Strong earnings don’t always reflect a company’s true financial performance. One-time revenue, unusual expenses, and inconsistent accounting practices can all distort reported results.
That’s why buyers, investors, lenders, and business owners often perform a quality of earnings (QoE) analysis before an acquisition, capital raise, or other strategic transaction.
As transaction activity remains strong, due diligence continues to play a critical role. According to PitchBook, global private equity deal value reached approximately $2 trillion in 2024, highlighting the importance of validating earnings before capital is committed.¹
This guide explains what a quality of earnings report is, what it includes, and how to perform a quality of earnings analysis.
What Is a Quality of Earnings Report?
A quality of earnings report is an independent assessment of a company’s earnings that helps determine whether reported profits are sustainable and supported by normal business operations. While financial statements report historical results, a QoE report evaluates the quality, consistency, and reliability of those earnings.
Quality of earnings reports are commonly prepared before acquisitions, capital raises, mergers, business sales, and refinancing transactions. They help buyers, investors, lenders, and business owners identify accounting issues early, reduce uncertainty during due diligence, and make better-informed decisions.
What Is Included in a Quality of Earnings Report?
Although every engagement is different, most quality of earnings reports include several core areas of review:
- Revenue quality to determine whether revenue is recurring, sustainable, and properly recognized.
- EBITDA adjustments to identify one-time or non-operating items that affect reported earnings.
- Working capital analysis to evaluate the company’s ongoing operating requirements.
- Customer concentration to assess revenue stability and dependence on key customers.
- Accounting policy review to identify inconsistencies that may affect comparability.
- Cash flow analysis to understand how earnings translate into operating cash flow.
- Key findings and recommendations that summarize significant observations and potential areas requiring additional attention.
Together, these analyses provide a clearer picture of the company’s true operating performance before important business decisions are made.
Why Quality of Earnings Analysis Matters
A quality of earnings analysis helps reduce uncertainty before a transaction moves forward. Buyers want confidence that reported earnings will continue after closing, while sellers want to demonstrate that the business is supported by reliable accounting information.
The analysis also benefits lenders evaluating financing requests, family offices considering direct investments, and private equity firms assessing acquisition targets. Rather than relying solely on reported profits, stakeholders gain a deeper understanding of the business’s underlying earnings, cash flow, and overall financial health.
How to Prepare a Quality of Earnings Analysis
Every quality of earnings analysis follows a structured review of the company’s financial performance and supporting information. While the scope may vary by transaction, the following steps form the foundation of most QoE analyses.
Step 1: Understand Revenue Quality
The first step in a quality of earnings analysis is evaluating how the business generates revenue. Analysts review whether revenue is recurring, diversified, and recognized in accordance with established accounting policies.
Particular attention is given to customer concentration, seasonal trends, unusual sales activity, and one-time revenue events. If a significant portion of revenue comes from non-recurring sources, reported earnings may not accurately reflect future operating performance.
Step 2: Normalize EBITDA
Reported EBITDA often includes items that are unlikely to occur again after a transaction closes. These items can overstate or understate the company’s ongoing earnings.
A quality of earnings analysis identifies and adjusts for non-recurring expenses, owner-specific costs, legal settlements, restructuring charges, and other unusual transactions. The result is a normalized EBITDA figure that provides buyers and investors with a more realistic view of operating performance.
Step 3: Evaluate Working Capital
Working capital directly affects the amount of cash required to operate a business after closing. For that reason, buyers closely examine trends in accounts receivable, inventory, accounts payable, and other current assets and liabilities.
Reviewing historical working capital helps establish a normalized operating level and identify unusual fluctuations that may affect purchase price negotiations or post-closing cash requirements.
Step 4: Review Accounting Policies
Accounting policies determine how a company records revenue, expenses, inventory, leases, and other financial transactions. While businesses may follow the same accounting standards, differences in policy application can significantly affect reported earnings.
A quality of earnings analysis reviews whether accounting policies have been applied consistently over time and whether they accurately reflect the company’s operations. Analysts also look for changes in accounting methods that may distort year-over-year comparisons or create an overly favorable view of financial performance.
Step 5: Analyze Cash Flow
Strong earnings do not always translate into strong cash flow. A company may report healthy profits while experiencing delayed customer collections, rising inventory levels, or increasing working capital requirements.
A quality of earnings analysis compares operating cash flow with reported earnings to determine whether profits are supported by actual cash generation. This helps buyers and investors assess the company’s liquidity, financial flexibility, and ability to sustain future operations.
Step 6: Identify Potential Red Flags
One of the primary objectives of a quality of earnings analysis is identifying issues that could affect valuation or increase transaction risk. Discovering these items early allows buyers, sellers, and investors to address concerns before negotiations progress too far.
Common red flags include:
- Significant one-time revenue or expenses
- Large EBITDA adjustments without adequate support
- Customer concentration
- Inconsistent revenue recognition
- Weak internal controls
- Unreconciled balance sheet accounts
- Declining operating cash flow
- Frequent changes in accounting policies
- Poor supporting documentation
Identifying these issues does not necessarily prevent a transaction from moving forward, but it provides stakeholders with a clearer understanding of the business and allows potential concerns to be addressed proactively.
Common Mistakes During a Quality of Earnings Analysis
Even a thorough quality of earnings analysis can produce misleading conclusions if the underlying information is incomplete or inaccurate. Avoiding these common mistakes can improve the reliability of the analysis and help prevent delays during due diligence.
Common mistakes include:
- Relying only on audited financial statements
An audit confirms whether financial statements are fairly presented, but it does not evaluate whether earnings are sustainable after a transaction.
- Waiting until due diligence begins
Delaying preparation often results in rushed reviews, missing documentation, and avoidable delays.
- Overlooking one-time transactions
Non-recurring revenue or expenses can distort normalized earnings if they are not properly identified.
- Using unsupported EBITDA adjustments
Every adjustment should be supported by clear documentation and a reasonable business rationale.
- Ignoring working capital trends
Changes in working capital can significantly affect valuation and post-closing cash requirements.
- Reviewing financial statements without supporting records
Contracts, reconciliations, and other documentation are often needed to validate reported results.
- Applying inconsistent accounting policies
Changes in accounting methods can make earnings difficult to compare across reporting periods.
Who Should Perform a Quality of Earnings Analysis?
A quality of earnings analysis should be performed by experienced accounting professionals who understand transaction advisory, financial reporting, and due diligence. An independent review provides buyers, investors, and lenders with greater confidence because the analysis is objective and supported by established accounting practices.
Organizations that commonly use quality of earnings analyses include:
- Private equity firms
- Family offices
- Independent sponsors
- Strategic acquirers
- Search funds
- Founder-led businesses preparing for a sale
- Companies raising growth capital
An independent assessment can also help management identify opportunities to strengthen reporting before entering a transaction.
Benefits of Completing a QoE Analysis Early
Completing a quality of earnings analysis before entering the market allows businesses to address accounting issues on their own timeline rather than under the pressure of due diligence. Early preparation often leads to a smoother transaction and gives management more confidence when responding to buyer or investor questions.
Key benefits include:
- Improved confidence in reported earnings
- Faster responses to due diligence requests
- Better organized financial documentation
- Reduced transaction delays
- More informed valuation discussions
- Greater credibility with buyers, lenders, and investors
- Earlier identification of accounting issues that may affect negotiations
The importance of reliable financial reporting continues to be emphasized by the Public Company Accounting Oversight Board (PCAOB), which identifies high-quality financial reporting as fundamental to protecting investors and maintaining confidence in capital markets.²
Final Thoughts
A quality of earnings analysis helps buyers, investors, lenders, and business owners determine whether reported earnings accurately reflect a company’s ongoing performance. By identifying potential issues before due diligence, it supports better decisions and smoother transactions.
At Wahl Street Accountancy Corporation, we help businesses prepare for acquisitions, capital raises, and other strategic transactions through Quality of Earnings, transaction advisory, and accounting services designed to strengthen reporting and build confidence.
References
- PitchBook. “A Look Back at Take-Privates in 2024.” PitchBook, January 15, 2025. https://pitchbook.com/news/articles/a-look-back-at-take-privates-in-2024.
- Public Company Accounting Oversight Board. “AS 1000: General Responsibilities of the Auditor in Conducting an Audit.” Public Company Accounting Oversight Board. Accessed June 30, 2026. https://pcaobus.org/oversight/standards/auditing-standards/details/as-1000–general-responsibilities-of-the-auditor-in-conducting-an-audit.
