What is quality of earnings?

A quality of earnings analysis — universally shortened to QoE — is a financial diligence study that interrogates whether a target's reported earnings reflect the true, sustainable economics of the business. It is not an audit. An audit asks whether the financials comply with accounting standards; a QoE asks whether the earnings are real, recurring, and likely to repeat.

The output is a QoE report, typically prepared by a transaction advisory team at an accounting or specialist firm, commissioned by the buyer (buy-side QoE) or, increasingly, by the seller to get ahead of the process (sell-side QoE). Its centerpiece is a bridge from reported EBITDA to an adjusted, "normalized" EBITDA that a buyer can actually underwrite.

Because price in most private deals is a multiple of EBITDA, the QoE-adjusted EBITDA number is frequently the single most consequential figure in the transaction. A dollar moved on or off that line moves the purchase price by the full multiple.

What a QoE actually tests

A QoE works through the income statement and the underlying ledgers looking for the gap between what was reported and what is durable.

  1. Revenue quality. Is revenue recognized appropriately, concentrated in a few customers, contracted versus one-time, and free of channel-stuffing or pull-forwards near period-end?
  2. Normalizing adjustments. Add-backs for one-time, non-recurring, and owner-specific items — and, just as importantly, deductions for understated run-rate costs the business will carry post-close.
  3. Run-rate and pro-forma effects. The full-year impact of recent price changes, lost or won customers, headcount changes, and acquisitions, so EBITDA reflects the go-forward business rather than a blended historical year.
  4. Working capital and cash conversion. Whether reported profit actually turns into cash, and what a normal level of working capital looks like — which feeds the closing mechanism, not just the price.
  5. Proof of cash. Tying reported earnings back to bank statements to confirm the profit was genuinely collected.

Why buyers and sellers both commission it

For a buyer, the QoE is the basis for the price they are willing to pay and the protections they negotiate. A finding that EBITDA is overstated by add-backs that won't survive ownership is direct leverage on price or structure.

For a seller, a sell-side QoE prepared before launch removes surprises. It lets the seller defend the EBITDA number with a credible third-party analysis already in the room, compressing the time a buyer's own QoE can take to chip away at value. Either way, the report becomes a core document in the data room and a reference point through closing.