What Is a Quality of Earnings (QoE) Report and Why Buyers Demand One
In private company M&A, the line between reported earnings and economic earnings is often where deals are won or lost. Buyers want assurance that the EBITDA they are paying a multiple on actually reflects sustainable cash flow. Sellers want to defend their value without conceding adjustments that should not exist.
That is what a Quality of Earnings (QoE) report is built to address. Once limited to larger transactions, QoE work has now moved firmly into the mid-market and lower mid-market. For owner-managed businesses in Vancouver, BC, and across Canada, understanding what a QoE is and how it differs from related work has become a basic requirement of running a sale process.
What a Quality of Earnings Report Actually Is
A Quality of Earnings report is a financial diligence product, usually prepared by an accounting firm or transaction services group, that tests the historical earnings of a business and proposes adjustments to arrive at a normalized, maintainable EBITDA.
It is not an audit. It is not a tax filing. It is a diligence-grade analysis built for transaction decisions.
The output is typically a written report supported by detailed analytics, including:
• a reconciliation of reported EBITDA to adjusted EBITDA
• analysis of revenue, gross margin, and operating expense trends
• working capital analysis
• customer and concentration analysis
• commentary on any unusual items
The report is designed to be relied on by a specific party, either the buyer (buy-side QoE) or the seller (sell-side QoE).
How a QoE Differs from a CBV Valuation
A Chartered Business Valuator (CBV) produces a valuation opinion. A QoE provider produces an earnings analysis. The two are related but distinct.
A CBV report typically:
• considers historical and projected financial performance
• applies valuation methodologies such as discounted cash flow, capitalized cash flow, or market multiples
• arrives at a conclusion of value, often as a range
• is used for purposes such as tax planning, shareholder disputes, succession, or strategic decisions
A QoE report typically:
• does not conclude on value
• focuses on adjustments to reported EBITDA
• supports the inputs that drive valuation but does not produce the valuation itself
• is used primarily in transaction contexts
In many transactions, both are used. The QoE establishes the earnings base, and the valuation framework applies a multiple or methodology to that earnings base.
How a QoE Differs from an Audit
An audit provides a level of assurance over a full set of financial statements prepared under a recognized accounting framework. It is focused on whether the statements are free from material misstatement.
A QoE does not provide that kind of assurance. It is not bound by an auditing standard. Instead, it dives into a narrower set of issues that matter to a transaction, often in greater depth than an audit would.
Key differences include:
• a QoE focuses on EBITDA quality, not on the financial statements as a whole
• a QoE relies heavily on management explanations and underlying data
• a QoE typically considers operational and customer-level information that an audit does not
• a QoE is forward-looking in spirit, even if anchored in historical periods
Many privately held businesses do not have audited financial statements. A QoE often becomes the practical substitute that gives a buyer comfort.
Why Buyers Want a QoE
From the buyer’s perspective, a QoE addresses the central question of any acquisition: are the earnings real and are they sustainable.
Specifically, buyers use a QoE to:
• validate reported EBITDA
• understand the basis for proposed adjustments
• identify revenue or expense items that may not recur
• test working capital and capital expenditure patterns
• inform their financing structure and lender discussions
For financial buyers in particular, the QoE is often the document that lenders rely on when sizing senior and subordinated facilities. A weak or incomplete QoE can directly affect how much debt the deal can support.
What a QoE Report Typically Covers
A standard QoE report includes sections on:
• reported and adjusted EBITDA by period
• revenue trends, customer concentration, and pricing
• gross margin analysis and cost of goods sold
• operating expense trends
• working capital, including accounts receivable, inventory, and accounts payable
• capital expenditure history and maintenance versus growth distinction
• one-time and non-recurring items
• owner compensation and related-party transactions
• seasonality and trailing twelve months analysis
The depth of each section varies with the size and complexity of the business, but the structure is broadly similar across providers.
Normalized EBITDA and Adjustments
The output that drives most negotiation is normalized, or adjusted, EBITDA. This is reported EBITDA adjusted to reflect the ongoing, maintainable earnings of the business under normal conditions.
A buyer paying a multiple of EBITDA is, in effect, buying a stream of future earnings. The closer the adjusted EBITDA is to a fair representation of those future earnings, the closer the purchase price is to a fair price.
Common Adjustments QoE Providers Make
Typical EBITDA adjustments include:
• owner compensation above or below market
• personal expenses run through the business
• one-time legal, consulting, or transaction costs
• losses or gains from non-recurring events
• rent paid to related parties at non-market rates
• discontinued products, customers, or business lines
• insurance recoveries and litigation settlements
• foreign exchange gains and losses outside normal operations
Some adjustments are easy to support. Others require detailed evidence. The quality of supporting documentation can have a meaningful impact on whether an adjustment is accepted or contested by the buyer.
Why Sellers Should Consider a Sell-Side QoE
A sell-side QoE is commissioned by the seller, usually in advance of going to market. The report is then shared with prospective buyers under appropriate confidentiality.
Benefits of a sell-side QoE include:
• a credible, independent presentation of normalized earnings
• fewer surprises during buyer diligence
• a stronger negotiating position on contested adjustments
• shorter buyer diligence timelines
• reduced risk of late-stage price reductions
In many processes, the sell-side QoE is one of the more impactful pieces of preparation. The cost is typically modest relative to the deal size and is often recovered many times over in retained value.
The Cost and Timing of a QoE
QoE fees vary based on the size and complexity of the business, the quality of available data, and the scope of work. For lower mid-market businesses in BC, typical engagements range from several weeks to a couple of months and from low five figures to mid five figures in fees.
Timing should be considered in the context of the overall process. A sell-side QoE is most useful when completed before launching the process, not midway through it.
How a QoE Connects to Valuation
Adjusted EBITDA from a QoE feeds directly into the valuation discussion. The valuation multiple is applied to adjusted EBITDA. A higher and more defensible adjusted EBITDA produces a higher enterprise value.
That is why disputes over adjustments are not technical accounting debates. They are valuation negotiations expressed in accounting language.
How KitsWest Capital Helps
KitsWest Capital integrates QoE considerations into both sell-side M&A engagements and buy-side advisory work. Our role is not to replace the QoE provider, but to ensure the QoE process is scoped appropriately, the adjustments are well-supported, and the report is positioned effectively in the broader transaction.
On the sell side, this often includes:
• helping owners decide whether a sell-side QoE is warranted
• coordinating with the QoE provider on scope and timing
• reviewing adjustments and supporting evidence
• positioning the report in the buyer process
On the buy side, this often includes:
• scoping the diligence work proportional to the transaction
• identifying adjustments that may be overstated or understated
• using the QoE to support financing discussions with lenders
• reconciling the QoE output with the broader investment thesis
Final Thoughts
In private company M&A, EBITDA is the currency, but Quality of Earnings is the audit of that currency. Buyers will look for sustainability. Sellers should expect that scrutiny and prepare for it.
Done well, a QoE protects value, reduces friction, and produces deals that close on the original terms. Done poorly or skipped entirely, it often becomes the place where price reductions are negotiated after the LOI is signed.
Speak with an Advisor
If you are evaluating a business sale, acquisition, unsolicited offer, or valuation matter, KitsWest Capital welcomes confidential discussions.
