Quality of earnings preparation means getting your books, add-backs and evidence into a state where an outside reviewer can rebuild your EBITDA from source records without surprises. Start months before you go to market: reconcile monthly financials, move to accrual accounting if you are not there, and attach documentation to every adjustment you plan to claim. The owners who do this keep their price. The ones who don’t often watch it get renegotiated late in diligence.
This guide is for owner-led companies heading toward a sale, a recapitalization or a financing. It covers what a quality of earnings (QoE) analysis tests, what to gather, which adjustments get challenged, a timeline that works, and the mistakes that weaken confidence.
TL;DR
- A QoE translates your reported earnings into a defensible view of ongoing, recurring earnings, usually expressed as adjusted EBITDA. It is not an audit.
- Preparation is mostly bookkeeping discipline: closed, reconciled monthly books on an accrual basis, plus a document behind every add-back.
- Begin 12 to 24 months of clean statements before launch, and finish the QoE before your marketing materials quote any earnings figure.
- The most common failure is an adjustment supported only by the owner’s judgment. Tie each one to an invoice, contract or cash impact.
- Know your weak spots first: customer concentration, margin swings and owner-dependent costs.
Table of Contents
- What a quality of earnings analysis actually tests
- When to start preparing
- What to gather before the reviewer asks
- Normalization adjustments: what gets reviewed
- Build an adjustment schedule with evidence
- Mistakes that delay the analysis or weaken confidence
- Perspective: what we see with owner-led companies
- A practical preparation timeline
- Thinking about the buyer’s side of the table
- Where our ProfitDriver Analysis™ fits
- FAQ
- Sources
What a quality of earnings analysis actually tests
Reported earnings under GAAP look backward. Buyers price a business on what it will earn going forward. A QoE bridges the two: Mercer Capital describes it as translating historical GAAP earnings into a reliable base of ongoing earning power, and says it is neither an audit nor a projection.
In practice the reviewer is trying to answer a handful of questions:
- Are the historical numbers accurate and traceable to source records?
- Which earnings are recurring, and which came from one-off events?
- Where do profits come from, and does a single customer or product carry too much of them?
- Does cash flow support the profit that the income statement shows?
HawkEye Capital Partners lists the same core objectives: test accuracy and sustainability of historical earnings, identify their sources, and assess concentration by customer or product that could threaten future profitability.
Buy-side versus sell-side
Buyers commission a QoE to confirm the EBITDA the seller presented and to identify adjustments that produce a normalized figure, as Pursant explains. Sellers commission one to find and fix problems before formal diligence begins. The seller’s version is the one you control, and it is the one this guide prepares you for.
There is a negotiating logic as well. A buyer who receives third-party analysis has less reason to suspect the numbers were dressed up, which Sapling Financial Consultants notes can give the buyer confidence to move faster.
How it differs from an audit
An audit gives an opinion on whether financial statements are presented in line with applicable accounting standards. A QoE asks a different question: what does this company really earn on an ongoing basis? The two share some procedures. Baker Tilly cautions that diligence should never be confused with an audit, even though both use methods such as proof of cash and revenue recognition testing. An audited company can still have a messy QoE, and an unaudited one can have a clean one. What matters is whether your numbers can be rebuilt from evidence.
When to start preparing
The honest answer is earlier than feels necessary. Advisors at Pease Bell recommend preparing months before you go to market, and having 12 to 24 months of financial statements on an accrual basis, because cash-basis books distort trends and make normalization harder.
Three timing rules are worth fixing in your head:
- Books must be closed. Reviewers need closed monthly periods before they begin. The Impetus Group notes that starting too early produces a stale report, while starting too late can delay your launch.
- The QoE comes before the CIM. The same source advises finishing the report before you finalize the Confidential Information Memorandum, so the key figures in the CIM come directly from the analysis rather than from a spreadsheet you built last quarter.
- Prep time is longer than active sale time. Our own view, laid out in our M&A timeline for sellers, is that the active sale process takes 6 to 12 months while preparation runs 12 to 36 months. Cleaning up financials is the part of that runway owners most often underestimate.
The engagement itself follows a recognizable pattern: scoping, data requests and fieldwork, draft findings, final alignment, and updates as new months close. How long each stage takes depends on the condition of your records and the scope you agree on, which is one more reason clean books pay off.
What to gather before the reviewer asks
A reviewer’s first request is a long document list. You save weeks by assembling it first. A sell-side advisory firm, PRIME exits, publishes a typical set: three or more years of annual and monthly profit and loss statements and balance sheets, trial balances, general ledgers, tax returns, bank statements, payroll data, material contracts, and support for the adjustments you propose.
A working checklist:
| Category | What to assemble | Why it gets asked for |
|---|---|---|
| Financial statements | Monthly P&L and balance sheet, 3 fiscal years plus trailing twelve months | Trend and seasonality |
| Ledgers and trial balances | General ledger detail, trial balance per month | Rebuilding EBITDA from source |
| Tax returns | Federal and state, same periods | Reconciling book income to filed income |
| Bank statements | All operating accounts, every month | Proof of cash |
| Payroll | Registers, owner and family compensation, bonuses | Compensation normalization |
| Revenue detail | Sales by customer, product and month | Concentration and recognition testing |
| Contracts | Customer, supplier, lease, debt and related-party agreements | Durability and one-off items |
| Adjustment support | Invoices, settlement letters, compensation studies | Defending each add-back |
The three-years-plus-trailing-twelve-months window matches how The Bonadio Group describes the standard review: monthly data for the most recent three fiscal years and the trailing twelve months, from which adjusted EBITDA is calculated as a proxy for recurring earnings.
Get the books reconciled first
Before sending anything, reconcile bank accounts, close every month, and confirm that revenue and expense definitions did not change between periods. If your bookkeeper recategorized expenses in year two, write down what changed and why. Our guide to the role of clean financials in an exit covers this groundwork in more detail.
Normalization adjustments: what gets reviewed
Adjusted EBITDA is where valuation lives, because a multiple applies to it. Mercer groups the common adjustments into five categories: discretionary expenses; unusual and nonrecurring revenue and expenses; timing or accounting-policy differences; major customer wins and losses; and M&A run-rate effects.
The Bonadio Group gives concrete examples: non-operating or non-cash income and expense, one-time legal or professional fees, penalties, settlements, refunds and credits, and normalization of items such as insurance, repairs, travel, bad debt and inventory write-offs.
Examples an owner will recognize
- Owner compensation. If you pay yourself well above or below what a replacement manager would cost, the difference is adjusted to a market figure. Note that this cuts both ways: an underpaid owner means EBITDA is overstated.
- Personal and family expenses. A vehicle, travel or a relative on payroll who does no work. These are classic add-backs, and they are also the most scrutinized.
- One-time costs. A lawsuit settlement, a failed software migration, a one-year flood repair. Each needs a document showing it will not recur.
- Large customer changes. A contract won in month 30 may be annualized upward. One lost in month 34 may be removed from the base.
- Depreciation treatment. Depreciation sits below EBITDA, but tax strategy affects what the books show. If you used accelerated deductions on equipment or buildings, understand how they interact with your reported earnings; this explainer on cost segregation and bonus depreciation is a useful starting point before you speak with your CPA.
For a deeper walk through the add-backs that tend to survive scrutiny, see five EBITDA add-backs mid-market owners can defend.
Where aggressive adjustments backfire
Not every non-GAAP figure is safe to present. The SEC cautions that excluding normal, recurring cash operating expenses necessary to run a business could make a non-GAAP measure misleading. That guidance is aimed at public registrants, but the principle is the one a private-company buyer applies: if a cost shows up every year, it is not one-time, whatever you label it.
Pursant makes a related point: adjustments are not necessarily errors, but certain presentations can obscure how sustainable earnings truly are. Your goal is a figure the reviewer arrives at independently, not one you argued them into.
Build an adjustment schedule with evidence
The single most useful preparation document is an adjustment schedule. A robust framework, as one 2026 research note puts it, separates reported EBITDA from adjusted, pro forma and forecast figures, and tracks each adjustment by category, rationale and owner.
A simple version looks like this:
| Column | Example entry |
|---|---|
| Period | FY2 Q3 |
| Category | One-time expense |
| Amount | Your actual dollar figure from the ledger |
| Rationale | Legal fees for a resolved vendor dispute |
| Evidence | Invoice, settlement letter, ledger reference |
| Owner | Controller or CFO responsible for the support |
| Recurrence check | Any similar cost in other periods? |
If you can open the schedule and click through to a source document for every row, you are ready. If you are rebuilding one from memory, you are not.
Our six-step EBITDA bridge shows how to reconcile reported to adjusted figures in Excel, line by line, so every dollar has a home.
Mistakes that delay the analysis or weaken confidence
Advisory firms writing about sell-side prep keep naming the same problems. Here they are, with what to do about each.
Unsupported adjustments. GBQ’s guidance calls out judgment calls without backup. Each add-back should be supported with invoices, contracts or a compensation study. Management’s belief that a cost is unusual is not evidence.
Unreconciled books. If the ledger does not tie to bank statements and tax returns, the reviewer spends the engagement finding out why. Reconcile before kickoff.
Figures that cannot be traced. The same GBQ piece lists numbers that cannot be tied to supporting records. A summary in a spreadsheet with no path back to the ledger counts as untraceable.
Definitions that drift. The research note above warns that deal retrades often follow when EBITDA cannot be reconstructed from source evidence, when definitions change between periods, or when revenue quality weakens under testing. Pick definitions, document them, and keep them stable.
Hiding the concentration problem. If one customer is a large share of revenue, or one supplier is critical, the reviewer will find it. PRIME’s advice is to identify risk flags such as customer or supplier concentration and margin volatility early, and to arrive with a plan: evidence of contract terms and renewal history, and remediation steps under way.
Waiting. The Pease Bell team advises treating the QoE as the start of the overall diligence process, so the same documentation supports the whole transaction story. A rushed QoE produces a rushed narrative.
Perspective: what we see with owner-led companies
Most owners we work with think of a QoE as a financial exercise. We see it as a test of whether the business runs on systems or on the owner. Many of the hardest adjustments trace back to the same root: informal arrangements that live in the owner’s head. Compensation set by feel, a key customer relationship held by one person, pricing that varies by who answered the phone.
Those are not accounting problems. They are operating problems that show up in the numbers, and a buyer prices them as risk. That is why we start with diagnosis before anything else. Our ProfitDriver Analysis™ looks at business data, stakeholder interviews and the drivers behind results (people, systems and operations) to find profit leaks and bottlenecks and rank where to fix things first. Owners who fix those issues before the QoE tend to walk into diligence with fewer surprises.
Our advice: treat the 12 to 36 months before a sale as the period when you make the business explainable. If someone else can read your books and your playbooks and understand why the earnings repeat, you have done the real preparation.
— Andre
A practical preparation timeline
Use this as a skeleton and adjust to your size and complexity.
- 12 to 24 months out: Move to accrual accounting if needed. Standardize the chart of accounts. Begin month-end close discipline, with reconciliations completed every month.
- 9 to 12 months out: Draft your adjustment schedule. Start collecting evidence for each item. Document owner compensation, related-party transactions and any personal expenses run through the business.
- 6 to 9 months out: Analyze customer and product concentration. Review contracts for change-of-control language. Decide whether to commission a sell-side QoE and choose an independent accounting or transaction advisory firm.
- 3 to 6 months out: Kick off the engagement once recent months are closed. Respond to data requests quickly; delays here are the biggest controllable cause of slippage.
- Before the CIM: Review draft findings, resolve disagreements with evidence, and take marketing figures directly from the final report.
- During the sale process: Update the analysis as new months close, so buyers see a current trailing twelve months.
If you are deciding whom to hire and at what stage, our piece on sell-side due diligence for mid-market owners walks through the options by type of provider. For a plain-language overview of the five core checks, see quality of earnings for M&A.
Thinking about the buyer’s side of the table
Preparing well means understanding what the other party will do with your report. A buyer’s team will compare your numbers to their own model, test working capital, and look at how the deal will be financed. If a buyer plans to finance part of the price with seller notes or SBA-backed debt, the rules around those structures shape how hard they push on earnings. This overview of seller financing and SBA rules shows the buyer-side considerations you may meet at the negotiating table.
Where our ProfitDriver Analysis™ fits
A QoE tells you what your earnings are. It does not tell you how to make them larger or more durable. If you are 12 months or more from a sale and suspect your margins are held down by leaks you cannot pinpoint, the ProfitDriver Analysis™ is built for owner-led businesses with annual revenue between $3M and $5M. It gives you a prioritized roadmap of what to fix first, based on your real-time data and stakeholder interviews rather than a generic template.
If you want to see where you stand before committing to anything, start with our exit readiness assessment, or talk to us through the application form.
FAQ
What is a quality of earnings analysis?
It is a financial review that tests whether a company’s reported earnings are accurate and repeatable. The reviewer adjusts historical results for one-time, non-operating and discretionary items to arrive at adjusted EBITDA, a proxy for recurring earnings. It is neither an audit nor a forecast.
How far ahead should I prepare?
Begin at least 12 to 24 months before launch if your books are not yet on an accrual basis or reconciled monthly. If your financials are already clean, three to six months of focused work on the adjustment schedule and documents may be enough. Finish the QoE before you finalize your CIM.
Do I need a QoE if the buyer will do their own?
Not always, but a sell-side report lets you find problems on your timeline instead of theirs. It also reduces the risk that a buyer’s findings reopen the price late in the process. Owners with concentrated customers or complex adjustments benefit most.
Which records matter most?
Monthly financial statements, ledgers, trial balances, tax returns, bank statements and payroll for at least three years, plus the invoices, contracts or studies behind each adjustment. Without them, your adjustments are opinions.
Sources
- Quality of Earnings Analysis (Mercer Capital)
- Quality of Earnings Reports (HawkEye Capital Partners)
- Quality of Earnings: What Buyers and Sellers Need to Know (Pursant)
- Quality of Earnings (Sapling Financial Consultants)
- Ten considerations in a quality of earnings study (Baker Tilly)
- Preparing a Quality of Earnings Review Before You Sell (Pease Bell)
- Sell-Side Quality of Earnings Report: Scope, Timing (The Impetus Group)
- Sell Side QoE (PRIME exits)
- Common Quality of Earnings Adjustments (The Bonadio Group)
- SEC: Non-GAAP Financial Measures
- Quality of Earnings before the Buyer Arrives
- 10 Steps To Streamline Your Sell-Side Quality of Earnings (GBQ)