Common QoE Adjustments: What They Mean for Your Deal

Author: Will McCurdy, CPA Target keywords: "quality of earnings adjustments" (150/mo, KD 1), "ebitda adjustments" (200/mo, KD 3), "ebitda add backs" (150/mo, KD 0), "normalized ebitda" (150/mo, KD 0) Meta description: "The most common Quality of Earnings adjustments explained with real examples. What owner add-backs, one-time expenses, and revenue normalizations mean for your deal price."

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You're reviewing the Quality of Earnings report that just hit your inbox. The seller told you the business does $950K in EBITDA. The QoE provider is showing adjusted EBITDA of $770K. That is $180K lower than what you underwrote.

Before you panic or fire off an angry email, understand this: quality of earnings adjustments are the entire point of the report. They are how you get from "what the seller says the business earns" to "what the business actually earns on a recurring, normalized basis." Some adjustments increase EBITDA. Others decrease it. What matters is whether the final number reflects what you are actually buying.

This post walks through every common adjustment category with real dollar examples, explains which way each one moves the number, and shows you exactly how adjustments translate into purchase price changes. If you have already read our complete guide to Quality of Earnings reports, think of this as the deep dive on the adjustment section -- the part of the report that drives every negotiation.

What Are QoE Adjustments?

Quality of earnings adjustments are changes a QoE provider makes to the seller's reported financials to arrive at a normalized EBITDA -- the true, recurring profitability of the business stripped of noise.

Every business has noise in its financials. The owner pays himself below market rate. A one-time lawsuit settlement inflated expenses last year. The owner's wife is on payroll but does not actually work in the business. Revenue spiked because of a one-time government contract that will not repeat.

None of these things reflect what the business will earn under new ownership on a go-forward basis. Adjustments remove the noise so you can see the signal.

There are two directions adjustments can go:

- Add-backs increase EBITDA. These are expenses in the books that will not recur or are not truly business expenses. - Downward adjustments decrease EBITDA. These are revenues that will not recur or expenses that are understated.

A good QoE report has both. If every single adjustment goes in the seller's favor, that is a red flag, not a good sign.

The Most Common Quality of Earnings Adjustments

Here is every major category of EBITDA adjustments you will see in a QoE report, with concrete examples from the types of deals we work on every day.

Owner Compensation Normalization

This is the single most common adjustment in lower middle market deals, and it almost always moves EBITDA significantly.

The issue: Business owners rarely pay themselves a market-rate salary. Some pay themselves far below market (to inflate EBITDA and make the business look more profitable). Others pay themselves far above market (pulling cash out of the business as compensation instead of distributions).

Example -- owner underpaid:

The seller of a $4M revenue HVAC company pays himself $65,000 per year. A qualified general manager to replace him would cost $150,000 in salary plus $30,000 in benefits.

The adjustment adds $115,000 in expense to reflect the true cost of replacing the owner. EBITDA goes down by $115,000.

This is the adjustment that surprises buyers most often. The seller's $950K in "adjusted EBITDA" assumed the next owner would work for $65K. They will not.

Example -- owner overpaid:

A seller of a $6M revenue professional services firm pays himself $425,000. Market rate for his role is $200,000.

The adjustment removes $225,000 in excess compensation. EBITDA goes up by $225,000 because the next owner (or a hired manager) would not cost $425K.

Why it matters: Owner comp normalization can swing EBITDA by $100K-$300K in either direction on a typical deal. This is often the largest single adjustment in the report.

One-Time and Non-Recurring Expenses

EBITDA add-backs for non-recurring items are the most intuitive adjustments. If an expense happened once and will not happen again, it should not be included in normalized earnings.

Common one-time expenses that get added back:

- Lawsuit settlements or legal fees for litigation - Natural disaster damage and repairs (flood, fire, storm) - COVID-related expenses (PPP loan adjustments, temporary shutdowns, one-time safety costs) - Restructuring costs (severance packages, office relocation) - One-time professional fees (ERP implementation, rebranding project)

Example:

A manufacturing business had a $78,000 legal settlement in Year 2 and $42,000 in flood repair costs in Year 1.

Without the add-backs, Year 2 looks like a terrible year. With them, you can see the business actually has a tighter earnings band of $668K-$722K -- which tells a very different story about stability.

The catch: Sellers love to call everything "one-time." A good QoE provider will push back. If the company has had a "one-time" legal expense in three of the last five years, it is not one-time -- it is a cost of doing business. We see this constantly, and it is one of the reasons a QoE report delivers value that a standard audit never will.

Related Party Transactions

This is where deals get interesting. Related party transactions are any financial arrangements between the business and entities connected to the owner. They are extremely common in privately held companies and almost always need adjustment.

Common related party issues:

- The business leases its building from an LLC the owner also owns -- at above-market (or below-market) rent - Family members on payroll who do little or no work - The business buys supplies or services from another company the owner controls, at non-market prices - Loans between the owner and the business at non-market interest rates

Example -- above-market rent:

A seller owns the real estate in a separate LLC and charges the business $14,000 per month in rent. Market rate for comparable space is $8,500 per month.

EBITDA goes up by $66,000 because the next owner will either negotiate a market-rate lease or find comparable space.

Example -- family on payroll:

The seller's spouse is on payroll at $55,000 per year as "office manager." During fieldwork, the QoE team determines this person works approximately 5 hours per week and handles tasks that a $40K part-time admin could do for $18,000 per year.

Related party adjustments can go in either direction. If the owner's LLC is providing below-market rent to make EBITDA look better, the adjustment goes the other way -- EBITDA goes down to reflect the true cost.

Revenue Adjustments

Not all revenue is created equal. The QoE team will examine whether reported revenue is recurring, sustainable, and representative of what the business will earn going forward.

Common revenue adjustments:

- One-time project revenue: A construction company landed a $600K government contract that will not repeat. That revenue needs to come out. - Customer concentration: If 40% of revenue comes from one customer, the QoE will flag the risk -- and the buyer may discount earnings attributable to that customer. - Pull-forward revenue: The seller accelerated shipments or invoicing before the sale date to inflate the trailing twelve months. - Lost customers: A major account churned three months ago and the trailing twelve-month financials still include their revenue.

Example -- one-time revenue:

An IT services company shows $3.2M in trailing twelve-month revenue. But $310,000 came from a one-time data center migration project for a client that has no further needs.

The adjustment removes the revenue and the associated costs. The net EBITDA impact is -$124,000. The business is still profitable -- just not as profitable as the top-line suggested.

Customer concentration does not always result in a direct EBITDA adjustment, but it will appear as a risk factor in the report. In practice, a buyer might apply a lower multiple to a business where 35%+ of revenue comes from a single account -- which has the same effect on purchase price.

Discretionary and Personal Expenses

Privately held businesses routinely run personal expenses through the company. This is one of the most common sources of EBITDA add-backs, and buyers generally expect to see some level of this.

Common discretionary expenses:

- Owner's personal vehicle, fuel, and insurance - Meals and entertainment beyond business necessity - Owner's personal travel (family vacations booked as "conferences") - Personal insurance policies (life, disability) paid by the business - Country club memberships - Charitable donations from the business (at the owner's discretion) - Personal cell phone plans for family members

Example:

EBITDA goes up by $60,100. These expenses will not exist under new ownership (or the new owner can make their own choices about them).

A word of caution: the QoE team will verify these add-backs. If the seller claims $15K in "personal meals" but cannot provide documentation showing which meals were personal versus business, a good provider will not add them back. Documentation matters.

Working Capital Normalization

Working capital adjustments are different from the others on this list. They do not change EBITDA -- they change how much cash the buyer needs to bring to the closing table.

Most purchase agreements include a working capital peg -- a target level of net working capital (current assets minus current liabilities) that the seller must deliver at closing. If actual working capital at close is above the peg, the buyer pays more. If it is below, the buyer pays less.

The QoE provider calculates a normalized working capital level, usually based on a trailing average.

Example:

If the seller tries to set the peg at $180,000 (the high-water mark), you are overpaying. The QoE analysis shows the normalized peg should be $150,000. That $30,000 difference comes straight out of your pocket at closing if you do not negotiate it.

Working capital is unglamorous but it is where a lot of money changes hands. It is also one of the most common post-closing disputes. A good QoE report gives you the data to negotiate the peg properly.

Accounting Method Differences

Many small businesses run on cash-basis accounting. QoE reports normalize to accrual basis to reflect the true economic activity of each period.

Why this matters: Under cash accounting, revenue is recognized when cash is received, not when the work is done. This creates timing distortions.

Example:

A consulting firm completed a $95,000 project in December but the client did not pay until January. Under cash accounting, that revenue shows up in January's financials. Under accrual accounting, it belongs in December -- when the work was performed and the economic value was created.

If you are looking at the trailing twelve months ending December, cash-basis financials miss $95,000 in revenue that actually belongs in that period. The QoE adjusts this.

Common cash-to-accrual adjustments:

- Unbilled revenue (work completed, not yet invoiced) - Prepaid expenses (insurance paid annually, recognized monthly) - Accrued liabilities (expenses incurred but not yet paid -- payroll, taxes) - Deferred revenue (payments received for work not yet performed)

These adjustments can go in either direction. The point is not to inflate or deflate -- it is to match revenue and expenses to the period where the economic activity actually occurred.

Which Adjustments Increase EBITDA vs. Decrease It

This is the question every buyer and seller wants answered. Here is a clear breakdown:

Adjustments That Typically Increase EBITDA (Add-Backs)

Adjustments That Typically Decrease EBITDA

In our experience across hundreds of engagements, the net effect of all adjustments tends to go down more often than up for seller-prepared financials. Sellers have a natural incentive to present the rosiest picture. The QoE report corrects for that.

That does not mean sellers are being dishonest. Most of the time, they genuinely believe their add-backs are reasonable. A QoE provider simply applies a more rigorous, third-party standard.

How Adjustments Affect the Purchase Price

This is where the math gets real. In small business acquisitions, purchase price is typically calculated as:

Purchase Price = Normalized EBITDA x Multiple

The multiple depends on the industry, size, growth, and risk profile -- but let's use a 4x EBITDA multiple as a common example for a business in the $1M-$5M revenue range.

Every $1 of EBITDA adjustment moves the purchase price by $4.

Here is what that looks like in practice:

In this example, the adjustments roughly wash out. But change one variable -- say the owner is underpaid by $200K instead of $115K -- and the net adjustment swings negative by $71K, which is $284K off the purchase price.

This is why the QoE report is the most important document in the deal. A comprehensive guide to the QoE process can help you understand the full picture, but the adjustment section is where the purchase price is won or lost.

As we discuss in our breakdown of QoE report costs, spending $6,000-$12,000 on a QoE to find $200K in adjustments is one of the best returns on investment in the entire transaction.

Red Flags in QoE Adjustments

Not all adjustments are legitimate. Here is what to watch for when reviewing a seller's proposed add-backs or a QoE report:

Aggressive Add-Backs

The seller's broker presents a list of 15 add-backs totaling $400K on an $800K EBITDA business. Half of them are things like "marketing spend we could cut" or "the new warehouse we opened that hasn't ramped up yet." These are not add-backs -- they are optimistic projections about the future. A QoE provider will reject most of these.

Rule of thumb: If the add-back requires the buyer to do something differently than the seller did, it is not an add-back. It is a business plan assumption.

Lack of Documentation

A seller claims $45,000 in personal meals and entertainment but cannot produce receipts, credit card statements, or any documentation separating personal from business meals. Without documentation, a responsible QoE provider will not support the add-back. If a report adds back undocumented items without noting the limitation, question the provider's rigor.

Too Many "One-Time" Items

If the business has "one-time" expenses every single year, they are not one-time. We see this pattern constantly:

- Year 1: "One-time" equipment repair ($35K) - Year 2: "One-time" employee severance ($28K) - Year 3: "One-time" legal settlement ($45K)

Each individual item may be non-recurring. But the pattern of unexpected large expenses is itself recurring. A good QoE provider will normalize for this by including an annual reserve for non-recurring items -- usually an average of the historical one-time expenses.

Every Adjustment Favors the Seller

In a legitimate QoE analysis, some adjustments go up and some go down. If every single adjustment increases EBITDA, either the QoE provider was hired by the seller and is not being objective, or the seller cherry-picked which adjustments to present. Ask for the full adjustment schedule, including downward adjustments.

Understated Replacement Costs

The seller claims the business can be run by a $60K manager. In reality, the owner works 60 hours a week, manages all customer relationships, and is the company's top salesman. The true replacement cost might be two hires totaling $200K+. Scrutinize the owner replacement assumption -- it is the adjustment with the biggest impact and the most room for creative interpretation.

Pro Forma or "Run-Rate" Adjustments

Some sellers present "pro forma" EBITDA that includes adjustments for things that have not happened yet: "We just signed a contract that will add $200K in annual revenue" or "We raised prices 10% last month so run-rate EBITDA is higher." These may be true, but they are forecasts, not normalizations. A QoE report deals with historical, verifiable data. Pro forma adjustments belong in the buyer's own financial model, not in the adjusted EBITDA used for pricing.

What to Do Next

If you are in the middle of a deal and staring at an adjustment schedule that does not make sense, here is what to do:

1. Read the adjustment schedule line by line. Every adjustment should have a description, a dollar amount, and supporting documentation. If any of those are missing, ask for them.

2. Separate the adjustments by direction. List out what goes up and what goes down. If it is all one direction, dig deeper.

3. Stress-test the owner compensation assumption. This is the biggest swing factor. Get a real market comp for what it would cost to replace the owner. Do not take the seller's word for it.

4. Look at the normalized EBITDA trend. After all adjustments, is normalized EBITDA growing, flat, or declining? A business with declining normalized EBITDA deserves a lower multiple, regardless of what the seller's add-back schedule shows.

5. Calculate the price impact. Multiply the net adjustment by your deal multiple. That is the dollar amount at stake in the negotiation.

6. Understand working capital. The adjustment schedule tells you about earnings. The working capital analysis tells you about the cash you need to deliver at closing. Do not overlook it.

If you do not have a QoE report yet, or if you are looking at a seller-prepared adjustment schedule and want a third-party opinion, that is exactly what we do. Bedrock QoE specializes in Quality of Earnings for deals between $1M and $30M. Flat-fee pricing from $6K-$12K, 2-3 week turnaround, and a team that has done hundreds of these engagements across PwC and RSM Transaction Advisory.

[Book a free consultation](https://tidycal.com/104e8jv/bedrockqoeconsultation) and we will walk through your deal.