A quality of earnings report is one of the most useful things a buyer commissions. It is also one of the most commonly misread.
It answers a precise question extremely well.
And it is easy to assume it answered a second question it was never designed to touch.
What is a quality of earnings report?
A quality of earnings report, usually shortened to QoE, is an accountant’s examination of whether a target company’s reported earnings are real, repeatable and correctly stated.
It normalizes for one-off items, owner compensation and accounting choices to establish what the business genuinely earns.
It is commissioned by the buyer. On most deals of any size it is a standard part of diligence, and it frequently changes the price.
Anyone buying a business should have one.
The Corporate Finance Institute keeps a clear reference definition for the accounting detail.
What does a quality of earnings actually cover?
It covers the integrity of the financial picture.
Revenue recognition, margin sustainability, working capital requirements, add-backs and adjustments, customer concentration as a number and whether the historical trend is what the seller says it is.
Done well, it tells a buyer what they are paying a multiple of.
That is a genuinely important thing to know, and it is usually worth what it costs.
What does a quality of earnings not tell you?
It does not tell you whether the earnings survive the owner leaving.
A QoE examines what the business earned. It does not examine how the business runs.
That is a different discipline looking at different evidence.
| The question | Quality of earnings | Operational diligence |
|---|---|---|
| Did they really earn it? | Yes | No |
| Will they keep earning it without the owner? | No | Yes |
| Are the customer relationships the company’s or the seller’s? | No | Yes |
| Could a competent stranger run the work from what is written down? | No | Yes |
| Is the team likely to stay? | No | Yes |
| What will it cost to fix after close? | No | Yes |
This is not a criticism of the accountants. A QoE is precise and does exactly what it says.
It was simply never scoped to measure owner dependency.
And owner dependency is often what decides whether an owner-led business survives its own sale.
Do you need both a QoE and operational diligence?
On an owner-led business, yes.
The two answer complementary questions, and the gap between them is where buyers tend to get hurt.
A clean QoE on a business that cannot run without its owner is an accurate report about a risk it was not asked to assess.
Across the twelve acquisitions our founder has integrated, the problems that needed repairing after close were almost never accounting problems.
They were operational ones.
Most were visible during diligence, if anyone had been looking at the operations rather than the numbers.
That is what operational due diligence is for.
When in the deal should each happen?
Both belong after the letter of intent and before the purchase agreement is final.
That window is usually the only point where a finding can still change the terms.
Which is the entire value of doing either.
Run them in parallel rather than in sequence.
They draw on different evidence and different people, and the findings from one frequently tell the other where to look.
What operational diligence finds also shapes the integration plan.
So the work is not wasted if the deal proceeds.
For a first read on where a specific deal is exposed, the free Deal Risk Check takes a few minutes.
For the full picture of how we approach the buy side, start with buying a business.
Common questions
Is a quality of earnings the same as an audit?
No.
An audit gives an opinion on whether financial statements comply with accounting standards, looking backward for a defined period.
A QoE is a buyer-commissioned analysis of whether earnings are sustainable and correctly represented.
That is a narrower and more forward-looking question.
Who pays for a quality of earnings report?
Normally the buyer, as part of diligence costs.
Some sellers commission their own sell-side QoE before going to market to get ahead of the questions.
That can speed a process up and reduce the discount a buyer applies for uncertainty.
Can we skip the QoE on a small acquisition?
Buyers regularly do below a certain deal size.
The trade is relying on the seller’s bookkeeping being accurate.
If you skip anything, skip it knowingly rather than by default.
Just know which questions have gone unanswered.
Does operational due diligence replace a quality of earnings?
No, and it should not be sold as though it does.
They answer different questions.
A QoE tells you the earnings are real. Operational diligence tells you whether they keep happening once the owner is gone.
On an owner-led business you usually want both.
