Quality of Earnings Checklist: What Every Buyer Should Verify Before Closing

Quality of Earnings Checklist: What Every Buyer Should Verify Before Closing

Most buyers know they need a Quality of Earnings report. Fewer know what should actually be in one — or how to tell if their QoE provider covered everything that matters for their deal.

This quality of earnings checklist is built from hundreds of engagements. Use it to understand what your QoE should cover, to pressure-test a report you've already received, or to prepare a document request list before diligence starts.

What a QoE Is (and Isn't)

A Quality of Earnings report is a focused financial analysis that answers one question: are the earnings real, recurring, and sustainable? It's not an audit. It doesn't test every financial statement assertion. It zeroes in on the numbers that drive valuation and identifies adjustments that change the deal.

For a $5M acquisition, a $200K difference in normalized EBITDA typically moves the purchase price by $600K–$1M depending on the multiple. That makes the QoE one of the highest-leverage investments a buyer can make.

The Quality of Earnings Checklist

Revenue

Revenue recognition policy confirmed — Does the business book revenue when cash is received, when services are delivered, or somewhere in between? Cash-basis recognition overstates revenue in growing businesses.

Revenue reconciled to bank deposits — Total deposits should tie to total revenue. Gaps indicate unrecorded refunds, credit memos, or timing differences.

Customer concentration analyzed — What percentage of revenue comes from the top 1, 3, and 5 customers? Any single customer over 20% of revenue is a risk that should affect valuation.

Recurring vs. one-time revenue split — What percentage of next year's revenue is already under contract or predictably recurring? One-time revenue should not be capitalized at the same multiple as recurring revenue.

Month-by-month revenue trend reviewed — Are there seasonal patterns? Lumpy months? Revenue that spiked right before the sale process started?

Revenue by service/product line — Is growth concentrated in one area? Are margins consistent across lines?

Backlog or pipeline quantified — For project-based or contract businesses, what is the current backlog value and average duration?

EBITDA Adjustments

Owner compensation normalized — What does the seller actually receive, including salary, distributions, benefits, and perks run through the business? What would a market-rate replacement cost?

Personal expenses identified and removed — Personal vehicles, meals, travel, phone plans, insurance, and other items run through the business.

Related-party transactions reviewed — Rent paid to a landlord entity owned by the seller, management fees to family members, vendor relationships with affiliated parties. These frequently disappear post-close — or don't, at above-market rates.

One-time expenses verified — The seller will have a list of add-backs. Each one should be supported by documentation, and your QoE provider should form an independent view on whether they're truly non-recurring.

One-time revenue removed — A PPP loan forgiveness gain, an insurance settlement, or a one-time government contract should not inflate EBITDA.

Run-rate adjustments for known changes — New lease at different rent? Recently hired employee replacing owner function? These should be reflected in normalized EBITDA.

For a deeper look at which EBITDA add-backs actually hold up in diligence and which don't, see our full breakdown.

Working Capital

Working capital defined and calculated — Accounts receivable + inventory + prepaid expenses minus accounts payable + accrued liabilities (adjusted for deal-specific items). This is the number that drives the working capital peg.

Historical working capital trend — 12–24 months of monthly working capital data, to establish a normalized level.

Accounts receivable aging reviewed — What's the distribution of AR by aging bucket (current, 30, 60, 90+ days)? Any customers consistently slow to pay? Any write-off history?

Inventory valued correctly — For product businesses: is inventory at cost? Are there obsolete or slow-moving items that should be written down? FIFO vs. LIFO?

Accounts payable aging reviewed — Is the business current on its vendor obligations? Are there any disputed invoices or deferred payments that will become your problem at close?

Accrued liabilities complete — Payroll accruals, vacation accruals, warranty reserves. Are they properly recorded?

Working capital peg set — The final purchase agreement should include a peg based on normalized working capital, with a post-close true-up mechanism. For more on how the peg works, see our working capital peg guide.

Cash Flow and Debt

Bank statements reconciled — 24–36 months of bank statements should reconcile to reported revenue, expenses and cash balances.

Debt and off-balance-sheet liabilities identified — Lines of credit, equipment notes, seller financing, deferred revenue, customer deposits, warranty obligations.

CapEx history reviewed — What has the business spent on equipment and infrastructure? Is there deferred maintenance that will require near-term investment?

CapEx vs. maintenance CapEx — Normalized EBITDA typically deducts maintenance CapEx. Growth CapEx is separate. Make sure the QoE distinguishes between the two.

Free cash flow calculated — EBITDA minus taxes minus maintenance CapEx minus changes in working capital. This is the number your lender cares about for debt service.

Operations and Quality Signals

The QoE is a financial document, but a good QoE provider flags operational issues that show up in the numbers:

Key-person dependency assessed — What happens to revenue if the seller leaves? Is there a transition plan? Are customer relationships in the seller's name or the company's?

Employee tenure and turnover reviewed — High turnover, especially in key roles, is a cost and an operational risk.

Contract terms reviewed for assignability — Do major customer or supplier contracts assign to the new owner? Some require consent. A few have change-of-control provisions that terminate the contract on sale.

Lease terms confirmed — When does the lease expire? Is it assignable? Is rent at market? If the seller owns the real estate separately, is a long-term lease in place at market rates?

Using This Checklist

Not every item applies to every deal. A service business with no inventory has different diligence needs than a product distributor. A SaaS business has deferred revenue and churn metrics that a plumbing company doesn't.

Use this list to have an informed conversation with your QoE provider before diligence starts. Know what questions you want answered. If the report comes back and doesn't address working capital, or doesn't test revenue against bank deposits, ask why.

A QoE report is only as good as the questions it answers. Make sure it answers yours.

For a comprehensive overview of the full buy-side due diligence process — including legal, tax, and operational workstreams — see our complete guide.

Bedrock runs QoE engagements for deals in the $1M–$40M range, with 2–4 week turnaround. Talk to us before you go under LOI.