Glossary
Quality of Earnings (QoE) Report: What It Is, What It Covers and When You Need One
A quality of earnings (QoE) report examines the support, timing and sustainability of reported earnings for a transaction. It rebuilds EBITDA from the general ledger, tests the adjustments a seller proposes, and sets out the working capital the business needs. It is advisory work, not an audit.
QoE is also written QofE or Q of E. Buyers can commission one before closing; sellers can commission one before going to market.
What is a QoE and what questions does it answer?
A QoE addresses three connected questions; its conclusions depend on scope, records and unresolved limitations:
What does the business actually earn on a recurring basis?
Reported EBITDA, adjusted for items that will not continue, costs the buyer will carry, and revenue or expenses recorded in the wrong period.
Do the financial records hold up?
Revenue and expenses are tested against bank statements, tax filings and source documents.
How much working capital does the business need?
The analysis informs the negotiated net working capital peg in the purchase agreement.
It usually covers two prior fiscal years and the trailing twelve months, so the trend is visible.
What does a quality of earnings report include?
The scope varies with the deal, but in our work the core procedures below are a starting point for agreeing the engagement scope.
| Procedure | What it answers | What it can change in the deal |
|---|---|---|
| Proof of cash | Can book receipts and disbursements be reconciled to bank activity after transfers, financing and timing differences? | Identifies unexplained differences; does not establish revenue recognition or detect every misstatement |
| Book-to-tax reconciliation | Can the books be reconciled to tax filings, including legitimate book-to-tax differences? | Identifies differences requiring explanation; a difference is not automatically an error |
| Invoice sampling and revenue tracing | Was revenue recorded when the work was done, and was it collected? | Cut-off and deferred revenue adjustments |
| General ledger and manual entry review | Are there unusual or year-end entries that move profit between periods? | Spreading or reversing entries, timing adjustments |
| EBITDA normalization | Which proposed add-backs are supported, and what did the seller miss? | Adjusted EBITDA, often the base for price |
| Customer and revenue analysis | Is revenue concentrated, churning or seasonal? | Structure: earnouts, seller notes, conditions |
| Net working capital | What normal level of receivables, inventory and payables does the business run on? | The peg and the closing adjustment |
| Debt and debt-like items | What obligations should reduce the price on a cash-free, debt-free basis? | Net debt deductions |
For how each adjustment is supported, see EBITDA normalization adjustments.
What does the deliverable look like?
Our transaction team has discussed two deliverable formats. Format alone does not tell you which procedures were performed; that belongs in the agreed scope.
A data book.
An Excel workbook with the QoE summary, monthly income statement and balance sheet, adjustment schedules, proof of cash, working capital and supporting analysis. In transaction scoping calls, our team has recommended this format when the buyer, lender and advisers will work from the schedules directly.
A data book plus a narrative report.
The workbook with a written report: scope and limitations, background, key findings, accounting observations, the QoE summary and working capital analysis. Useful when the findings need to be read by people who will not open the workbook, such as an investment committee or a lender’s credit team.
Either way, the report states that it is not an audit and provides no assurance.
What should be visible in the earnings bridge?
A useful report separates the seller’s proposed adjustments, supported diligence adjustments and unresolved items. In Treewalk’s transaction discussions, an unsupported personal-expense claim has been left open rather than accepted solely because it was labelled an add-back. Other discussions separate the historical insurance cost from the quote the buyer would face after leaving a shared arrangement.
Those examples point in different directions: one is an evidence gap; the other is a change in go-forward cost. Neither should disappear inside one unexplained “adjusted EBITDA” total.
For each material adjustment, ask to see the amount by period, the underlying record, the reason for the treatment, whether it is recurring and any open question. A potential adjustment is not the same as a confirmed adjustment. If a lender will use the result, agree which version and unresolved items it will receive.
How does the QoE process work?
The work runs in a consistent order, though depth varies with the size of the deal and the state of the books.
- Request list and data room. General ledger, bank and credit card statements, tax returns, payroll records, contracts and the seller’s proposed adjustments.
- Kickoff call with management. How the business earns revenue, how the books are kept (cash or accrual), who closes the month, and what changed recently.
- Integrity testing first. Proof of cash, tax reconciliation and invoice sampling, to identify what can be reconciled and where limitations remain. Our team typically starts with the proof of cash, to establish the bank-to-book reconciliation before interpreting earnings.
- Earnings and working capital. Adjusted EBITDA built from the ledger, then compared with the seller’s figure; the working capital peg calculated.
- Second management call. Specific questions on entries, contracts and adjustments, usually toward the end of the work.
- Delivery and walkthrough. Findings explained to the buyer, and often the lender, so they can be used in negotiation.
Timing depends mainly on how quickly the seller provides information and how clean the books are. In scoping calls, our team has used roughly three to four weeks as a planning estimate for a straightforward file once the records and seller access are available. That is an engagement estimate, not a measured average or a delivery commitment. Confirm the timetable, data dependencies and lender deadline for your file.
When should you get a quality of earnings report?
Buyers
usually commission one after a letter of intent is signed, when the seller opens the books. Discuss the scope, records and access before the LOI is signed so the work can begin when authorised.
Sellers
commission a sell-side quality of earnings before marketing the business, so the issues a buyer would find are dealt with first and the adjusted figure is documented.
Either side
can test how ready the records are now with the QoE readiness check, which covers the questions a buyer’s diligence team is likely to raise.
How is a QoE different from an audit?
| Audit | Quality of earnings | |
|---|---|---|
| Purpose | Opinion on whether financial statements are fairly presented | Analysis of recurring earnings for a transaction |
| Assurance | Reasonable assurance | None |
| Standard | Applicable auditing standards (Canadian standards where applicable) | Agreed scope; no assurance standard applies |
| Focus | Historical statements as a whole | Adjusted EBITDA, cash support, working capital, debt-like items |
| Intended users | As specified by the engagement and reporting requirements | Named users and reliance rights set by the engagement; do not assume all recipients may rely |
Treewalk does not provide audit or assurance services. A QoE also is not a valuation, though its adjusted EBITDA is often the input a valuation uses, and it does not replace legal or tax due diligence.
Frequently asked questions
What does QoE stand for?
Quality of earnings. QofE and Q of E mean the same thing.
Is a quality of earnings report required to buy a business?
A QoE is not a universal statutory step in buying a business. A lender or investor may require specific diligence and reliance terms. Confirm those requirements before commissioning the work.
Who pays for the QoE?
On a buy-side QoE, the buyer engages and pays the provider. On a sell-side QoE, the seller does. What drives the cost is scope, the number of entities and locations, and the condition of the books; see quality of earnings report cost.
Can the seller see the buyer’s QoE?
The report is prepared for the party that engaged the provider. Sharing is subject to the engagement’s confidentiality, distribution and reliance terms. A buyer may discuss supported adjustments with the seller without distributing the complete report.
What happens if the QoE comes in lower than the LOI?
The buyer uses the findings to renegotiate price or terms, restructure part of the consideration, or walk away. Finding this before closing is the purpose of the work.
Where to next
Read what to ask a QoE provider before engaging one, and check where your file stands with the QoE readiness check. To scope a quality of earnings for a specific transaction, contact our transaction advisory team.
