Common QoE Adjustments: What They Mean for Your Deal

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 common adjustment categories 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.
• Deducts 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. Fully burdened, that is $180,000, an incremental $115,000 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 could be 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)
• Temporary disruptions (e.g., COVID-related costs or grants, short-term shutdowns, one-time safety measures)
• 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.

Year 1
As Reported EBITDA: $680,000
Add-Back: $42,000 (flood)
Normalized EBITDA: $722,000

Year 2
As Reported EBITDA: $590,000
Add-Back: $78,000 (legal)
Normalized EBITDA: $668,000

Year 3
As Reported EBITDA: $710,000
Normalized EBITDA: $710,000

Without the add-backs, Year 2 looks like a bad year. With them, the business shows a tighter earnings range of $668K to $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 rent for comparable space is $8,500 per month.

Rent Expense (Annual)
As Reported: $168,000
Market: $102,000
Adjustment: +$66,000

EBITDA Impact

EBITDA increases by $66,000, as a new owner would either negotiate a market-rate lease or secure comparable space at market terms.

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.

Spouse Compensation (Annual)
As Reported: $67,000
Market: $18,000
Adjustment: +$49,000

EBITDA Impact
Increase: +$49,000

Related party adjustments can go in either direction. If the owner is paying below-market rent or compensation to make EBITDA appear higher, the adjustment goes the other way, and EBITDA decreases 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. However, $310,000 came from a one-time data center migration project tied to a client with no ongoing relationship, and there is no pipeline of similar projects.

Revenue
As Reported: $3,200,000
Adjustment: -$310,000
Normalized: $2,890,000

Associated Costs
As Reported: ($186,000)
Adjustment: +$186,000

EBITDA Impact
Adjustment: -$124,000

The adjustment removes both the revenue and the associated costs. The net EBITDA impact is -$124,000.

Not all project-based revenue is removed. The question is whether the work is repeatable and representative of ongoing operation

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

These may be added back, but they need to be supported.

A word of caution: QoE teams will verify these add-backs. If the seller cannot support which expenses are truly discretionary, they will not be added 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:

A business shows working capital ranging from $120,000 to $180,000 over the last six months, with an average of $150,000.

If the seller sets the peg at $180,000 instead of $150,000, you are effectively overpaying by $30,000.

That $30,000 comes out of your pocket at closing.

Working capital is unglamorous, but it is where real money moves. It is also one of the most common post-closing disputes.

A good QoE report gives you the data to set the peg correctly.

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:

Typically increase EBITDA:

• Discretionary or personal expenses
• Above-market related party costs (rent, payroll)
• One-time or non-recurring expenses

Typically decrease EBITDA:

• Owner compensation that is below market
• Non-recurring or non-repeatable revenue
• Lost customers or customer concentration risk
• Below-market related party costs

In practice, adjustments tend to decrease EBITDA more often than they increase it.

Sellers have a natural incentive to present the business in the best light. A QoE applies a consistent, third-party standard to determine what earnings actually look like.

That does not mean sellers are being dishonest. Most believe their adjustments are reasonable. The QoE simply brings a more rigorous view

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.

If normalized EBITDA is reduced by $115,000 due to owner compensation adjustments, the purchase price drops by $460,000 at a 4x multiple

This is where purchase price is won or lost. If you want a deeper breakdown of the process, see our 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.

Spending $15,000-$30,000 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

Sellers sometimes include items like “marketing we could cut” or “new capacity that has not ramped.” These are not add-backs. They are projections

Rule of thumb: If the adjustment requires the buyer to operate the business differently, it is not a real add-back.

Lack of Documentation

If an adjustment cannot be supported with records, it should not be included. A QoE provider should tie every adjustment to actual data.

Too Many "One-Time" Items

If a business has large “one-time” expenses every year, they are not one-time. The pattern is recurring, and should be normalized accordingly.

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

This is often the biggest adjustment. If the owner is underpaid or doing multiple roles, the true cost to replace them may be significantly higher than presented.

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. Verify support for every adjustment
2. Separate what increases EBITDA from what decreases it
3. Stress-test the owner compensation assumption
4. Look at the normalized EBITDA trend
5. Calculate the price impact

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 typically between $15K-$30K, 2-3 week turnaround, and a team that has done hundreds of these engagements across.

Book a free consultation and we will walk through your deal.