Why a Quality of Earnings Report Matters in Business Acquisitions
When considering an acquisition, potential buyers have plenty of business performance metrics to review. While some might be known as strong signals of profitability or momentum, it’s important to get a more detailed perspective. A company might have strong EBITDA or impressive top-line revenue, but that doesn’t necessarily guarantee a valuable acquisition.
Today, buyers are moving quickly, and competition for high-quality businesses is still strong. In fact, 51% of U.S. companies are still pursuing deals in 2025, a clear indication that strategic pivots and business model reinvention are not going away. Global data reveals that M&A deal values are up 15% year over year. As more capital is set in motion, the stakes grow higher, and you’ll need rigorous diligence before making any major plays.
A quick glance at the numbers might tell you how much a company is earning, but you’ll need more information to determine how reliable those earnings actually are. Are the earnings real? Are they recurring? And will they continue to be sustainable after the deal closes?
A Quality of Earnings (QoE) report can provide the answers. At 5th Line, we often advise clients to support activities including raising capital, improving financial operations, and evaluating acquisitions.
When there is interest in an acquisition, we consistently recommend early in the diligence process to commission a thorough, third-party QoE report. This report acts as a key decision-making tool that can uncover risks and red flags that might not be obvious in surface-level financials. It also gives buyers more leverage in negotiations and builds confidence for the lenders funding the deal.
In this post, we’ll break down what a Quality of Earnings report includes, why it matters, and how it fits into the full acquisition process.
What Is a Quality of Earnings Report?
A Quality of Earnings report is a financial analysis that comes from a third party tasked with assessing the reliability and sustainability of a company’s earnings. An important distinction is that it’s different from a tax return or a business valuation. It’s a separate deep dive into how the company really makes money and whether that revenue appears set to continue after a sale.
Typically, a QoE report is commissioned by prospective buyers. This can happen in private acquisitions, especially in search funds, ETA, or lender-backed deals. It’s also becoming common in sponsor-led transactions requiring thorough diligence to secure financing.
What a QoE Isn’t:
It’s not a legal or tax review
It doesn’t predict future performance
It isn’t a “value” estimate like a business valuation
A Quality of Earnings report is designed to verify that the seller’s earnings are adjusted, consistent, and defensible.
Why a QoE Is Essential for Buyers
1. It Verifies Earnings In Advance
The financial information provided by sellers often includes non-recurring revenue, aggressive accounting, or personal expenses that inflate EBITDA. A QoE will filter out the extras to give you a cleaner, more accurate picture of their true earnings.
2. It Raises Any Relevant Red Flags
An effective Quality of Earnings report can uncover:
Inflated profits stemming from one-time events
Overreliance on a single customer or product line
Hidden expenses or inconsistent reporting practices
These findings could reduce the price or even cause your team to walk away entirely. Either way, it’s better to discover issues before the deal closes.
3. It Supports Better Deal Structures
If the QoE reveals that EBITDA is overstated, you have a few options. Your team can:
Renegotiate valuation based on adjusted figures
Tie financing milestones or earn-outs to actual performance
Provide lenders with greater clarity to move forward
In deals backed by lenders, Quality of Earnings reports are often required. However, even in all-cash or equity-based transactions, they can be a useful way to confirm that what you’re buying matches what you expect to get.
What Does a Quality of Earnings Report Include?
Each QoE provider might have a slightly different format. Still, most reports cover:
Adjusted EBITDA Analysis
This portion will break down one-time, non-operating, or owner-specific expenses. This identifies the real earnings and helps to normalize profit figures across reporting periods.
Revenue Quality and Consistency
Here, you’ll receive an analysis of customer concentration, recurring vs. project-based income, and revenue recognition practices.
Cost and Margin Trends
This section helps determine if cost structures are sustainable or if there have been artificial boosts to the margins.
Working Capital Assessment
Get an overview of whether the business can keep supporting daily operations post-close without struggling to maintain cash flow.
Cash Flow Reconciliation
This part of the QoE report reveals how much actual cash the business generates and when.
When and How to Order a Quality of Earnings Report
The best moment to commission a QoE is after signing a Letter of Intent (LOI) but before final diligence begins. Working within this time frame gives your team the chance to renegotiate or exit if the report uncovers any major concerns.
Typical turnaround: 2–4 weeks
Pro tip: Get started early. A QoE report that uncovers major risks late in the process can delay the deal or end it completely.
QoE vs. Valuation: What's the Difference?
It’s not uncommon to confuse a Quality of Earnings report with a business valuation, but they serve unique purposes.
Business Valuation:
Estimates what a company is worth
Considers market comps, growth potential, and macro factors
Often based on EBITDA multiples
Quality of Earnings:
Verifies whether reported earnings are accurate
Focuses on financial accuracy and sustainability
Helps validate whether that EBITDA is reliable
What to Look for in a QoE Provider
Not all QoE reports will be created equal. To get the most out of the process, here’s what your team should look for:
Transaction Advisory Experience
Choose a third-party firm with a background in M&A accounting or private equity. They also must have experience in deal analysis.
Industry Familiarity
In niche industries, it becomes more important for your provider to understand the sector-specific revenue models, costs, and operational patterns that influence the company’s financials.
Clarity and Communication
Even the best analysis will be unhelpful if the buyer can’t understand it. Look for providers who present findings clearly and are able to tie them back to your investment thesis.
Trusted Credentials
Many reputable QoE providers have:
CPA or CFA certifications
Experience preparing reports for lenders or investors
Familiarity with the acquisition structures you’re using
Final Thoughts
A Quality of Earnings report shouldn’t be treated as just another box to check off the diligence checklist. Leading up to an acquisition, it can be a powerful risk management tool and an asset in negotiations.
Done well, a QoE report can:
Uncover dealbreakers
Help justify a better price
Increase lender confidence
Eliminate surprises and accelerate deal closing
At 5th Line, we work closely with growth-stage companies to help them prepare for and execute beneficial acquisitions. If you’re exploring a potential acquisition, get in touch with our team to learn more about how we can support your preparation and diligence processes.