What is a quality of earnings report, and how do you prepare for one?

A quality of earnings report is a financial due diligence report that tests whether a company's earnings are accurate and likely to continue after a sale. It restates reported profit as adjusted earnings, documents every adjustment, and ties the figures to tax returns and bank statements. It is not an audit, and it gives no opinion on the financial statements.

A buyer's letter of intent makes the price subject to a quality of earnings review, or the buyer's lender requires one. Or you plan to sell and want to see your earnings the way a buyer's reviewer will, before anyone else does. Either way, the adjusted earnings in that report are the figure a buyer multiplies to reach a price.

What is a quality of earnings report?

A quality of earnings (QoE) report measures how much of a company's reported profit is accurate, recurring, and likely to hold under a new owner. The U.S. Small Business Administration (SBA), in its lending rules, describes it as "a financial due diligence report that examines the reliability, sustainability, and accuracy of a business's historical and projected earnings."

The report ends in a normalized earnings figure, usually adjusted EBITDA, with a bridge from the profit on your income statement to that figure, one adjustment at a time. EBITDA is earnings before interest, taxes, depreciation, and amortization. When other items come out as well, the SEC's staff says the measure needs a different title, "such as 'Adjusted EBITDA.'"

A buy-side report is commissioned by the buyer or its lender during due diligence. A sell-side report is one the owner commissions before going to market, to find and explain problems before a buyer does.

Is a quality of earnings report an audit?

No. An audit and a quality of earnings report answer different questions, so one cannot stand in for the other. Under the AICPA's auditing standards, an audit exists "to provide financial statement users with an opinion" on whether the statements "are presented fairly, in all material respects" under the applicable reporting framework. A quality of earnings report gives no such opinion.

Audited statements still get a review, because the opinion covers the statements as presented and the review adjusts them for what a new owner would not inherit.

What does a quality of earnings report look at?

The SBA's rules name three things every lender-ordered report must cover: the adjustments to earnings, a cash proof, and the quality of revenue. On a sale, net working capital is a fourth, because the purchase agreement settles it separately.

Adjusted EBITDA and normalizing adjustments

A normalizing adjustment is a change to reported earnings that removes what a new owner would not inherit, or adds a cost that owner would have to carry. The SBA requires the report to "identify and document all add-backs and adjustments to the seller's reported earnings," and it names these:

The last row matters if your books follow the cash method. In the IRS's description, the cash method generally deducts expenses "in the tax year in which you actually pay them," while an accrual method generally reports income "in the year earned" and deducts expenses "in the year incurred." A reviewer moves cash-basis figures onto an accrual basis, so a payment collected in January for December's work lands back in December.

The cash proof

A cash proof rebuilds the money that came into and went out of your bank accounts and checks it against the income statement and the tax return. The SBA requires one in every lender-ordered report, for the trailing 12 months and the last two fiscal years, and says it "is designed to identify discrepancies in income and undisclosed expenses." The same rules have the report reconcile your year-end financial statements, tax returns, internal statements, and IRS transcript data into one adjusted earnings figure.

Revenue quality

Revenue quality is how likely today's revenue and margins are to continue under a new owner. The SBA asks the report to assess customer concentration, contract continuity, and "the likelihood that existing revenue and margins will be maintained post-sale." Why growing revenue can still lower business value explains how buyers read concentration and one-time sales.

Net working capital

Net working capital is current assets minus current liabilities, counting only the items the purchase agreement includes. SRS Acquiom's 2026 study of private-target deals calls the post-closing price adjustment that settles it "nearly universal on private M&A transactions." A report prepared for a sale should measure working capital month by month, because that history is what a fair target is set from. How to calculate the change in net working capital shows the arithmetic.

Why does a buyer or lender ask for one?

A buyer and its lender ask for one because the price and the loan both rest on the adjusted earnings. In an illustration at five times EBITDA, every $100,000 the review takes out of adjusted EBITDA takes $500,000 off the enterprise value. How to calculate an EBITDA multiple walks through that math.

SBA lenders have a rule. Under the SBA's lending rules (SOP 50 10 8.1), effective October 1, 2026, when a 7(a) loan finances a new owner's purchase of a business, or one business buying another, at a purchase price of $3 million or more, the lender must obtain a quality of earnings report in addition to a business valuation. The lender must work out from the report's earnings whether the business can carry the loan payments, and if it cannot at the valuation and the proposed debt, the loan amount must be reduced. Owner buyouts, where an existing owner stays, and employee stock ownership plan (ESOP) and cooperative transactions are exempt.

Other buyers run reviews too, and the SBA notes that some commission their own before they approach a lender. A buy-side review typically starts once a letter of intent is signed, during the exclusivity period, while you have agreed not to talk with other buyers.

Should you get a sell-side quality of earnings report?

A sell-side report makes sense when a buyer's review is coming anyway and you would rather find the problems first. You learn which add-backs hold, fix what can be fixed, and explain the rest in writing before a buyer prices it in. You also get a tested earnings figure to set your price expectations on.

It does not replace the buyer's review. For SBA-financed purchases, the lender's report "must not be prepared by or for the seller," so the buyer's lender will order its own, and other buyers may still run theirs. If your price is likely to fall below $3 million and your buyer will use an SBA loan, the lender is not required to obtain a report at all, and a clean monthly close with a documented add-back schedule may be the preparation you need.

How do you prepare for a quality of earnings review?

Do the reviewer's reconciliations yourself before the review starts, for the trailing 12 months and the last two fiscal years, the period the SBA requires. Close every month, reconcile every bank and credit card account, tie the monthly statements to the year-end statements and the tax returns, and explain each difference in writing. Then gather what the reviewer will ask for in a data room, a secure online folder the reviewer works from:

How long does a quality of earnings review take?

No rule sets a length, and the time depends mostly on how ready your records are. When every month is closed and reconciled, the reviewer tests your work. When the books are on a cash basis, accounts are unreconciled, or add-backs have no documents, the reviewer rebuilds them first, and each open question adds time. On a buy-side review, that time comes out of the exclusivity period, so start the reconciliations before you go to market.

What to do next

1. Ask the buyer or the lender what the review will cover: the period, the earnings measure, and who will perform it.
2. Reconcile the last two fiscal years and the trailing 12 months to your tax returns and bank statements.
3. Write your add-back schedule, attach a document to each line, and drop any add-back you cannot support.
4. Build 24 months of revenue by customer and of month-end net working capital.
5. Name one person on your team to answer the reviewer's questions.

If you want this done before a buyer's team starts, our M&A advisory work includes a sell-side quality of earnings analysis: normalized EBITDA with every adjustment documented, and the working capital analysis, ready for a buyer's or lender's review. We are not auditors: we only review the records you already have. We do not audit financial statements or give an opinion on them.

Questions owners ask

Can a quality of earnings report lower the price?

Yes. A letter of intent sets the price before the review is done, on the earnings you presented. If the review lowers adjusted EBITDA, expect the buyer to apply its multiple to the lower figure, or the lender to reduce the loan. Knowing your own adjusted figure first lets you answer each finding with documents instead of estimates.

Is a quality of earnings report the same as a business valuation?

No. A valuation estimates what the business is worth, and a quality of earnings report tests the earnings that a valuation relies on. The SBA treats them as separate requirements: for purchases of $3 million or more, the lender must obtain a quality of earnings report "in addition to the required Business Valuation."