What Is a Quality of Earnings (QoE) Report, and Do You Need One?
Buying or selling a business? A quality of earnings report can reveal whether the company's reported profits are sustainable—and potentially change the purchase price by hundreds of thousands of dollars.
Imagine you're preparing to buy a business that reports $500,000 in annual earnings. Revenue is growing, the financial statements look strong, and the owner believes the company deserves a premium valuation.
But what if some of those earnings came from a one-time contract? What if significant expenses were postponed? Or what if the company has outstanding customer payments that are unlikely to be collected?
Suddenly, the financial picture looks very different.
That's where a quality of earnings report (QoE) comes in.
A QoE is a financial due diligence analysis that examines whether a company's reported earnings accurately reflect its underlying financial performance.
For buyers, it helps reduce the risk of overpaying. For sellers, it can help support the asking price and prevent unpleasant surprises during negotiations.
And under new Small Business Administration rules effective October 1, 2026, an independent QoE is now required for certain SBA-financed business acquisitions of $3 million or more.
Here's what business owners need to know.
1. What Exactly Is a Quality of Earnings Report?
A quality of earnings report examines how reliable and sustainable a company's earnings are, typically in connection with buying or selling a business.
Its purpose is to distinguish profits generated through normal operations from earnings affected by unusual transactions, accounting decisions, or one-time events.
For example, a business might report unusually high profits because it completed a large, one-time project. That income is real, but a buyer shouldn't assume it will happen again.
Similarly, a company may report lower earnings because it pays certain expenses that won't continue after the sale, such as personal expenses of the owner or compensation above what a replacement executive would reasonably earn.
A QoE analysis examines these items to develop a clearer picture of sustainable profitability.
The central question isn't simply how much money the company made last year. It's how much of those earnings a buyer can reasonably expect the business to generate going forward.
2. How Is a Quality of Earnings Report Different From an Audit?
An audit and a QoE serve different purposes.
An audit checks whether a company's financial statements follow the applicable accounting rules and fairly present its financial position.
A QoE asks a different question: Will these profits continue after the business changes hands?
Financial Statement Audit | Quality of Earnings Report |
Examines historical financial statements | Examines the sustainability of earnings |
Focuses on compliance with accounting rules | Focuses on financial performance and transaction risks |
Provides an independent audit opinion | Does not provide assurance or an opinion |
Helps establish confidence in financial reporting | Helps buyers, sellers, and lenders evaluate a transaction |
A QoE report does not provide assurance or an opinion on the financial statements. It is not a substitute for an audit or a formal financial statement review.
Even companies with audited financial statements can benefit from a separate QoE analysis before a transaction.
3. What Does a Quality of Earnings Report Examine?
Although the scope varies by business and transaction, most QoE reports examine several important areas.
Revenue Quality
Not all revenue is equally predictable.
A company with recurring customer contracts and diversified revenue sources may have more stable earnings than one relying on occasional large projects.
The analysis examines revenue trends, customer retention, contract terms, concentration risks, and whether sales were recorded correctly.
For example, if 35% of a company's revenue comes from one customer whose contract expires in six months, a potential buyer needs to understand that risk.
Expenses and Adjusted EBITDA
Many business valuations use EBITDA—earnings before interest, taxes, depreciation, and amortization—as a starting point.
Adjusted EBITDA attempts to normalize this figure by accounting for appropriate unusual, nonrecurring, or nonoperating items.
Consider this hypothetical example:
Earnings Component | Amount |
Reported EBITDA | $400,000 |
Documented one-time legal expense | +$40,000 |
Owner compensation above market rate | +$60,000 |
Illustrative adjusted EBITDA | $500,000 |
The difference between reported and adjusted earnings can significantly affect what a buyer is willing to pay.
But not every proposed adjustment is valid.
Sellers often present management adjustments, which are expenses or income items they believe should be excluded when calculating normal operating earnings.
The QoE provider examines those claims and determines which adjustments the evidence supports. These are commonly called diligence adjustments.
For example, a seller might describe recurring equipment repairs as one-time costs. A QoE analysis could reject that adjustment if repairs are an ordinary part of operating the business.
Buyers want adjustments supported by documentation, not simply the seller's expectations.
Cash Flow and Proof of Cash
Reported profits don't always translate into cash in the bank.
A company can appear profitable while struggling to collect customer payments or pay its bills.
A QoE may include a proof of cash, which compares reported financial activity with bank transactions and other supporting records.
This helps identify differences between recorded sales, customer collections, expenses, and actual cash movements.
Working Capital Requirements
Working capital is the money a business needs to support everyday operations.
A QoE often examines historical working capital to help establish a net working capital peg, also called a working capital target.
This is an agreed-upon amount of working capital the seller is expected to deliver at closing.
For example, if the seller delays paying suppliers before the sale, the company's cash balance may temporarily look stronger while unpaid bills continue accumulating.
A working capital adjustment can help protect the buyer from receiving less operating liquidity than expected.
Financial Reporting Practices
A QoE also examines whether financial records are accurate and consistent.
Changes in how revenue, expenses, or inventory are recorded can make profits appear stronger or weaker than they really are.
Inconsistent reporting doesn't automatically mean something improper occurred, but it creates questions that must be addressed before completing a transaction.
4. How Can a QoE Report Affect the Purchase Price?
A relatively small change in sustainable earnings can have a major impact on business valuation.
Consider a hypothetical company valued at five times adjusted EBITDA.
Scenario | Adjusted EBITDA | Illustrative Business Value |
Seller's original estimate | $600,000 | $3,000,000 |
Earnings supported by QoE | $450,000 | $2,250,000 |
Difference | $150,000 | $750,000 |
In this example, a $150,000 difference in sustainable annual earnings translates into a $750,000 difference in estimated business value, assuming the valuation multiple remains unchanged.
What a seller actually walks away with also depends on debt payoff, cash in the business, transaction costs, and how the deal is structured.
This is why QoE findings can have such a significant effect on negotiations.
A buyer may use the findings to request a lower purchase price, change payment terms, or require additional protections.
Conversely, a seller with reliable records and well-supported earnings adjustments may be in a stronger position to defend the asking price.
5. Why Sellers Should Consider a Pre-Sale QoE
Quality of earnings reports aren't just for buyers.
A buy-side QoE helps a prospective buyer evaluate the company being acquired.
A sell-side QoE, sometimes called a pre-sale QoE, is commissioned by the seller before going to market.
The advantage for sellers is identifying financial issues before potential buyers discover them.
For example, a sell-side analysis might uncover:
Revenue recorded in the wrong period.
Personal expenses incorrectly classified.
Uncollectible customer balances.
Unsupported adjustments to earnings.
Inconsistencies between financial statements and tax returns.
Working capital trends that need explanation.
Addressing these issues before negotiations begin can make the process more efficient and reduce the likelihood of last-minute surprises.
However, a sell-side QoE doesn't guarantee a higher price or eliminate the buyer's need for independent financial due diligence.
For SBA-financed transactions subject to the new QoE requirement, a report prepared by or for the seller also cannot replace the lender's required independent analysis.
This is one reason to begin preparing your business for sale several years before an anticipated transaction. Reliable financial reporting and well-organized records should be part of your exit planning strategy long before a buyer appears.
6. New for 2026: When Does the SBA Require a QoE Report?
An important change took effect October 1, 2026.
Under SBA Standard Operating Procedure 50 10 8.1, certain SBA 7(a) business acquisitions and business expansion transactions must include an independent quality of earnings report.
The requirement generally applies when:
The transaction is a qualifying initial business acquisition or business expansion financed through an SBA 7(a) loan.
The business purchase price is $3 million or more, excluding the applicable appraised value of owner-occupied commercial real estate.
The threshold is measured before subtracting the buyer's down payment, seller financing, or other funding sources.
The updated requirements generally apply to applications assigned an SBA loan number on or after October 1, 2026.
Some transaction types, including certain ownership buyouts, may be treated differently. Confirm the specific requirements with the SBA lender.
The QoE is required in addition to the business valuation.
Who Must Prepare the Report?
The SBA requires an independent financial professional with appropriate experience to conduct the analysis for the lender's benefit.
The September 25, 2026, technical updates allow a lender to consider a previously buyer-commissioned QoE if it satisfies the applicable requirements and undergoes the necessary lender-approved review.
A report prepared by or for the seller cannot independently satisfy the requirement.
Buyers should coordinate with their SBA lender before commissioning a report to avoid unnecessary expenses or duplicate work.
For official guidance, see the SBA's original SOP 50 10 8.1 notice and its September 25, 2026 technical updates.
What Happens if the QoE Doesn't Support the Loan?
Lenders need confidence that the business generates enough cash to support the proposed acquisition financing.
If a QoE identifies lower sustainable earnings than originally projected, the lender may reduce the loan amount or require changes to the transaction.
The buyer could then need to contribute more equity, negotiate a lower purchase price, restructure the deal, or seek alternative financing.
A QoE isn't simply another document in the lending process. Its findings can determine whether the transaction moves forward.
What This Means If You're Selling
If your business is valued at $3 million or more and your likely buyer plans to use SBA financing, the lender's QoE could become an important part of your sale.
The lender will examine whether your reported earnings hold up under closer scrutiny.
Expenses you claim should be added back to earnings may be rejected if they can't be documented. Unreliable records, questionable revenue, or weak cash flow can also affect the lender's assessment.
That can reduce the financing available to the buyer, put pressure on your asking price, or threaten the transaction.
Getting your books in order before going to market is one of the most practical ways to prepare for this scrutiny.
7. Does Every Small Business Need a QoE Report?
No.
Outside transactions subject to specific lender or investor requirements, a formal QoE isn't universally required.
The appropriate level of financial due diligence depends on the purchase price, the complexity of the business, and the risks involved.
A smaller business with straightforward operations and reliable financial records may not need the same extensive analysis as a company with multiple locations, complicated revenue arrangements, or significant debt.
A more comprehensive QoE deserves consideration when:
The purchase price relies heavily on an earnings multiple.
The company has inconsistent financial reporting.
Revenue depends on a small number of major customers.
The seller proposes significant adjustments to reported earnings.
The business has complex inventory, billing, or cash flow requirements.
Significant borrowing is needed to finance the acquisition.
The transaction involves multiple entities or related-party arrangements.
Skipping a formal QoE shouldn't mean skipping financial due diligence altogether.
Even relatively small transactions can involve financial risks that justify closer examination.
8. What Happens When a QoE Uncovers Problems?
Not every issue discovered during financial due diligence is a dealbreaker.
Some findings simply require explanations or adjustments.
For example, if a company incurred a documented, nonrecurring legal expense, a buyer may agree to exclude that expense when calculating sustainable profitability.
Other findings can be more serious.
Uncollectible customer balances, declining revenue, unsupported earnings adjustments, or significant unrecorded liabilities can change the economics of a transaction.
Depending on the findings, buyers and sellers may negotiate:
A revised purchase price: Adjusting the amount paid to reflect the financial findings.
Working capital adjustments: Changing the final payment based on the operating assets and liabilities delivered at closing.
An earnout: Paying part of the purchase price later if the business meets agreed-upon performance targets.
A holdback: Setting aside part of the purchase price to cover specified risks or obligations that may arise after closing.
Additional documentation: Requiring the seller to provide more financial information or support certain claims.
The objective is to identify and evaluate risks before ownership changes hands.
9. How Should You Prepare for a Quality of Earnings Analysis?
Whether you're buying or selling, organized financial records make the process more effective.
For sellers, preparation typically includes gathering:
Three years of historical financial statements and tax returns, when available.
Recent financial reports.
General ledger records.
Customer revenue reports.
Accounts receivable and payable aging schedules.
Bank statements and reconciliations.
Documentation of unusual expenses and owner-related costs.
Payroll and compensation records.
Inventory reports and major customer contracts.
Buyers should work with their advisory team to identify the financial questions most important to the acquisition.
For sellers, maintaining accurate books throughout the year makes the process easier and helps avoid the pressure of trying to reconstruct financial history just before a transaction.
The U.S. Small Business Administration also provides guidance on business valuation and preparing to sell a company.
The more reliable your financial records are, the easier it becomes to answer the questions buyers and lenders will ask.
Frequently Asked Questions About Quality of Earnings Reports
Does a quality of earnings report have to be prepared by a CPA?
Not in every transaction. QoE analyses are commonly performed by CPAs and other experienced financial due diligence professionals. Some lenders, investors, and transactions have specific independence and qualification requirements.
Is a QoE report the same as an audit?
No. An audit examines financial statements and provides an independent opinion under established auditing standards. A QoE focuses on earnings sustainability and transaction risks. It does not provide assurance or an opinion on financial statements.
Does the SBA require a quality of earnings report?
Yes, for certain SBA 7(a) initial acquisitions and business expansions with qualifying purchase prices of $3 million or more under the rules effective October 1, 2026. The report must meet the lender's requirements. Not every SBA loan or business purchase is subject to this rule.
How much does a quality of earnings report cost?
Costs depend on the size of the business, the complexity of its financial records, and the work required. A smaller, straightforward transaction may cost less than a complicated acquisition involving multiple entities. Obtain a detailed proposal before commissioning the analysis.
How long does a QoE take?
A QoE analysis often takes several weeks, depending on the company's complexity, the scope of work, and how quickly complete financial records can be provided. Missing documentation can significantly delay the process.
Who pays for a quality of earnings report?
The party commissioning the report typically pays for it. Buyers often pay for buy-side diligence, while sellers fund pre-sale analyses. For SBA-financed acquisitions, who commissions and prepares the analysis must satisfy the lender's requirements.
Can a QoE report increase the value of a business?
A QoE doesn't create additional profits or automatically increase a company's value. However, it can substantiate legitimate earnings adjustments, improve confidence in financial information, and help support a well-documented asking price.
Better Financial Records Lead to Better Business Decisions
Buying or selling a business is one of the most significant financial decisions an owner can make.
A quality of earnings report helps look beyond reported profits to understand the financial performance and risks underlying the business.
Whether a formal QoE is required or a more targeted analysis is appropriate, understanding the numbers before committing to a transaction can help prevent costly surprises.
Thinking About Buying or Selling a Business? Start With Your Books.
A quality of earnings analysis is only as good as the records behind it. Accurate, well-organized financials can make the process faster, reduce surprises, and help support the value of your business.
We can help you get your financial records in order, document unusual expenses and owner-related costs, and prepare for the questions buyers and lenders are likely to ask.
Contact our office to talk about where your records stand today and what to do next.
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