A quality of earnings (QofE) analysis is an independent accounting investigation that tests how sustainable, predictable and accurately measured a target's reported earnings actually are. It is commissioned in nearly every serious private-company M&A deal — by the buyer ("buy-side QofE") and increasingly by sellers ahead of launch ("sell-side QofE").
What a QofE tests
- Revenue recognition. Are revenues recognised in the period earned, under consistent policy?
- Customer concentration and revenue mix. What share of revenue comes from the top customers? What share is recurring vs. project-based?
- Cost of goods sold and gross margin trend. Are margins stable? What drove movements?
- EBITDA bridge. A line-by-line walk from reported EBITDA to Adjusted EBITDA, scrutinising every add-back.
- Working-capital trends. What is the normalised working-capital target that should be set at closing?
- Net debt. Identifying balance-sheet items that should be treated as debt-like (deferred revenue, long-term accrued bonuses, pension under-funding).
- Run-rate / pro-forma adjustments. Does the run-rate revenue and EBITDA actually reflect contracts in hand?
QofE vs. audit
A statutory audit confirms financial statements are presented fairly under GAAP/IFRS. A QofE has a different objective: it tests the economic reality of the earnings on which a buyer is being asked to pay a multiple. A clean audit and a poor QofE are entirely consistent.
Sell-side QofE
A growing share of lower-middle-market sales — and most institutionally-advised sales above $5–10M EBITDA — now begin with a sell-side QofE. The seller commissions a top-tier accounting advisor (Big Four transaction services, BDO, Grant Thornton, RSM, regional specialists) to produce a QofE that is shared with bidders under NDA. The benefits:
- A defensible Adjusted EBITDA in the CIM and on the LOI.
- Sharply reduced room for the buyer to retrade in diligence.
- Compressed deal timeline, since the buyer's QofE provider can validate rather than rebuild.
The cost ($40K–$150K) is routinely justified by the difference in headline price.
Output
The deliverable is a QofE report: typically 80–200 pages, with a databook of supporting schedules. It is the single most important diligence document in private-company M&A and the central reference point for negotiating final price, working-capital target, indebtedness and earn-out terms.
See also
- Quality of earnings report — The formal deliverable from a quality-of-earnings engagement — a third-party accountant's analysis of a target's reported earnings, normalisation adjustments and revenue and cost trends.
- Normalization adjustments — Adjustments to reported earnings to remove one-time, non-operating or owner-specific items, producing a run-rate EBITDA that better reflects the ongoing business.
- EBITDA — Earnings Before Interest, Taxes, Depreciation and Amortization — a measure of a company's operating profitability used as the base for most M&A multiples.
- Due diligence — The structured investigation a buyer conducts on a target between LOI and closing — covering financial, legal, tax, commercial, operational, IT, HR and environmental workstreams — to verify the seller’s claims, find risks and shape final price and deal terms.
- Sell-side M&A process — The deal cycle from the seller's perspective: preparation, marketing materials, buyer outreach, IOIs, LOIs, exclusivity, due diligence, definitive agreement and closing.