A quality of earnings (QoE) report is one of the most consequential deliverables in a transaction — it either confirms the story the seller is telling, or it doesn’t. Here’s what a rigorous QoE review actually digs into.
Beyond the Reported Numbers
QoE isn’t an audit — it doesn’t opine on whether financial statements comply with GAAP or IFRS. It’s an analytical exercise focused on whether reported earnings are sustainable, recurring, and representative of the business going forward.
Core Areas of Focus
- Revenue quality: Customer concentration, contract-based versus transactional revenue, churn and renewal rates, and whether revenue recognition policies are consistently applied
- Margin trends: Gross and EBITDA margin trends by product line, customer segment, or region, to identify whether reported blended margins mask deteriorating segments
- Working capital normalization: Whether historical working capital levels reflect normal operations or are distorted by unusual payment timing
- Non-recurring items: Testing management’s proposed EBITDA add-backs against multi-year trends rather than accepting the current-year narrative
- Net debt and debt-like items: Identifying obligations that reduce proceeds at closing — deferred revenue, unfunded pension liabilities, or outstanding litigation reserves — that aren’t always obvious from the balance sheet alone
The Practical Takeaway
A good QoE report doesn’t just validate a number — it builds the buyer’s (or seller’s) confidence in the underlying story of the business, and surfaces the specific risks that should shape price, structure, or representations and warranties in the purchase agreement. Skipping or rushing this step to save time or fees is one of the more expensive shortcuts in M&A.
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