price dollar for dollar. |
| What if issues surface late? | Use price reductions, escrows, or earnouts. Document in an unresolved-items schedule and tie to APA changes. |
| Are limited-scope procedures enough? | Sometimes for narrow risks, but lender acceptance varies. Confirm in writing with your lender before proceeding. |
Next steps and how Dealflow can help
Start QoE immediately after signing the LOI and align scope with your valuation model, lender DSCR case, and APA mechanics. Dealflow connects buyers with vetted QoE providers, standardizes scope sheets, and coordinates lender-ready data rooms so diligence feeds directly into underwriting and contracts.
| Action | Timing | Outcome |
|---|---|---|
| Kick off QoE with a standardized scope | Day 1 post-LOI | Comparable quotes and faster start |
| Open a lender-ready data room | Week 1 | Shorter underwrite and fewer re-requests |
| Share draft QoE with lender | Week 4 to 5 | Align proceeds and conditions early |
| Tie findings to APA drafts | Weeks 4 to close | Clean WC definitions and targeted protections |
Buyer negotiation playbook: map findings to deal levers
Translate each QoE issue into a lever you can pull in valuation or the APA. Use this quick-reference list in negotiations.
- Revenue timing errors: price reduction or earnout tied to collections.
- Customer concentration risk: consent closing condition, revenue holdback.
- Deferred revenue obligations: debt-like reduction and service-level escrow.
- Data quality limits: larger holdback or higher R&W insurance retention.
- Inventory reserve shortfalls: price reduction, WC target increase.
Unresolved-items log
Maintain a live schedule of open items with amounts, evidence owners, and impact on valuation and APA terms. Close items methodically to prevent surprises.
| Item | Amount | Evidence needed | Owner | Valuation/APA impact | Next step |
|---|---|---|---|---|---|
| Deferred revenue reconciliation | $400,000 | Contract schedules and delivery status | Seller controller | Debt-like reduction and escrow | Obtain contract roll-forward |
| Owner comp normalization | $250,000 | Payroll reports, job description, market comp | Buyer QoE lead | EBITDA uplift and DSCR | Third-party comp benchmark |
