Quality of Earnings: The Complete Guide for Buyers

# Quality of Earnings Report: The Complete Guide for Business Buyers

You're under LOI on a $4 million business. The seller sent over two years of QuickBooks files and a P&L that shows $1.1 million in adjusted EBITDA. Your lender says they need a quality of earnings report before they'll issue a commitment letter. Your broker says the seller's numbers are "solid." Your attorney says, "Get the QoE done."

But nobody has told you what a QoE report actually covers, what it costs, how long it takes, or what you should do if the findings change the deal. This guide covers all of it.

I've led hundreds of Quality of Earnings engagements across manufacturing, healthcare, business services, technology, and consumer industries -- first at PricewaterhouseCoopers, then at RSM, and now at Bedrock. What follows is everything I wish someone had handed me when I was sitting on the other side of the table.

What a Quality of Earnings Report Actually Is (and Isn't)

A quality of earnings report -- often shortened to QoE report -- is a financial due diligence analysis that answers one question: Are the earnings this business is claiming real, recurring, and sustainable?

That sounds simple. It isn't.

Most small and lower middle-market businesses keep their books on a cash basis, or somewhere between cash and accrual. Owner compensation runs through the company in half a dozen ways. Revenue might be recognized inconsistently. Expenses get categorized however QuickBooks auto-suggested them three years ago. None of this is fraud -- it's just how owner-operated businesses work.

A QoE strips away that noise and reconstructs the economic reality of the business so you can answer the only question that matters: What will this business actually earn under my ownership?

What a QoE is not

A QoE is not an audit. An audit opines on whether financial statements are presented fairly under GAAP. A QoE doesn't care about GAAP compliance for its own sake. It cares about economic substance.

It's also not a valuation. A QoE tells you what the business earns. What you pay for those earnings is a separate decision.

| | Quality of Earnings | Audit | Valuation | |---|---|---|---| | Purpose | Verify normalized, sustainable earnings | Opine on GAAP compliance | Determine fair market value | | Who uses it | Buyers, lenders, investors | Shareholders, regulators | Tax, litigation, estate planning | | Typical cost (SMB) | $6,000 - $15,000 | $15,000 - $50,000+ | $5,000 - $25,000 | | Timeline | 2 - 3 weeks | 4 - 12 weeks | 3 - 6 weeks | | Forward-looking? | Yes (trend analysis, sustainability) | No (historical only) | Yes (projections-based) |

We'll cover the differences between a QoE and an audit in more detail in a future post on Insights. For now, the key takeaway is that if you're buying a business, you need a QoE. An audit won't answer your questions, and a valuation is premature until you know what the real earnings are.

What's Included in a QoE Report

Every QoE provider scopes their reports a little differently, but a thorough engagement covers these core areas:

Adjusted EBITDA and Earnings Normalization

This is the centerpiece. The report takes the seller's reported earnings and applies normalizing adjustments to arrive at what the business would earn under a new owner with no one-time events distorting the picture.

Common adjustments include:

- Owner compensation normalization -- replacing the owner's actual comp (salary, benefits, personal expenses run through the business) with a market-rate salary for their role - One-time and non-recurring items -- lawsuit settlements, PPP forgiveness, insurance claims, one-time project revenue - Related-party transactions -- rent to an owner's LLC at below-market rates, vendor relationships with family members - Accounting reclassifications -- moving items between revenue and COGS, or between operating and non-operating categories, to reflect economic reality - Revenue and expense timing -- converting cash-basis books to an accrual picture so you can see what's actually been earned and owed

Revenue Quality Analysis

Not all revenue is equal. A QoE examines customer concentration, contract versus non-contract revenue, recurring versus project-based income, and revenue trends by product line or service category. If 40% of revenue comes from one customer and that relationship has no contract, that's a risk the report will flag.

Working Capital Analysis

Working capital -- the cash tied up in accounts receivable, inventory, and accounts payable on a day-to-day basis -- is one of the most misunderstood parts of an acquisition. The QoE establishes a normalized working capital target, which becomes the basis for the working capital peg in your purchase agreement.

Get this wrong and you'll either overpay at closing or find yourself in a post-close dispute with the seller. We'll cover working capital mechanics in depth in a future post.

Balance Sheet Review

The report examines major balance sheet accounts for accuracy: Are receivables collectible? Is inventory valued correctly? Are there undisclosed liabilities? This isn't a full audit of the balance sheet, but it catches material issues that would affect the deal.

Trend and Sustainability Analysis

A good QoE doesn't just tell you what earnings were. It tells you whether those earnings are trending up, down, or plateauing -- and whether recent performance is sustainable. If Q4 revenue spiked because of a one-time contract that won't repeat, you need to know that before you set a purchase price based on a trailing twelve-month number.

Buy-Side vs. Sell-Side QoE

A buy-side QoE is commissioned by the buyer. A sell-side QoE is commissioned by the seller, usually before going to market.

| | Buy-Side QoE | Sell-Side QoE | |---|---|---| | Who pays | Buyer | Seller | | Primary goal | Protect the buyer, surface risks | Support the seller's asking price | | When it happens | After LOI, before closing | Before listing, during marketing | | Skepticism level | Higher -- looking for problems | Lower -- building a credible narrative | | Who relies on it | Buyer, buyer's lender | Potential buyers, seller's advisor |

If you're a buyer and the seller hands you a sell-side QoE, read it carefully. It may be well-done. But understand that it was paid for by someone who wants you to pay top dollar. A sell-side report is a starting point for diligence, not a substitute for your own.

At Bedrock, the majority of our engagements are buy-side. We work for the buyer. Our job is to give you the clearest possible picture of what you're actually buying.

How a QoE Engagement Works

Here's what the process looks like from start to finish, using our typical engagement as the example.

1. Initial Consultation and Scoping

You reach out, usually while you're under LOI or evaluating whether to submit one. We review the deal summary -- business type, deal size, structure, timeline -- and determine scope. Most of this happens in a single call.

2. Data Request

We issue a detailed data request to the seller (or the seller's broker). This typically includes:

- Three years of financial statements and tax returns - General ledger detail - Bank statements - Revenue detail by customer and product/service line - Accounts receivable and accounts payable aging - Payroll records - Material contracts and leases

How quickly the seller responds to this request is the single biggest driver of timeline.

3. Analysis and Fieldwork

This is where the real work happens. We reconstruct the earnings picture, test revenue, analyze expenses, build the working capital model, and document every adjustment with supporting evidence. We typically have direct communication with the seller's bookkeeper or controller during this phase.

4. Draft Report and Discussion

Before we finalize the report, we walk you through our findings. This is a collaborative conversation -- we want to make sure you understand not just what we found, but what it means for the deal. If we've identified a significant adjustment, we discuss how it might affect price, terms, or structure.

5. Final Report Delivery

The final report is a presentation-ready document you can share with your lender, attorney, and equity partners. It includes the adjusted EBITDA bridge, working capital analysis, revenue analysis, and all supporting detail.

The entire process, from engagement letter to final report, typically takes two to three weeks assuming the seller provides data promptly.

What a QoE Typically Costs

At Bedrock, engagements are priced on a flat-fee basis between $6,000 and $12,000, depending on the complexity of the business. No hourly billing. No surprise invoices. You know the cost before we start.

Here's what drives where you land in that range:

| Factor | Lower End ($6,000 - $8,000) | Higher End ($9,000 - $12,000) | |---|---|---| | Revenue | Under $5M | $5M - $30M | | Entity structure | Single entity | Multiple entities or related parties | | Revenue model | Straightforward (e.g., service business) | Complex (e.g., construction, long-term contracts) | | Book quality | Clean QuickBooks or Xero file | Inconsistent records, multiple systems | | Add-backs | Few, well-documented | Many, requiring reconstruction |

For context, Big 4 and large regional firms charge $30,000 to $100,000+ for the same analysis. That pricing makes sense for $100M+ deals. For a $2M to $30M acquisition, you need the same rigor at a price point that doesn't eat your deal budget.

A note on "cheap" QoE options

You'll find providers advertising QoE reports for $2,000 to $3,000. Be skeptical. A meaningful QoE requires 60 to 100+ hours of CPA-level analysis. At $2,500, either the scope is drastically limited (essentially a financial review, not a QoE), or the work is being done by staff with minimal transaction experience. When the report is the primary tool standing between you and a bad acquisition, this is not where you cut costs.

How Long Does a QoE Take?

Two to three weeks from the time we receive full access to financial data. That's the standard at Bedrock, and it's realistic for most deals in the $1M to $30M range.

The actual elapsed time depends almost entirely on the seller. If the seller provides complete data within a few days of our request, we can often deliver a draft report in under two weeks. If the seller takes ten days to send a partial response and another week to fill gaps, the timeline extends accordingly.

Here's a realistic timeline:

| Phase | Duration | |---|---| | Scoping and engagement letter | 1 - 2 days | | Data request issued | Day 1 | | Seller provides data | 3 - 10 days (varies widely) | | Analysis and fieldwork | 7 - 10 business days | | Draft review with buyer | 1 - 2 days | | Final report delivery | 1 - 2 days after draft |

Pro tip: If you're working under a tight closing timeline, tell your broker to have the seller start assembling financial data before the QoE provider is formally engaged. A prepared seller can shave a full week off the process.

Who Needs a QoE?

The short answer: anyone acquiring a business where the purchase price is based on the seller's reported earnings. But the buyer profiles we work with most often are:

SBA Borrowers

If you're using an SBA 7(a) loan to acquire a business, your lender will almost certainly require a QoE report. This isn't optional -- it's part of the underwriting process. The lender uses the QoE to verify debt service coverage, and their credit committee won't approve the loan without it.

SBA buyers also tend to be first-time buyers. The QoE isn't just a lender requirement -- it's your safety net. It's the independent analysis that tells you whether the cash flow you're counting on to service debt and pay yourself is actually there.

Search Fund Operators

Search funds live and die by deal quality. A search fund principal who closes a bad deal doesn't just lose money -- they lose their investors' capital and two to three years of their career. The QoE is the primary diligence tool that separates a good deal from a disaster.

We work with search fund operators regularly and understand the specific dynamics -- compressed timelines, investor reporting requirements, and the need for a report that stands up to LP scrutiny.

Independent Sponsors

Independent sponsors need a QoE that satisfies their capital partners. The report needs to be thorough enough that an institutional investor is comfortable writing a check based on its findings. We scope our engagements accordingly.

Private Equity Add-Ons

PE firms acquiring add-on businesses in the $1M to $15M range often need QoE work done at a pace and price point their usual Big 4 provider can't match. We fill that gap.

First-Time Buyers

If you've never bought a business before, the QoE is arguably the most important part of your diligence process. You don't know what you don't know -- and a good QoE provider will surface the risks you wouldn't think to look for.

What Happens When the QoE Finds Problems

This is where the QoE earns its fee. Let me walk through a real-world example.

A buyer came to us with a deal for a home services business. The seller's broker package showed $800,000 in adjusted EBITDA based on trailing twelve months. The asking price was $3.2 million -- a 4x multiple.

Our QoE found the following:

- $95,000 in revenue was from a one-time insurance claim that wouldn't recur - $45,000 in owner add-backs were personal expenses the seller had already excluded from their adjusted number (double-counted) - $40,000 in understated subcontractor costs due to cash-basis timing -- work performed but not yet paid at the measurement date

After adjustments, normalized EBITDA was $620,000 -- not $800,000. At the same 4x multiple, the business was worth $2.48 million, not $3.2 million. A $720,000 difference.

The buyer didn't walk away. Instead, they used the QoE findings to renegotiate the purchase price to $2.6 million and restructured the seller note to include an earnout tied to post-close performance. The deal closed, and the buyer went in with realistic expectations about cash flow and debt service.

That's the point. A QoE doesn't kill deals. It gives you the information to do deals on the right terms.

Common findings that change deal terms

Not every QoE produces a dramatic repricing. But here are the most common findings that move the needle:

- Owner compensation higher or lower than market -- a $400K owner salary replaced with a $150K manager salary creates a significant add-back (or vice versa) - Revenue concentration -- one customer representing 30%+ of revenue is a risk that often leads to holdbacks or earnouts - Expense misclassification -- capital expenditures run through repairs and maintenance, inflating EBITDA - Working capital anomalies -- the seller collecting aggressively pre-close, leaving you with a receivables shortfall - Trend deterioration -- trailing twelve-month numbers look strong, but the most recent quarter is declining

How to Choose a QoE Provider

Not all QoE providers are the same. Here's what to look for:

Transaction experience, not just accounting credentials

You want a CPA who has done hundreds of these, not a tax partner doing their first QoE as a favor. Transaction advisory is a specific skill set. The ability to spot a buried related-party transaction or reconstruct revenue from bank deposits when the books are a mess comes from repetition, not textbook knowledge.

A named engagement lead

Ask who will actually do the work. At many firms, a partner sells the engagement, a senior manager reviews it, and staff associates do the analysis. You're paying for the partner's reputation and getting a first-year's judgment. At Bedrock, I lead every engagement personally. You work directly with me from the initial call through report delivery.

Flat-fee pricing

Hourly billing on a QoE creates a bad incentive structure. The more problems the provider finds, the more hours they bill. Flat-fee pricing aligns incentives: we scope the engagement upfront, and the price doesn't change if the analysis takes longer than expected.

Industry-relevant experience

The mechanics of a QoE are consistent across industries, but the red flags are industry-specific. A QoE provider who has analyzed 50 home services businesses will catch things that a generalist won't. Ask about relevant deal experience in your target industry.

Turnaround and communication

Two to three weeks is standard for our size range. If a provider quotes six to eight weeks for a $5M deal, they're either understaffed or not prioritizing your engagement. Also ask about communication cadence -- you should be getting updates throughout the process, not radio silence followed by a 60-page report.

A checklist for evaluating providers

- Does the engagement lead have direct transaction advisory experience (not just audit or tax)? - Will you work with the same person who does the analysis, or is it delegated? - Is pricing flat-fee or hourly? - Can they deliver within your closing timeline? - Do they have experience with your deal type (SBA, search fund, PE)? - Will they walk you through findings before the report is final? - Can they provide a sample report or redacted deliverable?

Next Steps

If you're evaluating a business acquisition, here's what to do right now:

1. Don't wait until your lender asks. Start the QoE process as soon as you have an executed LOI. This keeps your timeline on track and avoids the scramble of trying to close diligence in a week.

2. Get the seller assembling data early. Share a standard data request list with the broker as soon as the LOI is signed. Seller responsiveness is the number one driver of timeline.

3. Talk to a QoE provider before you need one. A 15-minute scoping call costs nothing and gives you a realistic picture of cost, timeline, and what to expect. If something about the deal seems off, a good provider will tell you before you engage them.

4. Budget for it. On a $3M deal, a $6,000 to $12,000 QoE is 0.2% to 0.4% of the purchase price. It's the cheapest insurance you'll buy in the entire transaction.

We built Bedrock specifically for acquisitions in the $1M to $30M range -- flat-fee pricing, two-to-three-week turnaround, and a CPA with hundreds of engagements leading the work directly. If you're under LOI or evaluating a deal, [book a free consultation](https://tidycal.com/104e8jv/bedrockqoeconsultation) and we'll give you an honest assessment of what the engagement would look like.

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This is the first post in our Quality of Earnings series. Coming next: a detailed breakdown of [common QoE adjustments](/insights), how to read the adjusted EBITDA bridge, and a head-to-head comparison of QoE vs. audit for business buyers.