A quality of earnings report, universally shortened to QoE, is the analysis a buyer's accountants perform on your financials before closing a deal. Its job is to answer one question: is the EBITDA this business claims the EBITDA a new owner will actually receive?
It is not an audit. An audit asks whether your statements follow accounting rules. A QoE asks whether your earnings are real, recurring, and transferable, which is a harsher and more commercial question. Businesses with clean audits fail QoEs all the time.
What the QoE team actually does
They rebuild your EBITDA from the bottom up, then adjust it line by line. Four areas absorb most of the work:
Add-backs, tested. You added back your above-market salary, the family vehicles, the one-time lawsuit. They will test every item: is it truly non-recurring, truly personal, truly documented? Undocumented add-backs get struck, and each struck dollar costs you that dollar times the multiple.
Revenue quality. How much revenue is contractual versus repeat-but-optional versus one-time? Any customer over 15 to 20% of sales? Any revenue pulled forward, channel-stuffed, or recognized aggressively? This is where revenue quality stops being a concept and becomes a schedule with your name on it.
Margin sustainability. Are recent margins the real run rate, or a spike? Deferred maintenance, under-market owner labor, expiring supplier pricing, and unbilled contract escalators all get normalized, in whichever direction the evidence points.
Working capital, normalized. The team computes the working capital the business genuinely needs, which sets the peg in the purchase agreement. Bloated receivables and heavy inventory become negotiating material, which is why the cash-cycle work pays twice.
What it typically finds, and what that costs
Diligence practitioners' rule of thumb: most owner-prepared EBITDA figures move in the QoE, and the move is rarely up. A 10-15% re-cut is common in unprepared companies. At a 5x multiple, a $300K EBITDA adjustment is $1.5M of price, and the damage compounds. A large re-cut also tells the buyer your numbers cannot be trusted, which infects every remaining negotiation and is the classic setup for the late-stage re-trade.
How to pass a QoE before one exists
The preparation is not mysterious, it just takes time, which is why it lives on the 18-month exit-readiness clock:
- Document add-backs as they happen, not from memory three years later. A folder with invoices and a one-line rationale per item is worth six figures of defended EBITDA.
- Get monthly financials to close cleanly and fast, with revenue recognized the same defensible way every period.
- Build the customer and margin schedules yourself first. Revenue and contribution by customer, concentration, cohort retention. Whatever the QoE will find, find it first, and either fix it or be ready to explain it.
- Normalize your own working capital and manage to it for a year, so the peg gets set off disciplined numbers instead of bad habits.
- Run a mock QoE 12 to 18 months out. A sell-side readiness review costs a fraction of what a single surprise costs at the closing table.
That fifth item is exactly the work of an exit-readiness engagement: sitting on your side of the table, finding what a buyer's team will find, while there is still time to change the answer. The two-minute Exit-Readiness Scorecard will tell you roughly what a QoE would flag today.
The owners who do this describe diligence as boring. In this context, boring is the most valuable word in the language.