²ÝÝ®ÊÓƵ

June 3, 2026

Contributors: Megan Schwab, CPA

The BasicsÌý

• A Quality of Earnings (QofE) report is not an audit; it is a deep-dive analysis into the sustainability and repeatability of aÌýtarget’sÌýearnings.ÌýÌý
• Normalized EBITDA is the deal’s north star, removing one-time spikes or non-operatingÌýexpenses to find the true cash-flow engine of the business.ÌýÌý
• Working capital analysis ensures a fair “peg” at closing, preventing sellers from stripping cash or buyers from overpaying for a depleted balance sheet.Ìý Ìý

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AÌýQofEÌýÌýReport:ÌýTheÌýFinancial Engine ofÌýM&AÌýDeal SuccessÌý

TheÌý“sticker price” of aÌýmerger orÌýacquisitionÌýisÌýrarely the final cost, especially given theÌývolatility ofÌýM&A activityÌýinÌý2025 andÌýearlyÌý2026.Ìý

That’s whereÌýaÌýQofEÌýreportÌýcomes in.Ìý

What is aÌýQofEÌýReport?

A financial analysis that evaluates the sustainability and repeatability of a target company’s earnings, a QofE report provides a foundational understanding of a deal’s true cash flow.ÌýÌý

While a standard audit confirms that financial statements follow accounting rules, aÌýQofEÌýreport asks if those profits are real and repeatable.ÌýThe processÌýmoves beyond the trial balance toÌýuncover the true health of the target,ÌýidentifyingÌýunrecorded liabilities and pro-forma adjustments that directlyÌýimpactÌýthe purchase price.ÌýÌý

The technical depth of aÌýQofEÌýlies in the bridge from reported EBITDA to Adjusted EBITDA. Professionals look for “secondary” financial impacts,Ìýsuch as the normalization of owner-lifestyleÌýexpenses or below-market related-party leases,Ìýwhere personal or non-operating costs have been run through the business.ÌýThese practicesÌýhideÌýthe true profitability that a new owner would actually realize post-closing.ÌýBy quantifying these add-backs,ÌýweÌýcan transition a confusing P&L into a clear, defensible valuation.Ìý

Deep-Dive: Analyzing the Quality of RevenueÌý

A criticalÌýcomponentÌýof theÌýQofEÌýprocess is a granular analysis of the revenue stream. It is not enough to see that revenue is growing; theÌýobjectiveÌýis to understand exactly why and how that growth is being achieved.Ìý

An analysis of revenue stream quality should entail:Ìý

• Customer concentration stress testing.ÌýDeterminingÌýtheÌýfinancial impactÌýif a top client were toÌýdepartÌýpost-closing, going well beyond a simple list of the top 10 customers.Ìý
• Relationship depth and duration.ÌýReviewing the length of each key customer relationship alongside the specific profit margins associated with each client.Ìý
• ContractÌýexpirationÌýexposure.ÌýIdentifyingÌýupcoming contract renewal dates and flagging situations whereÌýa significant portionÌýof profit is tied to a single client whose contract expires shortly after closing, which materially lowers the quality of those earnings.Ìý
• Revenue stickiness.ÌýEvaluating contract terms, renewal rates, and historical pricing power to assess how reliably revenue will carry forward after the transaction.Ìý
• Non-recurring revenue identification.ÌýIsolating one-time project fees, windfall sales, or other anomalies thatÌýwon’tÌýrepeat, ensuring buyersÌýaren’tÌýpaying a premium for a temporary spike in performance.Ìý
• Pricing trend analysis.ÌýDistinguishing between sustainable volume-driven growth and aggressive, one-time price increases that could alienate customers over the long term.Ìý
• Revenue recognition policy review.ÌýScrutinizing whether theÌýtarget’sÌýpolicies align with GAAP and confirming that revenueÌýhasn’tÌýbeen pulled forward from future periods to inflate current-year results.Ìý
• Proof of cash reconciliation.ÌýReconciling reported revenue against actual bank deposits to confirm that every dollar of income being valued is fully supported by real cash inflows.Ìý

What is aÌýWorking Capital Peg?Ìý

A working capital peg is a normalized targetÌýestablishedÌýduring due diligence to prevent cash manipulation before closing.ÌýOne of the most frequent areas of post-deal friction isÌýthe netÌýworking capital adjustment. AÌýQofEÌýstudy analyzes 12 toÌý24 monthsÌýof historical data toÌýestablishÌýa normal level of working capitalÌýrequiredÌýtoÌýoperateÌýthe business.ÌýÌý

This peg prevents the seller from accelerating collections or delaying payables just before the deal closes to artificiallyÌýboostÌýcash. ByÌýsettingÌýa clear, data-driven expectation, both parties can move toward closing with a shared understanding of the balance sheet’s health.ÌýÌý

Strategic Value: The Seller’s MultiplierÌý

For a seller, sell-sideÌýQofEÌýis a proactive strategy to cleanÌýhouseÌýbefore going toÌýmarket. ByÌýidentifyingÌýfinancial issues early,ÌýsellersÌýcan preventÌý“price chips,” where a buyer discovers anÌýissueÌýmid-diligence and demands a lower purchase price or a larger escrow. A cleanÌýQofEÌýreport, backed by professional analysis, builds the credibility needed to accelerate the closing timeline and secure a higher valuation multiple from suitors and their lenders.ÌýÌý

Your TakeawayÌý

In mergers and acquisitions, financial surprises rarely work in anyone’s favor. AÌýreliableÌýQofEÌýreport removes the guesswork,Ìýgiving both buyers and sellers a reliable picture of business performance, a more defensible deal value, and a stronger foundation for what comes after closing.Ìý

Taking a proactive stance on financial riskÌýisn’tÌýjust goodÌýpractice.ÌýIt’sÌýone of the most effective ways to protect the deal, reduce friction at the closing table, and set both parties up for lastingÌýsuccess.

Don’t Let Hidden Risks Derail YourÌýTransaction

A QofE report is only as good as the team that prepares it. ²ÝÝ®ÊÓƵ’s transaction advisory team brings the objectivity, technical depth, and hands-on deal experience needed to assess the true financial health of any business. Whether you’re buying or selling, we go beyond the numbers to uncover what’s really driving performance — and what could derail your deal.Ìý

Here’sÌýwhatÌýaÌýQofEÌýreport from ²ÝÝ®ÊÓƵÌýmeans for your M&A deal:Ìý

• Hidden risks,ÌýidentifiedÌýearlyÌýbefore they become costly surprises at closingÌý
• Real opportunities, clearly mappedÌýso you negotiate from a position of strengthÌý
• Unbiased analysisÌýgrounded in experience across hundreds of M&A transactionsÌý

To discuss your deal and find out how a rigorousÌýQofEÌýanalysisÌýcouldÌýprotect your investment and sharpen your decision-making,ÌýcontactÌý²ÝÝ®ÊÓƵ’s transaction advisory team today.Ìý

Frequently Asked QuestionsÌý

Q:ÌýCan I use an audit in place of aÌýQofEÌýstudy?Ìý

A:ÌýNo. Audits look at historical accuracy; aÌýQofEÌýlooks at future sustainability. They are separate tools for separate goals.ÌýÌý

Q:ÌýIs due diligence necessary for small transactions?Ìý

A:ÌýYes. Financial risk is not always proportional to deal size. Smaller businesses often have less formal internal controls or sophisticated accounting departments, which can result in significant errors in revenue recognition or unrecorded expenses. AÌýQofEÌýanalysis ensures that a buyerÌýisn’tÌýinheriting these structural risks, regardless of the purchase price.Ìý

Q:ÌýWhen should theÌýQofEÌýprocess begin?Ìý

A:ÌýIdeally, as soon as a Letter of Intent (LOI) is signed. ThisÌýallowsÌýample time for thorough analysis and potential remediation.Ìý