Why Every M&A Deal Needs a Quality of Earnings (QofE) Assessment

Updated April 30, 2025

Whether you are on the buyside or sellside in an M&A deal, one financial metric will define negotiations and business valuation: earnings. The question is, how do you know you can trust the numbers? The unfortunate truth is, a bit of “clever accounting” can allow any company to show strong revenue, healthy margins, and growing income. But if those earnings turn out to be misrepresented or unsustainable, that dream deal may quickly turn into a nightmare. 

A prime example is a company almost everyone has heard of, General Electric. In 2020, the same year Fortune 500 ranked GE as one of the largest U.S. firms by gross revenue, the SEC announced that the company would pay $200 million in penalties to settle disclosure failure charges. Despite reporting stellar numbers, a federal investigation found that as much as 25% of GE’s profit in 2016 and 50% in 2017 was intentionally misrepresented. It turns out they had overstated costs in earlier years, making it seem as though profits were improving in an effort to prop up their stock price and boost investor confidence. As a result, their stock fell by 76% in 2017 and 2018. 

Now imagine you weren’t just investing in a company, but buying it. Sure, most companies won’t engage in outright deception like GE, but accounting errors, aggressive reporting, and missing documentation are more common than you think. Failing to notice these irregularities can be catastrophic, leading to overvaluation, last-minute retrades, or losing the deal entirely. The best way to avoid this, while simultaneously gaining leverage in negotiations, is with a Quality of Earnings (QofE) assessment. 

What is a Quality of Earnings (QofE) Assessment?

A QofE assessment is an in-depth earnings analysis that takes place during the M&A due diligence process. The goal is to clarify where a company’s earnings are coming from, how reliable those earnings have been historically, and whether current performance is likely to continue post-acquisition. A completed QofE report typically breaks income down into two categories:

• Recurring revenue from core business operations
• Non-recurring revenue or non-operating income, such as one-time contracts, temporary cost-saving measures, or unusual transactions

The result is a document that verifies the company’s actual business performance, adjusted to account for anomalies, inaccuracies, and isolated spikes in revenue. While your initial analysis might reveal excellent financials, sometimes even strong enough to sign a Letter of Intent (LOI), the QofE is where you confirm fair-market valuation. Without this element of due diligence, you risk overpaying or, worse, inheriting financial issues that are now your responsibility to rectify. 

What Does a Quality of Earnings Assessment Look For? 

QofE reports look to determine whether earnings are stable, sustainable, and reported accurately. To make sure a company’s financials meet these standards, a QofE assessor will typically adjust for factors like:

• Discontinued Operations: If a company has shut down a product line or exited a specific market, any revenue or profit from that segment shouldn’t be counted as part of future earnings. A QofE report removes those figures to prevent inflating the normalized earnings profile. 
• Non-Recurring Business Activity: Sometimes, a revenue spike comes from a one-off event, but the increase in earnings is folded into revenue growth plots. QofE identifies outliers such as government grants, short-term contracts, or profit surges due to uncommon events like the COVID-19 pandemic. These are all adjusted out as a way to avoid distorting the company’s true valuation. 
• Transactions at Non-Market Rate: Private companies will occasionally do business with friends, family, or long-time clients at discounted rates. QofE adjusts those transactions to reflect fair market pricing, giving a more accurate picture of actual earnings potential. 
• New Product Acquisition Costs: Rolling out a new product can temporarily inflate operating expenses. A QofE analysis will isolate those costs and evaluate how they impact short-term profitability versus long-term growth. 
• Accrual-Based Accounting Conversion: Many small and mid-sized businesses use cash-based accounting, which can misrepresent when revenue and expenses actually occur. By converting financials to an accrual basis, QofE assessments can show a more chronologically accurate picture of a company’s economic activity. 

By taking anything out of the equation that isn’t an ongoing part of core business operations, these adjustments can help assessors determine adjusted EBITDA. Done correctly, QofE should give you an idea of a company’s actual earning power on a run-rate basis, not just how it performed in a particularly profitable quarter. While this procedure may seem similar to a financial audit, QofE is a separate process. Audits typically focus on transaction verification, while QofE is tuned more to separate and categorize financial transactions to give an unobstructed, forward-looking view from an earnings standpoint.

Buyside QofE vs. Sellside QofE

One of the biggest misconceptions we hear is that QofE assessments only have buyside use cases, but this couldn’t be further from the truth. Without a sellside Quality of Earnings report, you put yourself at an immediate negotiating disadvantage. If the buyers find inconsistencies, sellers will be forced to explain or justify line items that sellside QofE could have identified and resolved in advance. M&A deals can be delicate; one small detail missed by subpar QofE can mean the difference between success and failure.

When we first started Embarc Advisors, we worked on a middle-market M&A deal that seemed solid. It was so solid, in fact, that we’d already entered into an LOI with a 60-day exclusivity period. But the buyer’s QofE uncovered a messy mix of cash and accrual accounting, overstated assets, and missing paperwork. We were forced to defend the original valuation with shaky numbers and nearly lost the deal. If we had done a sellside QofE analysis upfront, that all could have been avoided. 

That is not to say there aren’t numerous buyside applications as well. As a buyer, poor QofE analysis (or worse, none at all) can be disastrous. Miss one major adjustment, and the acquisition price could end up being 20-50%x more than what the business is actually worth. By the time those overlooked issues surface organically, it’s often too late to renegotiate. Working capital is a common example of this: Without a QofE report, it may not be possible to establish a fair working capital peg. Once capital shortfalls emerge post-close, buyers could find themselves scrambling for a post-acquisition cash injection just to keep daily operations afloat. 

To summarize:

• Advantages of a Sellside QofE: A seller’s Quality of Earnings assessment puts the sellside in control, reinforcing their negotiating power rather than forcing them to rely on (or be blindsided by) the buyer’s financial analysis. A sellside QofE can also root out red flags before the buyer can use them as leverage, giving the seller time to rectify them and reducing the risk of retrades or last-minute deal failure. 

• Advantages of a Buyside QofE: A buyer’s Quality of Earnings assessment can secure a fair deal based on a company’s actual value. Without a buyside QofE report, you risk overpaying for a business with inflated EBITDA figures, hidden liabilities, or anomalous income events disguised as recurring revenue. 

Who Performs a QofE Assessment?

In most cases, a third-party advisory firm is responsible for conducting a QofE analysis. While audits may be handled by in-house accountants, the quality of a QofE report hinges on the specific expertise and unbiased perspective that only an M&A or transaction advisory firm can provide. QofE analysts need to understand not only how to assess earning potential, but how those numbers influence valuation, deal structure, and negotiations. Unlike internal accountants, an M&A advisor won’t hesitate to give you an honest evaluation of your company’s earnings. They’re not there to tell you what you want to hear; their goal is to provide the data you will need to defend your valuation and close the deal. 

The process to perform a QofE analysis can vary depending on what firm you choose. For example, we use an 80:20 approach that focuses on high-impact areas rather than racking up billable hours. This efficiency model gives us breathing room to take care of other essential tasks, like building trust with the counterparty, negotiating better terms, and supporting the post-acquisition integration process. 

But no matter what advisory team you choose, an effective QofE assessment should be a top priority. Without one, you risk being unable to defend your valuation as the seller or identify red flags as a buyer, leading to bad deals, reputational damage, or even the permanent loss of trust with a potential deal partner.  

Takeaway

A Quality of Earnings (QofE) assessment is a critical part of the M&A due diligence process. On the buyside, these assessments can provide the adjusted EBITDA of a potential acquisition and help to secure a more favorable deal; on the sellside, QofE can strengthen bargaining power and identify potential earnings red flags before the other party does. 

QofE reports typically adjust to account for a variety of factors, such as:

Unlike a financial audit, which focuses on broader inspection of financial reporting accuracy and compliance, QofE analytics is conducted by a dedicated M&A firm. When done properly, a QofE assessment can validate a company’s actual earnings power, reveal inconsistencies before they derail a deal, and give you the leverage to negotiate effectively. For information on how a Quality of Earnings assessment can benefit your business, contact Embarc Advisors to learn more. 

Quality of Earnings (QofE) Frequently Asked Questions

How Much Does a QofE Cost? 

• While the cost of a QofE analysis can vary, the price for a mid-market business will typically fall between $20-$45k for a boutique firm and can be $50k+ for large national accounting firms. The final price can vary based on company size, depth of analysis, and the scope and depth of the review. Advisory firms with significant M&A experience may charge more, but they also tend to deliver reports that hold up under buyer scrutiny. Low-cost QofE, while potentially saving money upfront, can fail to reveal key inconsistencies or errors. This may result in retrades, valuation disputes, and deal terminations.

What is the Difference Between an Audit and a QofE?

• While both audits and QofE assessments analyze financial statements, they serve very different purposes. An audit verifies whether financials are prepared according to generally accepted accounting principles (GAAP) or international financial reporting standards (IFRS). A QofE, on the other hand, evaluates the quality and sustainability of earnings, adjusting out non-recurring items to assess real run-rate profitability. This helps buyers validate valuation assumptions and gives sellers a clearer narrative to support their asking price. 

What is the Purpose of a QofE?

• As a foundational part of the M&A due diligence process, a Quality of Earnings (QofE) assessment gives buyers and sellers an accurate analysis of a company’s financial performance. A high-quality report will identify any inconsistencies, flag one-time events or unusual income, and adjust earnings to distinguish what’s recurring and reliable from items that are temporary or inflated. This can benefit buyers and sellers by providing supporting evidence for valuations, giving parties a more favorable position in negotiations.