Glossary
Quality of Earnings Report
A Quality of Earnings (QoE) report is a deal-focused, non-attest analysis that a buyer commissions to test whether a target company’s reported earnings reflect the cash flow a new owner would actually inherit. It is built on management’s financials but rebuilds them: GAAP-correcting accounting policies, normalizing EBITDA for one-time and owner-specific items, proving the cash, and pricing the working capital the buyer will need on day one. At Treewalk, our transaction advisory practice runs QoE engagements for SMB deals in the $1M to $15M revenue range, where the seller’s books are almost never deal-ready when we open them.
What a QoE actually is
A QoE is a report addressed to the buyer, marked for internal use only, with a Notice to Readers stating no audit was performed and no assurance is provided. It is not an audit, not a review, not an opinion on fairness. It is an investigative document.
The standard deliverable has two pieces: an Excel workbook (the QoE appendix with all schedules, period comparisons, and supporting calculations) and a PDF report with the narrative findings. The report is structured the same way across every engagement: Notice to Readers, Glossary, Background, Executive Summary points of interest, Accounting Process, the QoE itself, Net Working Capital plus the cash conversion cycle, income statement and balance sheet analysis, and three appendices covering procedures, proof of cash, and balance sheet supporting schedules.
The report exists to answer three questions:
- What is the company’s normalized, recurring EBITDA?
- Is the cash on the books real and the working capital position normal?
- What ought the buyer be looking at, asking about, or concerned by before closing?
How we approach it at Treewalk
We run every QoE through the same eight-phase process. The depth at each phase varies with deal size and book quality, but the order does not.
Kickoff
We sit with management and the outside CPA to understand the organizational structure, the basis of accounting (cash or accrual), the revenue model, and the control environment. We analyze the general ledger for atypical entries, look at related-party relationships, and learn the business before we touch a number.
Accounting policy assessment
We test whether the books reflect GAAP. For Canadian targets that means IFRS or ASPE; for US targets, US GAAP. If the company runs on cash accounting (common in SMB deals), we restate to accrual so the comparison periods mean something.
Quality of Earnings
This is the core: we normalize EBITDA. We pressure-test the seller’s proposed adjustments, identify additional adjustments they missed, and group everything into management adjustments, Treewalk-identified adjustments, and potential adjustments. Standard categories include non-recurring expenses, personal expenses run through the business, owner salary normalization, family members on payroll at non-market rates, accounting policy corrections, gains and losses on asset disposals, PPP forgiveness, and bad-debt or deferred-revenue corrections. We present the adjustments across three periods, typically the two prior fiscal years and the trailing twelve months.
Income statement analysis
Horizontal revenue trends, customer concentration, seasonality, gross-margin breakdown by segment, and payroll reconciliation between the payroll provider and the GL.
Balance sheet analysis
This is where most surprises live. Proof of cash (Appendix B) reconciles bank statements to the books for receipts and disbursements separately, with a tolerance of roughly 3 to 5 percent net variance. AR aging for collectability and DSO. AP aging for unrecorded liabilities. Related-party transactions for arm’s-length pricing. Off-balance-sheet items: deferred revenue, operating leases, contingent liabilities.
Ratio analysis
Current, quick, asset turnover, DSO, DPO, DIO, debt service coverage where relevant.
Net working capital peg
We identify the normalized working capital level the buyer needs to keep the business running post-close, on a cash-free, debt-free basis. The peg drives a real dollar number in the closing mechanics.
Commitments and contingencies
Forward purchase commitments, operating-lease obligations, lawsuits, environmental exposure. The buyer needs to know what’s coming.
What you get
Two artifacts:
The PDF report
narrative findings, the executive summary points of interest the buyer will use in negotiation, full accounting-process notes, the QoE summary table, NWC analysis, and the IS/BS analysis. Roughly 30 to 60 pages depending on deal size.
The QoE workbook (Excel)
every supporting schedule, period-over-period adjustment, proof-of-cash detail by month and bank account, balance sheet supporting schedules. This is where the buyer’s diligence team and lender’s underwriter actually live.
What a QoE is NOT
It is not an audit. It is not an opinion on whether the financial statements are presented fairly. It is not a valuation, although the normalized EBITDA we produce is the input most multiples-based valuations are built on. And it is not a substitute for legal due diligence, tax due diligence, or operational diligence.
Frequently asked questions
Is a Quality of Earnings report the same as an audit?
No. An audit is performed under professional standards published by CPA Canada (or AICPA for US filers), produces an opinion on the fairness of the financial statements, and gives reasonable assurance. A QoE is a deal-focused investigation. We do no attest work, give no assurance, and the report’s Notice to Readers states this on page one.
What deal sizes do you do QoE work for?
Our sweet spot is SMB deals with target revenue in the $1M to $15M range. Smaller than that, the cost-to-deal-value ratio rarely makes sense. Larger than that, a national accounting firm with a dedicated transaction services team is often a better fit. We have closed buy-side QoE files at $845K target revenue and at $10.5M target revenue.
How long does a typical QoE engagement take?
Three to four weeks from kickoff to deliverable for a clean target. Six weeks if the books are cash-basis and we have to restate. The constraint is almost always the seller’s responsiveness to information requests, not our throughput.
Do you do sell-side QoE as well as buy-side?
Yes. Sell-side QoE is increasingly common in the SMB market as a seller-prepared package given to qualified buyers. The process is identical; only the addressee changes. Sell-side QoE strengthens the negotiating position because the surprises get found before the LOI rather than during diligence.
What is the deliverable’s reading audience?
The buyer, the buyer’s lawyer, and the buyer’s lender. Occasionally the buyer’s PE backer or family-office capital partner. The report is marked for internal use only, and we ask buyers not to distribute it to the seller without consultation.
Where to next
If you are looking at a target and want to know whether a QoE is the right next step, our transaction advisory team is the place to start. Email Avnit Sekhon at avnit.sekhon@treewalk.com or call (604) 813-2432.
