Key Takeaways
- Validated earnings strengthen negotiating power. Third-party normalization of EBITDA builds buyer confidence and supports higher valuation multiples.
- Early issue identification preserves deal value. Addressing financial gaps and risks pre-market prevents price reductions during due diligence.
- Preparation accelerates and de-risks transactions. Organized, credible financial data shortens timelines and increases the likelihood of closing at expected terms.
For many business owners, the decision to sell is the culmination of decades of hard work, personal sacrifice, and strategic growth. However, in today’s M&A landscape, simply having a "good business" isn't enough to secure a premium valuation. We are currently seeing a significant "sell-side surge," where high-quality companies are flooding the market. To stand out, you must move beyond basic financial reporting and focus on exit readiness.
Preparing for a business sale is about building a proactive defense. By identifying and correcting financial potholes before a letter of intent (LOI) is ever signed, you maintain control of the narrative and the leverage in negotiations. This preparation transforms your financial data from a backward-looking report into a forward-looking tool that justifies your asking price.
What is a Quality of Earnings Report, Exactly?
A quality of earnings (QoE) report is an in-depth analysis of a company’s financial data that focuses on the "soul" of the business: its sustainable cash flow. A QoE report digs into the source and persistence of those earnings. It answers the fundamental question a buyer asks: "If I buy this company today, can I expect these profits to continue tomorrow?"
The report primarily centers on adjusted EBITDA (Earnings Before Interest, Tax, Depreciation, and Amortization). It strips away one-time events — such as a legal settlement, a non-recurring equipment repair, or the owner's personal travel expenses — to reveal the "normalized" earnings of the company. It provides a granular look at revenue by customer, gross margin by product line, and the impact of accounting policies on reported profits.
In essence, a sell-side QoE is your pre-inspection. Just as you would have a mechanic look at a car before you sell it to ensure you get top dollar, a QoE ensures your financial engine is running exactly as described.
Here are seven key benefits of obtaining a QoE report before your business sale:
1. A QoE Report Normalizes Earnings
A QoE report provides an independent, unbiased view of a seller’s earnings by evaluating historical revenue and EBITDA adjustments alongside additional context provided by the seller to assess how the business may perform in the future.
This normalization process is where the "real" value of your company is often found. For example, if you overpaid yourself as a CEO or ran personal expenses through the business, a QoE adds those back to the profit. These add-backs directly increase the EBITDA figure that the buyer’s multiple is applied to, often resulting in millions of dollars in additional transaction value. Conversely, if you underpaid rent because you own the building, the report adjusts the expense to market rates.
Without this independent analysis, buyers will often be skeptical of "owner-provided add-backs." Having a third-party CPA firm validate these numbers gives them a seal of approval that carries weight during negotiations.
2. A QoE Report Gives You Flexibility & Timeliness
A QoE engagement’s procedures can be tailored based on a seller’s specific needs. For instance, if a business is only planning to sell a certain division, a QoE report can carve out the necessary financial information so that a potential buyer can focus on the division-specific results and earnings. This "carve-out" capability is essential for diversified companies where one high-performing segment might be masked by the overhead of a struggling department.
In addition, a QoE engagement can vary its scope or time period to fit the seller’s needs. It can be performed on a company’s annual fiscal year-end and include financial information based on a recent Trailing Twelve Month (TTM) period. In many cases, having a QoE report that includes a TTM period is vital because it provides more timely information, especially if a transaction is slated for the later part of a year.
Audited or reviewed financial statements are typically only prepared based on the company’s fiscal year-end, which can be "stale" by the time you reach the closing table in October or November. A QoE keeps the data current, allowing you to show the buyer the most recent growth trends and operational improvements that occurred after your last official audit.
3. A QoE Report Considers Trend Analysis
In terms of trends, a QoE report focuses on the drivers that ultimately increase or decrease revenues, costs, and the company’s overall gross profit. To fully understand these items, QoE engagements review information that would not be readily apparent from internally prepared financial statements.
This information could be particularly important to a buyer as it can shed light on whether these margins or results are attainable in the future, or whether there are any potential addbacks or deductions required to EBITDA for any significant changes in the business, such as discontinuations in product lines, vendor changes, or the removal of inflationary surcharges. If your margins spiked because of a temporary dip in raw material costs, the QoE will identify that so it doesn't become a point of contention later.
Furthermore, trend analysis helps bridge the gap between your accounting records and your operational reality. For instance, if you transitioned to a new software system or changed your revenue recognition policy mid-year, a QoE will "pro-forma" the numbers so the buyer can see a clean, apples-to-apples comparison of your growth over the last three years.
4. A QoE Report Provides a Rigorous Working Capital Analysis
Working capital is an important aspect of any transaction. When the business changes hands between owners, the new owner will expect an appropriate level of working capital to be maintained in the business on the day of the transaction. They want to ensure the business can operate normally on Day 1 without needing an immediate cash infusion from the new parent company.
As a result, a working capital analysis is necessary to help the seller and potential buyer define the target or peg. A sell-side QoE looks at 12 to 24 months of working capital cycles to determine what is actually "normal" for your specific business. Without this analysis, a buyer might set a working capital peg that is unfairly high, effectively forcing you to leave more cash in the business and lowering your net proceeds at closing.
By analyzing these cycles early, you can also identify ways to "lean out" your working capital — such as collecting receivables faster or managing inventory more tightly before the sale. This not only makes the business look more efficient but can also put more cash in your pocket at the closing table.
5. A QoE Report Proactively Identifies Problem Areas
Another significant benefit of a sell-side QoE is that it can identify potential problem areas before a company goes to market and allow sufficient time for management to take the necessary corrective actions. Making sure that road bumps are identified and flattened can pay significant dividends for a potential transaction.
Having a buyer identify issues during their due diligence creates doubt. When a buyer finds one error, they begin to wonder what else is hidden, leading to risk premiums that lower your valuation. Examples of potential issues include insufficient financial records, unrecorded liabilities, tax uncertainties (especially regarding nexus), bad inventory, uncollectible receivables, and inconsistent accounting policies.
Having a qualified firm perform the QoE will often provide the seller with valuable insight into how a buyer may view various aspects of the business, which the seller may not be able to see on their own. It allows you to fix the accounting policy or clean up the aging receivables now, so that when the buyer’s team arrives, your data is bulletproof.
6. A QoE Report Analyzes Concentrations & Risk
A QoE report will also identify concentrations of risk that may stem from significant customer relationships, major vendors, or even key employees. It will analyze and identify the amount of revenue generated from at least the top 10 customers. If 40% of your revenue comes from one client, that is a risk a buyer will price into their offer. Knowing this ahead of time allows you to prepare a narrative about the longevity and contract strength of that relationship.
It will also identify revenue by product or service to ascertain whether the business has diversified product or service offerings. In addition, QoE reports will look for major vendor or supplier relationships that potentially pose a risk to the business’s success. If your main supplier is in a volatile region or you lack a long-term contract, a QoE identifies this so you can address it (perhaps by securing a backup vendor) before going to market.
Beyond identifying the risk, the report also quantifies it. By showing that your top 10 customers have been with you for over a decade, you can transform a concentration risk into a loyal customer base strength. This level of detail is rarely found in a standard audit but is the primary focus of an M&A professional.
7. A QoE Report Can Increase Speed to Close
Time kills deals. The longer a transaction takes, the higher the likelihood that market conditions change or a competitor interferes. A sell-side QoE significantly accelerates the closing process because you are providing the buyer with a data room that is already organized and vetted.
When you hand a buyer a high-quality QoE report from a reputable firm, you are signaling that you are a sophisticated seller. This builds immediate trust and often allows the buyer to rely on your report, potentially reducing the scope (and cost) of their own due diligence. A deal that moves quickly is a deal that is much more likely to close at the original price.
Maximize Your Valuation Through Preparation with Kreischer Miller
Without a doubt, there are various benefits of QoE engagements that are outside the scope of a reviewed or audited financial statement. Audited and reviewed financial statements provide valuable information but are based on strict accounting rules, which may not be entirely reasonable for a specific business or industry.
A QoE engagement, on the other hand, provides additional information, flexibility, and insight into the business that go well beyond accounting rules.
If you are considering a sale in the next 12 to 24 months, now is the time to look under the hood. A sell-side Quality of Earnings report is not just an expense; it is a strategic investment in your transaction's success.
If you would like to learn more about sell-side engagements or have questions about our Quality of Earnings Advisory Services, please contact us.