A quality of earnings (QoE) report is an independent accountant’s analysis of a target company’s earnings that looks behind the reported financial statements to test whether the profit is accurate, sustainable and free of one-time distortions — a diligence step that goes further than an audit or a review engagement ever does.
treadstonelaw.ca defines the report as “an independent analysis — typically performed by an accounting firm — that looks behind a target business’s reported financial statements to assess whether its earnings are accurate, sustainable, and representative of how the business actually performs going forward.” The core of the work is “normalizing earnings — adjusting reported profit for one-time items, owner-specific expenses, or unusual transactions that wouldn’t recur under new ownership” — alongside testing revenue quality, customer concentration and working capital trends over time.
Either side of the table can commission one. The same source notes “either party can commission a QoE report, and in some deals the seller commissions a ‘sell-side’ QoE proactively to support their asking price. There’s no fixed rule for who bears the cost.” (treadstonelaw.ca) Where the target’s figures also underpin a formal valuation conclusion, CBV Institute requires that conclusion to meet its Valuation Practice Standards — a separate, higher bar than the QoE report itself, which tests earnings, not value.
A fund is buying a $14 million platform add-on and commissions a buy-side QoE. The report finds $310,000 of related-party rent paid to the seller’s own holding company above market rate, plus $140,000 of Q4 revenue recognized on shipments that had not actually left the warehouse. Together those findings move normalized EBITDA from the seller’s claimed $2.6 million down to $2.15 million — a fact the fund uses to reprice the multiple in its letter of intent before it will move to a definitive agreement.
See also: Pro forma financial statements · Run-rate revenue · Where AI diligence actually saves deal teams a week.
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