Quality of Earnings in M&A: An Advisor's Guide

A quality of earnings (QoE) report determines whether a seller’s EBITDA is real, recurring, and defensible under scrutiny. In any mid-market M&A transaction, it is one of the most consequential documents in the process — and for sell-side advisors, understanding it is essential to protecting the client’s valuation from close to the wire.

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What Is a Quality of Earnings Report?

A quality of earnings report is a financial due diligence analysis — typically prepared by a Big Four or specialist M&A accounting firm — that examines the sustainability and accuracy of a company’s reported earnings. The focus is EBITDA: Are the stated adjustments legitimate? Is revenue recurring? Does accounting treatment match economic reality?

QoE reports are standard in mid-market M&A. Any transaction with more than $3–5M EBITDA will face rigorous buy-side QoE scrutiny. Experienced sell-side advisors commission their own sell-side QoE before marketing begins — both to validate the numbers and to reduce diligence friction later in the process.

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What a QoE Report Covers

A full quality of earnings engagement has five core workstreams:

1. Revenue Quality

The QoE team examines revenue for concentration, sustainability, and recognition accuracy. Key questions:

• What percentage of revenue is recurring versus project-based or one-time?
• Is there material customer concentration (any single customer above 20% of revenue)?
• Are revenue recognition policies consistent and in line with GAAP or IFRS?
• Has revenue been accelerated from future periods to inflate current-year results?

Revenue quality findings often surface customer concentration issues, contract renewal risk, or timing anomalies in channel bookings — all of which affect how buyers model go-forward cash flows and risk-adjust the multiple they apply.

2. EBITDA Normalization

This is the core of the QoE analysis. The accountants review every EBITDA adjustment in the seller’s financial presentation and categorize each one as:

• Supported — genuinely one-time and non-recurring (e.g., legal settlement, one-off restructuring, property disposal gain)
• Partially defensible — reasonable but likely to face challenge (e.g., above-market owner compensation, related-party transactions at non-arm’s-length rates)
• Unsupported — adjustments that cannot be validated with documentation

The resulting QoE-adjusted EBITDA becomes the baseline that deal multiples are applied against. Every dollar of challenged addback translates directly into a multiple reduction in enterprise value.

3. Working Capital Analysis

QoE reports include a working capital analysis that establishes a normalized working capital peg — the baseline level of net working capital required to run the business at its current level of operations. This figure becomes critical at close: it determines whether the cash the seller receives is adjusted up or down versus the negotiated price.

Advisors who reach LOI without a working capital analysis regularly find the effective deal price renegotiated through working capital adjustments during the confirmatory diligence phase.

4. One-Time and Non-Recurring Items

The QoE team scrutinizes all non-recurring line items presented as EBITDA addbacks. Common items that face challenge:

• Management fees or consulting payments to related parties
• Excess owner compensation or discretionary owner expenses that will not continue post-close
• COVID-era relief payments, one-time government subsidies, or insurance proceeds
• Elevated professional fees directly related to the transaction preparation
• Pre-sale investments in marketing or sales headcount intended to inflate growth optically

Every challenged addback reduces adjusted EBITDA and therefore the applicable valuation range. A well-prepared sell-side QoE works through these in advance and provides the documentation to defend each one.

5. Pro Forma Adjustments

If the business has made acquisitions, divested assets, or has run-rate revenue from contracts signed after the measurement period, the QoE will assess whether pro forma adjustments are defensible. This is especially relevant for platform businesses or roll-up strategies where LTM EBITDA is not representative of go-forward performance.

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Sell-Side QoE vs. Buy-Side QoE

Both parties in a transaction can commission a QoE report. The key differences:

	Sell-Side QoE	Buy-Side QoE
Commissioned by	Seller (via sell-side advisor)	Buyer (via buy-side advisor)
Purpose	Pre-validate EBITDA; surface issues before marketing	Independently verify seller’s claims; identify risks
Timing	Before CIM finalized (4–6 weeks into engagement)	After IOI or LOI, during confirmatory diligence
Output used in	Pitchbook, CIM financial section, data room	Buyer’s internal pricing model, lender submissions
Outcome	Validated EBITDA baseline for deal marketing	Buy-side adjusted EBITDA for final pricing

According to EY’s M&A diligence research, sell-side QoE reports reduce total diligence duration by 3–5 weeks on mid-market transactions, because buyers can begin confirmatory testing from a validated baseline rather than building the EBITDA analysis from scratch.

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When to Commission a Sell-Side QoE

The optimal timing is before the CIM is sent to buyers — ideally 4–6 weeks into the sell-side engagement. This allows the advisor to:

1. Incorporate QoE-adjusted EBITDA into the pitchbook and CIM financial section before any buyer sees the numbers
2. Prepare management for diligence questions before buyers start asking them in a competitive context
3. Pre-populate the data room with the supporting documentation that buyers will request anyway
4. Reduce re-trading risk by eliminating unsupported addbacks before LOI stage, when the seller still has negotiating leverage

Commissioning a QoE after entering exclusivity is a common mistake. At that point, any adverse findings become direct price-chipping leverage for the buyer with no competitive pressure to counterbalance.

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How QoE Findings Affect Deal Pricing

The arithmetic is straightforward. A deal priced at 8x EBITDA on a $10M adjusted EBITDA baseline yields an enterprise value of $80M. If the buy-side QoE successfully challenges $1.5M of addbacks, adjusted EBITDA drops to $8.5M — reducing enterprise value to $68M at the same multiple. That is $12M off the price from a single diligence session.

The converse applies equally. A well-documented sell-side QoE that validates $2M in addbacks — excess owner compensation, one-time litigation costs, pre-close transaction fees — adds $16M of enterprise value at 8x versus a scenario where the same adjustments face challenge and are partially rejected.

PwC’s M&A transaction benchmarking shows that sell-side processes with a pre-marketing QoE achieve meaningfully higher exit multiples on average, primarily because sellers enter competitive bidding with a validated, fully-documented EBITDA position that buyers cannot credibly attack.

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The Advisor’s Role in the QoE Process

As a sell-side advisor, your role in the QoE process is active, not passive:

1. Brief the accounting team on the business model, key addbacks, and areas of likely buyer scrutiny before work begins
2. Review the draft QoE before it is finalized — flag any conclusions that conflict with your financial presentation or that need additional documentation to support
3. Decide what to share — sell-side QoE reports are often shared as data room documents; some advisors share summary findings only and reserve the full report for confirmed bidders
4. Prepare management for the specific questions the QoE surfaces, so they do not appear inconsistent during management presentations
5. Update the financial summary in the CIM to reflect QoE-adjusted figures

The CIM financial section should always reflect QoE-adjusted EBITDA, not raw reported figures. A mismatch between the CIM and the eventual QoE findings erodes buyer confidence and creates re-trading pressure at the worst possible point — after IOI, when pricing expectations have been set.

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Connecting QoE to the Rest of the Sell-Side Process

The QoE does not exist in isolation. It feeds directly into:

• The pitchbook — the EBITDA bridge in a sell-side pitchbook is built on QoE-adjusted figures
• The CIM financial section — historical financials presented on a normalized basis
• The data room — the QoE supporting schedules (addback documentation, working capital analysis) become key data room deliverables
• The management presentation — management must be prepared to walk buyers through the same addback logic that the QoE validates

Bookbuild automates the research, comp selection, and formatting pipeline for pitchbooks and CIMs — including the financial section that references QoE-adjusted EBITDA. When the financials are finalized, the platform structures them into deal documents automatically. Request early access →

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Related Resources

• M&A Due Diligence Checklist for Advisors
• What to Include in a CIM
• Vendor Due Diligence in M&A
• Adjusted EBITDA: Definition and M&A Usage
• The Sell-Side M&A Process: A Banker’s Playbook
• Glossary: Exclusivity