What a Quality of Earnings report actually covers (and what it does not)

You’re six weeks into diligence on a $3M add-on acquisition. The seller’s financials show 35% YoY revenue growth and solid margins. Your investment committee wants a Quality of Earnings report before moving to LOI. Your M&A advisor quotes $18,000 and a four-week turnaround—and the target is already nervous about timeline. So you’re asking the real question: what exactly does a Quality of Earnings report actually do, what doesn’t it touch, and do I genuinely need a full, expensive engagement for this deal?

What a Quality of Earnings Report Actually Does

A Quality of Earnings (QoE) report is fundamentally a forensic restatement of a company’s reported earnings. A licensed CPA firm examines the accounting records, tax returns, and general ledger to answer one core question: how much normalized, repeatable earnings did this business actually generate?

The report does three things well:

• Identifies and quantifies add-backs. The CPA removes non-recurring items (severance, one-time legal fees, relocation costs, gain/loss on sale of fixed assets) from reported earnings so the buyer sees what the business would earn on a normalized run-rate basis.
• Validates revenue recognition and completeness. The firm tests a sample of transactions to confirm revenue was recorded in the right period, that sales adjustments were appropriate, and that the top line wasn’t artificially inflated or contains red flags.
• Tests margin stability and cost structure. It examines cost of goods sold, operating expenses, and headcount trends to flag whether margins are sustainable or rely on one-time efficiencies or cost cuts that won’t survive the acquisition.

A rigorous QoE engagement also scrutinizes related-party transactions, customer concentration, inventory valuation, and accrued liabilities—anything that affects earnings quality. The output is a normalized EBITDA or SDE figure that the buyer and their lender can feel confident using for valuation, financing decisions, and purchase price adjustments.

What a Quality of Earnings Report Does Not Do

This is where many buyers get surprised after the engagement is already underway and the invoice is half-paid.

A Quality of Earnings report does not:

• Assess market risk or competitive position. It doesn’t tell you if the business is losing customers, if a major contract is about to expire, or if the industry is consolidating and pricing power is eroding. That’s strategy and market due diligence.
• Evaluate capital intensity or future capex requirements. It doesn’t model what it will cost to refresh equipment, rebuild infrastructure, or invest in technology post-close. Those questions belong in operational due diligence.
• Validate customer or supplier relationships. The report doesn’t contact the top 10 customers to confirm they’ll renew, and it doesn’t assess whether supplier contracts have change-of-control provisions or price increases at closing. That’s commercial and legal due diligence.
• Assess legal, compliance, or regulatory risk. It doesn’t uncover pending lawsuits, regulatory investigations, environmental liabilities, or labor law violations. A QoE is not an audit, and it’s not a legal review.
• Evaluate intangible assets or goodwill decay. It doesn’t assess whether customer relationships, brand value, or proprietary processes will survive the transition, or whether the seller’s key person is leaving post-close and taking revenue with them.

In short: a Quality of Earnings report answers the question “How much did the business really earn?” It does not answer “Is this a good business to own?” or “Will these earnings persist?”

When You Actually Need a Full QoE Engagement

A traditional, licensed Quality of Earnings engagement is essential when:

• The deal value exceeds $10M and your lender or equity investor explicitly requires it.
• Reported earnings rely heavily on aggressive accounting judgments (revenue recognition policies, reserve methodology, capitalization vs. expense decisions).
• The seller has a history of restatements, audit deficiencies, or accounting changes that raise credibility questions.
• Add-backs are material and contested—if the buyer and seller disagree sharply on what should be normalized, an independent CPA can settle the dispute and protect the buyer at closing.

For smaller deals—especially lower-middle-market acquisitions under $5M or add-on purchases with clean, audited or reviewed financials—the cost and timeline of a full QoE engagement can be a poor risk-return trade-off. You’re paying $15,000 to $25,000 and waiting three to five weeks for validation that a disciplined buyer can often achieve faster and cheaper through a combination of tax return analysis, bank reconciliation, and internal calculations.

The Faster Alternative: Normalized Earnings Calculation and Walkthrough

Many buyers in the lower-middle market—especially on add-on acquisitions or bolt-ons—start with a different workflow. They request three years of tax returns, the last 12 months of P&L statements, the general ledger, and the schedule of add-backs that the seller has already prepared. A buy-side controller or CFO (or a platform like Outsourcing Processing) can then organize and test those adjustments, calculate normalized EBITDA or SDE, and flag discrepancies or red flags without waiting for a formal CPA engagement.

Outsourcing Processing, for example, calculates normalized EBITDA and SDE by organizing the seller’s data and applying standard add-back categories—and the results are human-reviewed before delivery, not auto-generated. This is not a substitute for a full QoE if your deal size, lender requirements, or earnings complexity demand it, but it does serve as a faster first pass for smaller deals, allowing you to validate the reasonableness of normalized earnings before committing to a full engagement or moving to LOI.

The discipline is identical: extract the P&L, identify and quantify non-recurring items, test the math, and flag anything that doesn’t reconcile. The difference is speed and cost, not rigor.

Red Flags That Demand a Full QoE Regardless of Deal Size

Certain warning signs should trigger a formal Quality of Earnings engagement even on smaller deals:

• Unaudited or reviewed financials with large, subjective add-backs. If the P&L isn’t certified and the seller is claiming millions in “normalizations,” an independent CPA review is justified.
• Significant related-party transactions. Sales to or purchases from related entities, loans to/from owners, or rent paid to owner-occupied property all require rigorous testing to confirm they’re arm’s-length and won’t inflate normalized earnings.
• A seller who resists providing source documents. If you request bank statements, customer contracts, or general ledger detail and get pushback or delayed responses, that’s a signal to hire a CPA to do the digging for you.
• Sharp, unexplained changes in reported earnings or margins. If Year 1 was flat, Year 2 jumped 50%, and Year 3 jumped another 40%, the QoE should model the drivers and validate sustainability rather than relying on the seller’s narrative.

The Cost-Benefit Math for Smaller Deals

A $2M acquisition candidate with clean tax returns, stable margins, and modest add-backs might justify a $1,200 normalized earnings calculation. The same deal with murky accounting, aggressive adjustments, and a seller who can’t quickly produce supporting documents? That’s a $18,000 QoE engagement.

The decision isn’t about deal size alone—it’s about information risk. How confident are you in the reported earnings? How much would overpaying by 20% hurt your IRR or post-close integration plan? How much of the purchase price is dependent on normalized earnings hitting a specific target?

If normalized EBITDA is 60% of the acquisition multiple but the seller’s add-back schedule is a one-page spreadsheet with no supporting detail, the question isn’t “Can I afford a QoE?” It’s “Can I afford not to have one?”

Frequently Asked Questions

Does a Quality of Earnings report include an audit or attestation?

No. A QoE is not an audited financial statement and carries no audit opinion or attest. It’s an analytical restatement for due diligence—the CPA firm tests and validates reported earnings against underlying records, but the output is for the buyer’s own use in valuation and deal decisioning, not for public filing or lender compliance purposes.

Who pays for the Quality of Earnings report, the buyer or the seller?

Almost always the buyer. The seller has little incentive to fund an independent review that might reduce valuation or expose weaknesses. Occasionally, the purchase agreement includes a buyer-funded QoE with shared access to results, but cost allocation is negotiated case-by-case. Whoever funds it controls the scope and engagement terms.

Can I rely on the seller’s accountant to prepare a Quality of Earnings report?

Not for a true QoE. The seller’s CPA has an inherent conflict of interest—they prepared the original financial statements, and an independent QoE might contradict or undermine their work. Buyers hire independent CPAs (ideally firms with M&A and due diligence experience) specifically to avoid this conflict and generate a report that lenders and equity sponsors will trust.

How long does a Quality of Earnings engagement typically take?

A typical engagement on a small to mid-market acquisition takes three to five weeks, depending on financial complexity, how quickly the seller provides documents, and the scope of testing. Rush engagements can compress this to two weeks but often come with a premium fee and higher risk of incomplete diligence.

If I use Outsourcing Processing to calculate normalized EBITDA, do I still need a Quality of Earnings report?

Not necessarily. For smaller deals with clean financials, a calculated normalized EBITDA calculation can be sufficient to validate earnings and move to LOI. For deals above $5-10M, with complex add-backs, or when your lender or equity sponsor explicitly requires a QoE, a formal engagement is still the safer path. The platforms serve as a faster first pass, not a replacement for formal QoE when regulatory or investor requirements demand it.

The Bottom Line

A Quality of Earnings report is a targeted, forensic restatement of reported earnings—it validates normalized EBITDA or SDE, flags accounting risks, and tests margin sustainability. It is not an audit, not a market assessment, and not a substitute for legal or operational due diligence. For smaller deals with straightforward finances and modest add-backs, a disciplined normalized earnings calculation can answer the core question in half the time and at a fraction of the cost. For larger deals, complex accounting, or earnings that rely on aggressive adjustments, a licensed CPA engagement is justified and often required by lenders or equity sponsors. The key is matching the depth of diligence to the information risk: the less you know about the business and the greater the earnings uncertainty, the more a formal QoE makes sense.

This article is educational and does not constitute M&A, investment, or accounting advice — confirm findings with a licensed CPA or M&A advisor before making an offer.

This article is educational and does not constitute M&A, investment, or accounting advice — confirm findings with a licensed CPA or M&A advisor before making an offer.

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