Quality of Earnings
An outside CPA analysis that reconciles your reported earnings with the numbers in your CIM, and a major gate the deal must pass during due diligence.
What It Is
A quality of earnings report (Q of E) is an independent examination of a company's historical profit, commissioned by the buyer and performed by an outside CPA firm. Its job is narrow and specific: compare the EBITDA you claimed in marketing materials against what the books, bank statements, and tax returns actually support. Warrillow defines it as an outside-CPA analysis of historical EBITDA versus the CIM's figures, typically triggered after an exclusive LOI on deals over roughly $1 to 2 million. Below that size, a buyer often relies on a less formal review of the financials rather than a full Q of E.
The Q of E is where your add-backs and normalization get tested. Every adjustment you made to inflate adjusted profit, replacing your salary with a manager's, stripping out one-time legal costs, removing personal expenses, has to survive a skeptical accountant who is paid by the other side.
Why It Matters: The Diligence Gate
Passing the Q of E is not a formality. Warrillow frames it as a milestone that unlocks the rest of due diligence.
"A Q of E report can often be a milestone, enabling an acquirer to consider a major portion of their due diligence completed."
Warrillow, The Art of Selling Your Business, Appendix B
Clear the gate and the buyer treats much of their financial review as done, which protects deal momentum. Stumble at the gate and the deal stalls, the buyer hunts for more problems, and you become exposed to retrading.
The Real Risk: Numbers That Do Not Reconcile
McDannell is blunter about the stakes. In her seven-step process, the close-and-transfer chapter identifies the financial review as the single most common place deals collapse: deals most often die in due diligence when the financials do not reconcile. The defense is unglamorous and continuous, namely clean daily records and never misrepresenting the numbers in the first place.
The danger is not only the discrepancy itself but what a discrepancy signals. A buyer who catches one inconsistency stops trusting all of your figures.
"If they catch one lie, the first thing they're going to think is if they're lying about this, what else are they lying about?"
McDannell, Get Acquired, ch. 7
McDannell pushes this to an absolute: one white lie is enough to lose a buyer.
"It only takes one white lie to have a buyer not trust you."
McDannell, Get Acquired, ch. 3
How to Prepare
Both sources agree the work happens long before the CPA arrives. Keep separate personal and business accounts, maintain clean books from day one, and be ready to document every add-back you claimed. Warrillow cautions that running excessive personal expenses through the company backfires, because it lets a banker or buyer argue those costs are normal and resist your adjustments. The cleaner and more conservative your normalization, the less a Q of E can take away from your price. Assemble financials, tax returns, and bank statements in the data room before going to market, so the review confirms your CIM rather than contradicting it.
Further Reading
Sources: Warrillow, The Art of Selling Your Business Appendix B; McDannell, Get Acquired ch.3, ch.7.