What a Quality of Earnings Report Is and Why Buyers Run One Before They Close
Sam's List Editorial | 2026-06-23
What a Quality of Earnings Report Is and Why Buyers Run One Before They Close A seller signs a letter of intent at a number they love. Six weeks later, the buyer's accountants hand over a report, and the price quietly drops 18 percent. The seller, exhausted and already mentally spending the money, takes it. That report is a quality of earnings analysis. And if you only learn what it is after a buyer runs one on you, you've already lost the leverage. Here is the quality of earnings report explained in plain terms: it's the deep audit of whether your reported profit is real, repeatable, and clean enough for a buyer to underwrite. Not whether the books are technically accurate — whether the earnings will actually show up again next year for a new owner. Those are very different questions, and the gap between them is where deal value lives or dies. A QoE report asks one question your tax return never does Your tax return and your P&L answer "what happened." A quality of earnings report answers "what happens next, for someone else." A buyer doesn't pay for last year's profit. They pay a multiple of profit they believe will repeat under their ownership. So a QoE strips reported earnings down to a defensible baseline and tests every assumption underneath it. It scrutinizes whether revenue was recognized correctly under ASC 606 — earned when the performance obligation was satisfied, not when cash hit the account. It separates one-time gains from recurring ones. It checks whether margins are real or propped up by a delayed expense. The whole exercise is professional skepticism applied to the one number the entire deal hangs on. Normalized EBITDA explained: the number the deal is actually priced on The output everyone fights over is normalized EBITDA. Here's normalized EBITDA explained without the jargon: it's your earnings before interest, taxes, depreciation, and amortization — then adjusted to reflect what the business truly earns, stripped of noise that won't continue under new ownership. Those adjustments are called add-backs. Legitimate ones include genuine one-time costs (a failed product launch, a one-off legal settlement, a rebrand) and owner perks that leave when the owner does — an above-market salary, a spouse on payroll who doesn't work there, the car the company leases for personal use. Consider an illustrative example. Say a business reports $2M in EBITDA. The owner ran $250K of personal and one-time expenses through it. Documented and accepted, that's a normalized EBITDA of $2.25M. At a 5x multiple, that $250K of clean add-backs is worth roughly...
