Quality of Earnings: A Complete Guide for M&A Buyers

Quick answer

Quality of earnings analysis is the buyer-focused review of whether a target's reported EBITDA reflects recurring, supportable earnings after normalizing one-time, non-operating, or owner-specific items. It matters because buyers do not pay for headline EBITDA. They pay for the earnings base they believe will survive after closing and convert into cash.

Quality of earnings is where a buyer stops repeating management's EBITDA story and starts underwriting its own. It is the point in diligence where the team decides whether the reported earnings base is recurring, supportable, and worth paying a full multiple for.

That is why QoE is one of the highest-leverage workstreams in the deal. If the earnings base moves, the valuation moves. If the support behind the adjustments is weak, the purchase agreement posture changes. If the cash conversion story breaks under review, the buyer may still pursue the deal, but it will do so with a different price, a different structure, or a different level of conviction.

What quality of earnings is actually trying to prove

QoE is not just a list of add-backs. It is the buyer's structured answer to a more important question: what level of EBITDA should survive once temporary noise, owner-specific choices, accounting presentation issues, and unsupported management adjustments are stripped away?

In practice, that means a serious QoE workstream is trying to prove six things:

1. 1. Revenue is real and the reported period is not flattering the business with pull-forward activity or unusually favorable timing.
2. 2. Margins are understandable and not being overstated by one-time benefits, underinvestment, or misclassified costs.
3. 3. Adjusted EBITDA is supportable based on evidence rather than management narrative.
4. 4. Cash conversion is credible so the buyer is not underwriting earnings that do not turn into liquidity.
5. 5. Working capital and debt-like items are aligned with the earnings story rather than contradicting it.
6. 6. The final bridge is readable enough that partners, lenders, and investment committee members can follow it without translation.

Bayes Business School reported that the average pre-announcement due diligence period reached 203 days across studied deals from 2013 to 2022 [Bayes Business School, "Cautious M&A investors taking extra care with due diligence", 2024]. That is a useful reminder that buyers already spend substantial time validating the underlying economics of a target. QoE matters because even long processes still fail when the team reaches the right answer too late.

QoE is not the same as an audit

This confusion matters because sellers often assume audited financial statements settle the question. They do not.

An audit asks whether the historical financial statements are fairly presented under the relevant accounting framework. QoE asks whether the earnings base is decision-grade for valuation, underwriting, and negotiation. Those are different jobs.

An audited set of statements can still leave buyers with material open questions:

• Are the current margins inflated by temporary pricing or delayed costs?
• Are customer economics weakening underneath headline revenue growth?
• Are there owner-specific expenses or related-party arrangements that distort profitability?
• Is the reported run rate missing investments the buyer will have to restore after close?
• Does the EBITDA story still hold once working capital stress and debt-like items are considered?

That is why QoE is buyer-focused even when the seller has already been through a formal reporting process. It is not an accounting restatement exercise. It is an underwriting exercise.

The core workstreams inside a serious QoE

The exact scope changes by company and industry, but the structure is usually familiar.

The important point is that these workstreams should stay connected. A weak receivables profile is not only a working capital issue. It may also challenge the revenue story. A compensation add-back is not only a bridge issue. It may reveal missing post-close costs. Good QoE work links those questions instead of isolating them in separate files.

Where QoE findings actually change the deal

Buyers use QoE findings in at least four places at once.

First, they use it to refine valuation. If reported EBITDA falls after unsupported adjustments are removed, the enterprise value changes immediately. The math is mechanical, but the judgment behind the bridge is not.

Second, they use it to change negotiation posture. A clean earnings base may support speed and conviction. A weak one often moves the discussion toward price chips, specific protections, tighter definitions, or a more conservative structure.

Third, they use it to strengthen lender and committee materials. The people approving the deal do not only want the conclusion. They want to know why the team believes the adjusted number is durable.

Fourth, they use it to prioritize the rest of diligence. A QoE finding can tell the legal team where a contract issue needs to be tested, the tax team where an exposure may be flowing through the financials, or the deal lead where management's operating narrative is weakest.

Boston Consulting Group reported that large deals averaged 191 days from announcement to close in 2024 and that about 40 percent of announced transactions took longer to close than expected [Boston Consulting Group, "The 2024 M&A Report: Deals Are Taking Longer to Close. How to Respond.", 2024]. That is exactly why buyers need QoE findings to surface early. When the process is already long and complex, late-stage financial surprises are more expensive, not less.

Red flags that deserve immediate escalation

Not every QoE issue is fatal. But some patterns should move to the top of the deal agenda quickly:

• Add-backs that expand every time the seller updates the bridge
• Margin improvement without a clear operational explanation
• Large swings in accruals, reserves, or deferred balances near the sale process
• Revenue growth that is not matched by collections or cash flow
• Heavy customer concentration combined with weak contractual protection
• Related-party economics that flatter profitability or working capital
• Repeated classification changes that improve adjusted EBITDA but reduce clarity
• Missing support for items management describes as one-time

The right response is not always to walk away. Sometimes the answer is a lower price. Sometimes it is tighter definitions in the purchase agreement. Sometimes it is a deeper operating review. The important discipline is escalation while the deal team still has room to change its posture.

How QoE should run under deal pressure

Weak QoE work is usually not weak because the analysts do not understand accounting. It is weak because the process becomes unreadable.

The common failure pattern looks like this:

• the seller provides a revised bridge
• analysts test it in separate spreadsheets
• comments sit in email or meeting notes
• a partner asks for the current view
• the team rebuilds the same explanation for a new audience

That operating model creates friction, delay, and preventable inconsistency. It also makes it harder to tell which adjustments are truly resolved and which ones still depend on judgment calls or missing support.

A better QoE workflow keeps each material adjustment attached to four things:

1. 1. The evidence behind the item
2. 2. The reviewer view on whether the adjustment survives
3. 3. The commercial consequence if it changes
4. 4. The status of the issue for the next review audience

That is why QoE should not behave like a memo that appears at the end of diligence. The memo matters, but by the time the final write-up is produced, the underlying operating record should already exist.

Bain's 2025 M&A report is directionally right on this point: the best acquirers prepare earlier for what comes next rather than letting diligence operate as a late-stage reporting exercise [Bain & Company, "Looking Ahead to 2025: Preparing for What Comes Next", 2025]. In financial diligence, that means using QoE to sharpen the buyer's point of view while the deal is still live.

What AI can and cannot change in QoE

AI is now useful in QoE, but only if the team is clear about what the technology is actually improving.

It can accelerate:

• extraction of line-item detail from statements, schedules, and workpapers
• organization of add-back support and reviewer notes
• comparison of period-over-period anomalies across larger data sets
• first-pass flagging of items that deserve human review

It cannot replace:

• the judgment of whether an item is genuinely non-recurring
• the materiality decision about what changes the buyer's answer
• the negotiation call on how a finding should change structure or price
• the professional accountability for the final conclusion

McKinsey's January 2026 survey found that respondents using gen AI in M&A reported roughly 20 percent lower costs, and 40 percent reported 30 to 50 percent faster deal cycles [McKinsey & Company, "Gen AI in M&A: From theory to practice to high performance", January 2026]. That supports using AI to redesign diligence workflows, but it does not make the judgment layer optional.

AICPA's VS Section 100 toolkit makes the same point from a professional-standards perspective: AI does not remove the analyst's obligation to exercise skepticism or responsibility for the conclusion reached [AICPA & CIMA, "Statement on Standards for Valuation Services (SSVS)/ VS Section 100 Toolkit", 2023]. In other words, automation can speed the operating system around QoE, but it does not absolve the reviewer.

The output buyers actually need

At the end of QoE, the deliverable should not just be a normalized EBITDA number. It should be a decision-grade package that makes the number defensible.

That usually includes:

• a bridge from reported EBITDA to adjusted EBITDA
• the rationale and support for each material adjustment
• the open issues that still affect confidence in the number
• the connections to working capital, net debt, and other purchase price mechanics
• the items that need to appear in committee, lender, or negotiation materials

If that chain is missing, the number may still be directionally correct, but the team will struggle to defend it under pressure.

The bottom line

Quality of earnings is where buyers decide whether the earnings base is actually worth underwriting. It is the work that separates real recurring economics from temporary noise, unsupported optimism, and accounting presentation that does not survive scrutiny.

Good QoE work changes the deal at the right moment. Great QoE work does that while preserving the evidence trail, the judgment calls, and the commercial implications in one readable record.

Sources cited

1. Boston Consulting Group, "The 2024 M&A Report: Deals Are Taking Longer to Close. How to Respond.", 2024
2. Bayes Business School, "Cautious M&A investors taking extra care with due diligence", 2024
3. AICPA & CIMA, "Statement on Standards for Valuation Services (SSVS)/ VS Section 100 Toolkit", 2023
4. McKinsey & Company, "Gen AI in M&A: From theory to practice to high performance", January 2026
5. Bain & Company, "Looking Ahead to 2025: Preparing for What Comes Next", 2025

Author

Sorai Editorial

Editorial review team for Sorai's public diligence content

The editorial team translates public primary-source research and Sorai's workflow perspective into material designed for private equity, corporate development, and transaction advisory readers.

What is quality of earnings analysis?

It is the buyer's review of whether reported earnings are recurring and supportable after normalizing unusual or non-recurring items.

Why is QoE different from an audit?

An audit tests whether statements are fairly presented, while QoE tests whether the buyer should rely on the target's earnings base for valuation and underwriting.

What are the most common QoE adjustments?

Common adjustments include owner compensation normalization, one-time legal or transaction costs, unusual bonuses, accounting reclassifications, related-party items, and non-recurring revenue or expense swings.

How does QoE differ from net working capital analysis?

QoE focuses on the repeatability of earnings, while net working capital analysis focuses on the operating liquidity the business needs at closing. They are tightly connected, but they answer different questions: one tests earnings quality, the other tests whether the buyer receives a normal level of working capital.

Can AI replace human judgment in QoE analysis?

No. AI can accelerate document review, extraction, and issue organization, but professional judgment still determines whether an adjustment is supportable, material, and relevant to valuation. AICPA's VS Section 100 toolkit is explicit that AI does not remove the analyst's responsibility for conclusions.

Relevant workflows

Carry the analysis into the rest of diligence.

Use the linked workflow pages to connect financial findings to adjacent tax, legal, and platform review requirements.

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