By Jonah Gjertson, CVA, Senior Consultant at Blue & Co.
Buying a business is a complicated process with material financial implications each step of the way. There are many decisions to consider before signing a purchase agreement or closing a transaction.
Is the asking price supported by the company’s financial performance? Are the reported earnings sustainable? Will the business generate the cash flow needed to support debt service, future investments, and your expected return?
For many buyers, a Quality of Earnings (“QoE”) report is viewed as a financing diligence item. Lenders often require an independent analysis of the target company’s financial performance before committing capital to a transaction. While a QoE can help satisfy lender requirements, it also offers several benefits to the buyer as they evaluate a potential transaction.
A QoE is a valuable tool a buyer can use to understand the business they are acquiring. It can help support the purchase price, identify risks before closing, and give the buyer a clearer view of the operational and financial issues that may need attention after the transaction is complete.
Preparing for the financial due diligence process through a QoE report accomplishes three main objectives:
- Supporting the sustainability of earnings
- Identifying risks before closing
- Preparing for ownership after the transaction
What Is a Quality of Earnings Report?
A QoE is a detailed financial analysis that digs deep into:
- Performance over a two to three year operating history of the company, including an analysis of the most recent trailing twelve-month period (TTM), to provide a more recent analysis than a standard year-end audit or compilation
- Revenue trends and customer concentration
- Adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization)
- One-time or non-recurring expenses (add-backs)
- Working capital needs
- Industry-specific practices, benchmarks, and adjustments
A QoE report does not provide formal assurance or constitute an audit or formal review of the financial statements. An audit expresses an opinion on whether those financial statements are presented fairly, in all material respects, in accordance with applicable financial reporting frameworks such as U.S. Generally Accepted Accounting Principles (“GAAP”), and a QoE is an analysis designed to evaluate the reliability and sustainability of the company’s earnings.
For a buyer, the report is not just about confirming the historical numbers presented by the seller. It is about understanding how the business earns money, if those earnings are repeatable, and what may change after the transaction closes.
Why Buyers Should Obtain a QoE Report
Support the Sustainability of Earnings
- Support adjusted EBITDA and normalized earnings
- Evaluate if seller add-backs are reasonable and supportable
- Understand if reported revenue and margins are sustainable
Many transactions are valued using a multiple of EBITDA, EBIT (earnings before interest and taxes), or seller’s discretionary earnings (SDE). As a result, even small adjustments to earnings can have a material impact on the value of a business.
A seller may identify certain costs as non-recurring or discretionary add-backs. Some of those adjustments may be appropriate, while others may represent expenses that will continue after closing. A QoE helps the buyer evaluate these adjustments and determine whether the earnings used to support the purchase price reflect the company’s ongoing performance.
Additionally, a quality of earnings may reveal discretionary expenses that the seller is unaware of. While rare, these examples may appear when a business has been family-owned for more than one generation.
Example: “When I was evaluating a franchised car dealership, a QoE report that the Buyer commissioned revealed a used vehicle pack (an adjustment to the cost of sales for a vehicle) was not being considered by the Seller as an addback. The omission of this addback reduced the profitability of the used vehicle department and the dealership, reducing the overall value in the original pro forma. The inclusion of this addback increased the buyer’s pro forma without increasing the tentative purchase price of the business, in turn increasing the expected return rate for the transaction.”
Identify Risks Before Closing
- Identify financial and operational issues early
- Understand revenue trends and customer concentration
- Evaluate unusual expense classifications or margin fluctuations
- Ask better questions before committing to a purchase
A QoE report helps buyers look beyond the headline financial results. A company may have stable revenue but increasing customer concentration. EBITDA may appear strong, but it could include one-time income or exclude expenses that will continue after closing. Working capital may appear sufficient based on a year-end balance sheet, while the business may require more cash during other points in the year.
Identifying these matters before closing gives the buyer time to understand the risk and determine if changes to the purchase price, transaction structure, or post-close plan are necessary.
Example: “When I was evaluating a franchised car dealership, a QoE report revealed that fixed operations salaries expense was misclassified as general salaries and wages. This misclassification, while not affecting the total net income, incorrectly inflated the dealership’s fixed absorption ratio, which led to downward changes in the buyer’s pro forma and valuation of the dealership, providing greater clarity of the actual performance of the dealership.”
Prepare for Ownership After the Transaction
- Build a more reliable post-close financial plan
- Identify working-capital and cash flow needs
- Prepare more accurate projections for lenders and investors
- Prioritize operational issues requiring attention after closing
The benefits of a QoE do not end when the transaction closes. The findings can help the buyer develop a more informed post-close plan.
Understanding the company’s revenue drivers, expense trends, working-capital needs, and normalized earnings gives the buyer a stronger foundation for forecasting future performance. It also helps identify areas that may require immediate attention, such as customer retention, margin improvement, expense management, or financial reporting processes.
Example: “When a buyer commissions a QoE report early in the diligence process, the findings can be incorporated into the buyer’s pro forma income statement, cash flow forecast, and post-close operating plan. This allows the buyer to understand where management attention may be needed immediately following the transaction, rather than discovering those issues after closing.”
A QoE Is a Tool for the Buyer, Not Just the Lender
A lender uses a QoE report to assess the company’s ability to support debt service. A buyer can use it to make a clearer investment decision.
A Quality of Earnings Report may be a financing requirement for some buyers, but it is much more than that. It helps buyers support the business they are acquiring, negotiate with confidence, and prepare for ownership after closing.
Questions? We’re Here to Help.
Blue & Co. brings a combination of financial expertise, operational insight, and industry-specific advisory services to help entities navigate exactly the kind of transactions described in this article. Our approach to Quality of Earnings is comprehensive and tailored to the industry you serve. Contact a Blue & Co. advisor today.
About Us
Jonah Gjertson, CVA, Senior Consultant with Blue & Co., is a seasoned professional with a background in corporate development and business valuation. From 2022 to 2025, he served as a Corporate Development Analyst at Gee Automotive Companies, where he contributed to strategic growth initiatives within the retail automotive sector. His experience spans equity evaluation, financial modeling, and strategic consulting, and he has been praised for his analytical rigor and collaborative leadership in both academic and professional settings.
