Quality of Earnings: What a QoE Report Checks Before a Sale

What is a quality of earnings report?

A quality of earnings report is the written result of that analysis. It starts from the EBITDA management presents, usually called adjusted EBITDA, and walks it line by line to the EBITDA the evidence supports. The gap between the two numbers is the point of the exercise. Many private companies are valued as a multiple of EBITDA, so every dollar of earnings that does not hold up can cost the seller that dollar times the multiple.

EBITDA is not a US GAAP measure, and adjusted EBITDA is whatever the person presenting it says it is. The SEC's staff guidance for public companies says a measure calculated differently from plain EBITDA should carry its own title, such as "Adjusted EBITDA", and that leaving out normal, recurring cash operating expenses can make a measure misleading (SEC, Non-GAAP Financial Measures). A private sale is not bound by those rules, but a buyer's diligence team applies the same logic to every add-back on your deal sheet.

How is a QoE different from an audit?

An audit answers whether the financial statements are fairly presented. The SEC describes the auditor's product as a written report containing an opinion on whether the statements are fairly stated (SEC, All About Auditors). A QoE answers a different question: what does this business really earn on a normal, repeatable basis, and what will a new owner inherit on the balance sheet?

A QoE is usually performed as a consulting engagement. The AICPA's Journal of Accountancy describes consulting services under the CS section 100 standard as nonattest services in which no opinion, conclusion or assurance is provided (Journal of Accountancy). In practice, an audited company can still have weak quality of earnings, and a company with clean QoE findings has not been audited.

What does a quality of earnings report check?

Scope varies with the deal, but a complete review covers seven areas. Each one ends in a number the buyer will use in the price or the purchase agreement.

Revenue quality starts with timing. Under ASC 606, revenue is recognized as promised goods or services are transferred to the customer, in the amount the company expects to be entitled to (FASB, Topic 606). Books that record revenue when the cash arrives can show a strong year that belongs partly to the year before, or a year-end spike that reverses in January.

The working capital peg moves money at closing. A buyer expects the business to be handed over with a normal level of receivables, inventory and payables. The review measures that level over a trailing period, and the purchase agreement sets it as the peg: if working capital at closing comes in below the peg, the price usually comes down. Receivables that are too old to collect get excluded, which is why aging matters.

Debt-like items are obligations that are not bank loans but still cost the buyer cash after closing. Leases are a common one: under ASC 842, a lessee records a lease liability and a right-of-use asset for leases longer than twelve months (FASB, Topic 842).

Proof of cash is the simplest test and the hardest to argue with. The reviewer ties each month's revenue to deposits and each month's expenses to withdrawals. Every difference needs an explanation, whether timing, a transfer between accounts or an owner deposit.

What does a QoE find in practice?

In one review we ran ahead of a transaction, management had communicated EBITDA of $800,000 for a business with $2.07 million in revenue. Rebuilt from the general ledger, EBITDA was $679,819: a $120,181 overstatement, about 15 percent, found before the deal rather than after it. The work followed a quality of earnings approach and is written up in full in our financial due diligence case study.

The EBITDA gap was not the only finding:

• Concentration. 99.9% of revenue came from two clients, and every statement of work with both had expired on December 31, 2025 with no signed replacements.
• Receivables. $1.071 million, 75.3% of total assets, at roughly 189 days outstanding. Management did not permit independent confirmation of the balances.
• Governance. An executive card balance suggested personal charges settled through the company.

None of it was fraud. It was accrual timing, unreconciled accounts and a management report that had drifted from the books over several years. Priced on a multiple of EBITDA, the gap was worth far more than $120,181, and every cause was preventable with a proper monthly close.

Sell-side or buy-side QoE: which one do you need?

The analysis is the same; who commissions it, and when, is not.

A sell-side review rarely stops the buyer from running its own. It changes what the buyer finds: issues already explained or fixed, instead of a surprise that reopens the price after the letter of intent.

When should you get a QoE, and how long does it take?

Consider a quality of earnings review when any of these is on the calendar:

• A sale of the company, ideally a year or more before you go to market.
• A recapitalization, a minority investor or a partner buyout, where a price is set on EBITDA.
• A large loan where the lender sizes the facility on earnings.
• An acquisition you are making, where you need to test the seller's numbers.

How long it takes depends on the books. When every month is closed and reconciled, the analysis is a matter of weeks, most of it spent collecting contracts, payroll detail and bank statements. When the books are behind, the cleanup comes first and often takes longer than the review. That is the case for starting early: a buyer wants a run of clean months, not one year cleaned up in a hurry.

How do you prepare your books before a sale?

Most QoE findings trace back to the monthly books. These steps remove them at the source.

If the books are months behind, catch-up bookkeeping rebuilds and reconciles the backlog first; monthly bookkeeping and payroll then keeps every month closed through the sale.

What red flags do buyers find in a QoE?

These are the findings that reopen a price or add an earn-out:

• An EBITDA that does not trace to the ledger. The deal sheet and the general ledger disagree.
• One-time costs that happen every year. Buyers put recurring add-backs back.
• Revenue in the wrong period. Sales booked when cash arrives, or a year-end spike that reverses in January.
• Concentration with expiring contracts. A few customers, on terms that end inside the deal horizon.
• Old receivables. Balances aging past collection, or that cannot be confirmed.
• Missing liabilities. Accrued payroll, bonuses, taxes or customer deposits never recorded.
• Personal spending in the business. It weakens every add-back you claim, including the valid ones.
• Deposits that do not tie to revenue. A proof of cash with unexplained differences.

Where does Korven fit?

Korven is a remote finance office for established US companies with $2M to $50M in revenue. Pre-sale diligence like the review above is part of our fractional CFO work: a senior rebuilds EBITDA from your ledger, tests each add-back, measures working capital, lists the debt-like items and gives you the findings in writing. It is analysis, not an audit, and we do not issue audit or attest opinions. If a buyer or lender asks for a specific provider or type of report, tell us early so the schedules are built to match.

Through the sale itself, the Finance Office runs the monthly close, payroll and CFO reporting, so the numbers a buyer tests are the numbers you manage by. Korven prepares your books and tax file; our licensed CPA partner prepares, signs and files your return.

This guide is general information, not legal, tax or investment advice. Confirm the terms of any transaction with your own advisers.

What else do owners ask about quality of earnings?