ARTICLE | March 03, 2026

The Importance of Quality Earnings Reports in M&A Transactions

A Quality of Earnings (QoE) report provides an in-depth analysis of a company’s revenue and expenses to evaluate core earnings for a potential transaction. While audits, reviews, and compilations confirm that financial statements are accurate, a QoE assessment goes further by analyzing the drivers behind earnings before interest, taxes, depreciation, and amortization (EBITDA) and identifying adjustments needed to present normalized results.

Whether you’re considering buying or selling a business, having a clear understanding of the company’s financials is paramount. QoE reports are utilized by both buyers and sellers to evaluate and negotiate potential transactions.

What a Quality of Earnings (QoE) Report is Designed to Evaluate

A Quality of Earnings report focuses primarily on EBITDA because it is commonly used to calculate enterprise value. The goal is to normalize earnings so buyers and sellers can evaluate core operating performance.

Normalization includes identifying and adjusting non-recurring or unusual items. Examples may include excess owner compensation, PPP loan forgiveness, gains on asset sales, insurance proceeds, or other one-time events that would not continue after a transaction. Removing those items presents a clearer view of ongoing profitability.

A QoE assessment also evaluates balance sheet accounts that affect earnings quality as well as net working capital (NWC). Analysts review items such as customer prepayments, revenue recognition practices, uncollectable accounts receivable, and obsolete or excess inventory. Adjustments may be required if reported numbers rely on aggressive assumptions or timing differences that distort historical NWC.

Beyond financial adjustments, a QoE report examines operational strength and potential vulnerabilities. Areas commonly analyzed include:

• Customer concentration
• Vendor concentration
• Profit margin trends
• Variances across reporting periods
• Revenue consistency

A company that depends heavily on one or two customers may present higher risk than one with diversified revenue streams. Clear analysis and commentary allow decision-makers to understand these dynamics before negotiating final terms.

Why Quality of Earnings Matters in M&A Transactions

In M&A, confidence drives momentum. Buyers want assurance that projected returns are achievable. Sellers want confidence that their business is being valued fairly.

A QoE report provides both parties with a common financial baseline. Adjusted EBITDA becomes the starting point for valuation discussions. When earnings are clearly supported, negotiations tend to focus on strategy rather than disputes over accounting treatment.

What a Quality of Earnings Report Provides to Buyers

For buyers, a QoE delivers deeper insight than audited financials alone. Detailed analysis of trends, margins, and working capital allows more accurate forecasting. That clarity may reinforce the purchase price or prompt renegotiation if risk is identified.

How a Sell-Side Quality of Earnings Strengthens a Seller’s Position

For sellers, a sell-side QoE provides the opportunity to prepare in advance. Viewing the business through a buyer’s lens allows management to anticipate questions and address weaknesses before entering the market. Proactive preparation can reduce friction during due diligence and demonstrate readiness to serious buyers.

How Quality of Earnings Reports Identify Financial Risk

Every transaction carries risk, but not all risk is obvious from headline financial statements. A Quality of Earnings review uncovers issues that may not surface in standard reporting.
Common areas of risk include:

• Revenue recognition inconsistencies
• Significant swings in gross margin
• Reliance on short-term contracts or loss of customers
• Weak internal controls affecting financial reporting
• Unusual related-party transactions

Identifying these factors early protects both sides of a deal. Buyers can assess whether risk warrants a price adjustment, indemnity, or modified deal structure. Sellers gain the opportunity to explain anomalies or correct issues before they become obstacles.

Risk assessment also extends to working capital. Understanding normalized working capital levels helps prevent post-closing disputes and supports accurate purchase price adjustments.

How Quality of Earnings Impacts Valuation and Deal Structure

Valuation in lower-middle-market transactions often centers on a multiple of adjusted EBITDA. Even small changes to normalized earnings can significantly influence the purchase price.

For example, removing non-recurring income may lower EBITDA, reducing valuation. Conversely, identifying add-backs that reflect true operating performance may support a higher multiple. Clear documentation of adjustments strengthens credibility in negotiations.

Quality of Earnings findings also influence deal structure. If risk is elevated, buyers may request earn-outs, holdbacks, or escrow arrangements. If earnings are stable and well-supported, transactions may proceed with more cash up front and fewer contingencies.

Transaction advisory support can help both buyers and sellers align valuation with financial reality. Deal structuring, working capital projections, financial modeling, and negotiation assistance are often integrated into the broader advisory process.

When Quality of Earnings Becomes Critical in a Transaction

Having a normalized EBITDA number does more than impact the purchase price. It also changes how lenders, investors, and buyers evaluate earnings strength. Stakeholders want to know whether earnings are sustainable, whether adjustments are defensible, and whether working capital supports projected performance.

A Quality of Earnings review becomes especially important when:

• Preparing for a sale, recapitalization, or refinancing
• Entering discussions with private equity investors
• Negotiating a strategic acquisition
• Seeking bank financing tied to transaction metrics
• Planning ownership transition or succession

Insero’s Quality of Earnings & Due Diligence advisors assess revenue streams, cost structures, working capital trends, and recurring versus nonrecurring items to determine the sustainability of earnings. We develop normalized EBITDA analyses and identify risks that may influence valuation, debt capacity, or negotiation leverage.

On the buy side, our team validates historical performance and stress-tests assumptions. On the sell side, we help leadership address potential concerns before they surface, improving control over timing and deal dynamics.

If you’re evaluating leverage, refinancing, or a future transaction, early Quality of Earnings analysis can provide clarity before negotiations begin. Schedule a consultation with our advisors today to discuss how proactive due diligence can help protect value and support a more confident transaction process.