A Quality of Earnings report is the financial backbone of any serious business acquisition. Here's what you need to know:
What a QoE report does: The QoE provider (an independent CPA firm) analyzes the target business's financial records to determine the true, sustainable earnings power. They're looking for the answer to: "If I buy this business today, what can I realistically expect it to earn going forward?"
Key components of a QoE report: 1. Adjusted EBITDA/SDE — The "real" earnings after removing one-time items, normalizing owner compensation, and accounting for accounting irregularities 2. Revenue quality analysis — Is revenue recurring, growing, and diversified? 3. Working capital normalization — How much cash does the business need to operate day-to-day? 4. Trend analysis — Are earnings trending up, flat, or down on a monthly basis? 5. Add-back verification — Are the seller's claimed add-backs legitimate and documented? 6. Customer/revenue concentration — Risk analysis of customer and product mix
Why you need one: - Your SBA lender will require it for any acquisition over ~$350K - It catches financial misrepresentations before you close - It establishes the true purchase price basis (adjusted earnings × multiple) - It identifies working capital needs for your pro forma - It provides leverage for price renegotiation if earnings are lower than represented
What a QoE typically finds: In most deals, the QoE-adjusted earnings differ from the seller's represented earnings. Common adjustments: - Overstated add-backs (personal expenses that are actually business expenses) - Understated expenses (deferred maintenance, below-market employee pay) - Revenue timing issues (recognized too early or too late) - Inventory adjustments - Related-party transaction normalization
Cost and timeline: - Small businesses (<$2M revenue): $15K–$25K, 2–3 weeks - Lower middle market ($2M–$10M): $25K–$40K, 3–4 weeks - Choose a QoE provider with industry experience in your target sector