Quality of Earnings Reports: What Sellers Need to Know Before a Buyer Orders One

When a buyer moves into due diligence, their advisors want to know whether the earnings you have presented will hold up under close examination. A quality of earnings report is one of the ways they find out. 

You do not need to be an accountant to prepare for one. The report tests the same things a well-prepared seller is already working on. Once you understand how it works, you can get ready on your own timeline rather than the buyer’s. 

 

Key Takeaways 

• A quality of earnings report checks whether your reported results reflect the normalized cash flow a buyer is paying for. 
• It is not an audit. It works with adjusted figures, often month by month, and focuses on the questions a buyer cares about. 
• Because price is usually based on a multiple of earnings, every add-back you cannot support costs you several times its value. 
• Findings can shape the working capital target and the deal structure, not only the price. 
• A sell-side report, prepared before going to market, lets you find and address issues before a buyer does. 

 

What a Quality of Earnings Report Actually Measures 

A quality of earnings report, often shortened to QoE, examines what a business earns once its numbers are adjusted. Its purpose is to demonstrate a company’s adjusted, or normalized, cash flow. The report starts with your reported results and works toward a figure a buyer can rely on.  

According to Eide Bailly, a typical report covers normalized EBITDA and the add-backs that bridge reported earnings to adjusted earnings. It examines how results move from month to month and year to year, and how revenue and gross margin break down by product or customer. It also reviews operating expenses, staffing, key balance sheet items, and the working capital needed to run the business.

Much of that will sound familiar. The adjustments at the centre of a QoE are the same ones that turn net income into normalized EBITDA in any valuation. What changes is the level of scrutiny each one receives. 

 

How It Differs From an Audit or Your Year-End Statements 

Owners sometimes assume their year-end statements already answer a buyer’s questions. Each type of report is built for a different job. 

Report	What it is designed to tell you
Compilation engagement report (formerly Notice to Reader)	Year-end figures prepared on a stated basis of accounting. CPA Canada notes this basis is usually substantially different from ASPE, and a c ash flow statement and notes are often left out.
Review engagement report	Year-end figures the accountant has checked through inquiry and analytical procedures under Canadian review standards (CSRE 2400). It gives limited assurance that nothing appears materially misstated, but does not test individual transactions. It is the most common report among the businesses Alberta Business Exchange works with.
Audit	Annual results. Audits serve a different purpose from transaction due diligence.
Quality of earnings report	Whether adjusted earnings hold up month by month. It also covers areas an audit may not focus on, such as customer sales trends and cost structure.

 

A business valuation does a different job again. It sets out what the business should sell for and why. A QoE tests whether the earnings behind that number survive a buyer’s review. 

 

Where Add-Backs Survive or Fall Away 

This is where the report most directly affects your sale price. 

 

Every add-back you claim will be tested. One you cannot support with invoices, statements, or payroll records drops out of the calculation. CBIZ makes a point worth keeping in mind. The buyer’s team is not incentivized to find add-backs for you. Their role is to test the ones you present. 

 

If that feels a little adversarial, it is worth remembering that it is not personal. Most owners run some personal or discretionary expenses through the business, and there is nothing wrong with that. The goal is simply to make sure you can show the paper trail when it counts. 

 

A simple, hypothetical example shows why this matters. Suppose $50,000 of personal expenses run through the business, but only $30,000 can be traced. The remaining $20,000 is removed from adjusted earnings. At an illustrative multiple of four, that gap lowers the price by $80,000, not $20,000. 

 

How the Findings Show Up in Your Deal 

The good news is that a finding is not the same as a problem. Most issues a review uncovers have a practical solution, and many can be handled in how the deal is put together. The price is the most visible effect, but the findings can reach further into the agreement. 

 

Price. Buyers generally bid higher on a business they see as clean. Surprises uncovered during their review have the opposite effect, reducing trust and potentially the value of the deal.  

Working capital. Because the report estimates how much working capital the business normally needs, it feeds into one of the more technical parts of the negotiation. Buyers insist on setting a working capital amount up front. At closing, the sale price is adjusted if the actual figure comes in above or below it.

Structure. Not every concern comes out of the price. Some risks remain after the review, such as a key customer relationship tied to the owner. These can be addressed through the structure of the deal instead. A holdback or an earnout protects the buyer, and you still receive the full amount if the agreed conditions are met. 

 

Should You Commission Your Own Before You Sell? 

A sell-side report, also called vendor due diligence, puts the same analysis in your hands before buyers see the numbers. 

 

Sell-side reports help deals come together and close more quickly. Finding problems early also lets you fix them, or disclose them on your own terms, before a buyer uncovers them in their own review. 

 

Timing determines how useful it is. Eide Bailly notes that most sellers engage a QoE advisor six to 12 months before going to market. Some owners commission one 18 to 36 months ahead to find weak spots while there is still time to fix them. Most findings, the firm adds, can be corrected or improved before a sale. 

 

Whether or not you commission a full report, the underlying preparation does not change. Alberta Business Exchange works alongside your accountant on cash flow planning and accounting system reviews. The goal is for the numbers a buyer examines to be organized and supported before the request arrives. 

 

Common Questions About Quality of Earnings Reports 

 

How long does a quality of earnings report take? 

Usually four to six weeks. The timeline depends on how complex the business is and how easily its records can be gathered. 

 

Will a buyer still do their own review if I commission one? 

Yes. A sell-side report does not replace the buyer’s own due diligence, but it can make that review easier. Addressing issues early can strengthen your valuation and help due diligence run more smoothly. 

 

What information will I need to provide? 

Typical requests include financial statements, general ledger data, and tax returns. Expect to provide customer contracts, receivables and payables reports, payroll records, and revenue schedules as well

 

Confidence Starts With a Clear Valuation 

Building business value before selling includes making sure your earnings will hold up when a buyer examines them. For most sellers, that work is best done through a thorough business valuation rather than a separate report. Normalizing earnings is central to how Alberta Business Exchange values a business, and it requires a detailed analysis of every revenue and expense account. When your add-backs are identified and supported from the start, the numbers a buyer reviews already tell a clear story, and a seller-side quality of earnings report is rarely needed. 

 

A well-supported valuation also strengthens the other half of a successful sale. Alberta Business Exchange takes pride in finding the right buyer for each business, and targeted buyer outreach brings forward buyers who are a genuine fit. When the right buyer reviews financials that hold up, they can move ahead with greater confidence in the transaction. 

 

If you are considering a sale, book a confidential consultation to talk through how a valuation can prepare your business for a buyer’s review. A first conversation is meant to give you a clearer picture, with no pressure and no obligation.