Why does Quality of Earnings (QoE) Report matter?
Reported EBITDA or revenue is easy for a seller to make look better than the underlying business, a large one-time contract counted as recurring, an understated related-party expense, aggressive revenue recognition. A QoE report is the buyer's primary tool for finding the gap between the number in the pitch deck and the number the business will actually produce going forward, which directly affects the price a sophisticated buyer is willing to pay.
What does Quality of Earnings (QoE) Report look like in practice?
Suppose a target reports $4,000,000 in trailing EBITDA. The QoE report finds $600,000 of that came from a one-time services engagement unlikely to recur, and another $200,000 reflects below-market rent from a related-party landlord that will reset after the deal. The buyer's adjusted EBITDA comes in near $3,200,000, and that lower, normalized figure (not the original $4,000,000) becomes the basis for the valuation multiple.
What are the common mistakes with Quality of Earnings (QoE) Report?
- Assuming reported EBITDA is what a sophisticated buyer will actually price the deal on, rather than the normalized figure a QoE report produces.
- Being unprepared to explain one-time items, related-party transactions, or aggressive accounting choices when the QoE analyst asks about them.
- Commissioning the report too late in the process to actually influence negotiation, rather than getting a sell-side QoE done proactively to control the narrative.
- Treating a QoE report as an audit, when it is a normalization and risk-flagging exercise, not a certification that the financial statements are correct.
Related concepts
- Financial Statement Audit vs. Review vs. CompilationThree escalating levels of assurance an outside accounting firm can provide on financial statements, a compilation organizes management's numbers with no assurance, a review offers limited assurance, and an audit independently verifies the underlying transactions.
- Working Capital AdjustmentA post-closing true-up to the purchase price based on the difference between the target's actual working capital at closing and an agreed-upon target level (the peg), designed so the seller cannot strip cash or inflate receivables right before the deal closes.
- Gross MarginRevenue minus the direct cost of delivering the product, as a percentage of revenue, the share of each dollar left over to fund everything else.