That gap between what you think your business earns and what a buyer will pay for matters enormously. Quality of earnings (QoE) analysis is how that gap gets closed, or widened, depending on who controls the narrative.
GF Data's analysis of 360 transactions since Q3 2024 found sellers who commissioned a sell-side QoE averaged a 7.4x TEV/EBITDA multiple, compared to 7.0x for sellers who skipped it, with the benefit most pronounced above $50M in enterprise value (GF Data, 2025). On the flip side, Axial's 2025 review of 75 failed deals found QoE-related EBITDA discrepancies contributed to over 21% of broken transactions (Axial, 2026). That share has more than doubled: it was 10.6% in 2023 and reached 21.3% in 2025.
This guide breaks down what a QoE analysis actually involves, why it shapes valuation and deal structure, and how founders can use it proactively instead of reactively.
Key Takeaways
- QoE analysis tests whether earnings are sustainable, recurring, and cash-backed, not just historically accurate
- Three pillars anchor every analysis: adjusted EBITDA, proof of cash, and working capital
- Sell-side QoE gives founders leverage before buyers find issues themselves
- Most engagements take three to six weeks, depending on complexity
- The 2021 and 2022 earnings peak is the most common normalization problem a QoE now finds
What Is a Quality of Earnings Analysis?
A quality of earnings analysis is a targeted financial review that tests whether reported earnings are sustainable, accurate, and cash-generating. A compliance audit checks GAAP adherence; a QoE analysis tests whether those reported earnings hold up under deal scrutiny.
Warren Averett describes QoE as a comprehensive evaluation of financial statements and tax returns, typically performed by an accounting or advisory firm as part of a transaction, not a routine annual exercise (Warren Averett, 2023).
Bonadio puts it plainly: an audit confirms GAAP compliance, while a QoE normalizes historical results by stripping out non-recurring, unusual, or one-time items that distort the real earnings picture.
QoE work shows up in:
- Buy-side and sell-side M&A due diligence
- Private equity investment decisions
- Recapitalizations and strategic transitions
Buy-Side vs. Sell-Side QoE
| Perspective | Core question | Typical use |
|---|---|---|
| Buy-side | Are earnings sustainable enough to support the proposed price? | Informs valuation and deal structuring for the buyer |
| Sell-side | Can the seller substantiate the earnings and equity story before buyers test it? | Prepares buyer-ready financials and justifies asking price |
Why Quality of Earnings Analysis Is Critical in M&A Transactions
Adjusted EBITDA drives the entire negotiation. BDO notes that acquisitions are typically priced as a multiple of EBITDA, and that adjusted figure becomes the basis for the buyer's valuation model (BDO, 2016).
Sellers who understand their earnings quality before a buyer's team digs in walk into negotiations with more confidence, and far less exposure to a repriced deal.
A QoE analysis:
- Establishes a credible, defensible EBITDA baseline for negotiations
- Uncovers red flags before buyers do, reducing renegotiation risk
- Strengthens buyer confidence and speeds up closing timelines
- Identifies working capital and cash flow issues that affect deal structure
- Supports better post-close planning for both parties
- Helps founders capture full value for sustainable, recurring earnings
The consequences of skipping this step can be severe. Blue & Co. documented a 2022 construction acquisition where the seller hadn't prepared work-in-process schedules.
A QoE reclassified more than $1.1M in final billings, eliminating over 30% of expected EBITDA. The deal survived, but only after the structure changed to include a larger seller note (Blue & Co., 2022).
How Quality of Earnings Analysis Works – Step by Step
Advisory teams follow a practical sequence with clear checkpoints at each stage. Common mistakes that weaken the analysis include:
- Rushing data gathering before scope is locked
- Failing to document add-backs clearly
- Ignoring working capital normalization until it is too late to fix
Step 1 – Scope and Objective Setting
Define the transaction goals, timeline, and whether the analysis serves a buyer or seller. This shapes engagement scope and keeps everyone aligned on what "adjusted" means.
Step 2 – Data Collection
Gather financial statements, tax returns, general ledger detail, customer contracts, and AR/AP data. Completeness here determines how defensible the final numbers are.
Step 3 – Normalize and Adjust EBITDA
Identify management, due diligence, and pro forma adjustments that bridge reported earnings to a true, sustainable figure. This is where owner perks, one-time fees, and non-recurring items get separated from ongoing operations.
Step 4 – Proof of Cash and Working Capital Review
Reconcile bank activity against reported revenue and expenses. Assess working capital trends to establish a normalized peg, which sets the right closing-date adjustment.
Step 5 – Findings and Discussion
Present preliminary findings to management (or the buyer), gather clarifications, and resolve open questions before anything goes final. Early discussion surfaces disagreements while there is still time to rework the analysis.
Step 6 – Final Report and Negotiation Use
Finalize the adjusted EBITDA figure. Both sides use this number to anchor valuation talks, purchase price, and key deal terms.
Quality of Earnings Analysis – Example Case Walkthrough
Consider a common scenario: a founder-led manufacturing or distribution business with $12M in revenue.
The QoE team finds three issues during review:
- Personal expenses running through the business: a company vehicle, travel, and country club dues the owner treats as operating costs
- A one-time consulting fee paid for an unrelated litigation matter, booked as a normal operating expense
- Inconsistent revenue recognition on a major contract, where the company recorded revenue ahead of actual delivery milestones
The team documents each item as a specific add-back or adjustment, with supporting evidence (invoices, contracts, bank statements) rather than a vague explanation. It then recalculates EBITDA with those adjustments clearly labeled and defensible.
Here's the mistake that sinks deals: not disclosing these items upfront. If a buyer's diligence team finds them independently, buyers treat it as a credibility problem instead of normal accounting cleanup. That is when renegotiation, or a walked deal, becomes likely.
Handled proactively, the adjusted EBITDA figure becomes the anchor for the final valuation multiple. The founder controls the narrative instead of reacting to buyer-driven discoveries.
The Normalization Trap
There is one adjustment a QoE provider looks for before any of the three above, and most sellers do not know it is coming. It is not about add-backs. It is about which years you are asking a buyer to pay for.
Many lower-middle-market companies had unusually strong 2021 and 2022 results, driven by stimulus spending, supply chain pricing power, deferred maintenance cycles, workforce dislocation that temporarily suppressed labor costs, or simple pent-up demand. The revenue was real. The EBITDA was real. The durability of those earnings was not.
By 2023 and 2024 many of those same businesses normalized. Margins compressed, revenue flattened. The trailing financials a seller uses to frame value may describe a company performing at a level it has not seen since, and a buyer's quality of earnings provider will find that inside the first two weeks of diligence.
The seller believes they are presenting peak performance. The buyer's QoE team is underwriting a normalization problem. That is where the 10.6% to 21.3% increase in QoE-driven deal failures comes from, and it is why the trend is a preparation issue rather than a market one: over the same period, deals dying from financing failure fell from 21.3% to 10.7%. Capital got easier and more deals broke anyway.
Handling it is straightforward, if uncomfortable. Show the peak, explain what drove it, and present a normalized run rate you can defend. A buyer who is told about the 2022 tailwind adjusts a model. A buyer who discovers it adjusts a price.
How Exit Boston Can Help
Exit Boston is a New England middle-market M&A advisory firm based in Danvers, Massachusetts, working with founders and private business owners generating $10M–$100M in revenue. The firm prepares companies to present as institutional-quality assets before they go to market, including the earnings quality and data discipline buyers expect in a Quality of Earnings review.
That support includes:
- Deep valuation and CPA expertise from co-founder Steve Vesey, who has spent more than 25 years preparing business valuations and guiding owners through succession planning
- Operational insight into institutional buyer scrutiny from partner Sevan Demirdogen's 40+ years leading businesses including Kano Laboratories, Scapa Group plc, and Illinois Tool Works
- Buyer-specific positioning through tailored Investment Summaries built around each qualified buyer's acquisition criteria
- Sector coverage across distribution, manufacturing, building products, food and beverage, and specialty plastics
Exit Boston has earned recognition from Axial as a top-ranked U.S. M&A advisory firm, including a #1 Massachusetts ranking in 2024.
Financial Clarity is one of the firm's Seven Pillars, and its buyer question is the same one a QoE asks: can we trust the numbers, and can we model the future from them? The rest follows. Every dollar of unexplained variance is a dollar a buyer discounts.
Conclusion
Quality of earnings analysis gives you a defensible adjusted EBITDA figure and real leverage in buyer negotiations. You walk into diligence prepared instead of explaining gaps after the fact.
Treat sell-side QoE as preparation, not a reaction to a buyer’s request. Fix earnings-quality issues before you go to market, while you still control the narrative.
Frequently Asked Questions
How do you perform a quality of earnings analysis?
The process involves gathering financial statements and tax returns, normalizing EBITDA by identifying non-recurring items, reviewing working capital trends, and validating cash flow through proof-of-cash procedures.
What’s included in a quality of earnings report?
A typical report includes an executive summary, an adjusted EBITDA bridge showing each normalization item, a working capital analysis, and a proof-of-cash review reconciling reported earnings to actual bank activity.
What is the difference between a quality of earnings report and an audit?
An audit confirms financial statements comply with GAAP and provides an opinion on that compliance. A QoE report instead assesses whether earnings are sustainable and defensible for a specific transaction.
How long does a quality of earnings analysis take?
Most engagements take three to six weeks, depending on business complexity, accounting system quality, and how quickly the company delivers requested data.
When should a business owner get a quality of earnings analysis done?
Six to twelve months before going to market. That is enough time to address findings and to build a defensible normalized run rate if your peak year was 2021 or 2022, before a buyer's provider finds it.
How does a quality of earnings analysis affect purchase price?
Since most middle-market deals are priced on EBITDA multiples, any adjustment to the EBITDA figure directly moves enterprise value, up or down, often by a meaningful multiple of the adjustment itself.
