A quality of earnings (QoE) report is a financial analysis that adjusts a company's reported EBITDA to show its true, sustainable, recurring earnings. It strips out one-time events, owner-specific costs, and accounting anomalies that distort what the business actually earns under normal operating conditions.
Buyers, private equity firms, lenders, and investors routinely commission QoE reports before closing transactions. If you're selling a business, raising growth capital, or refinancing, you'll either need to commission a QoE or be prepared to respond to one from the other side of the table.
Why reported EBITDA isn't the whole story
EBITDA — Earnings Before Interest, Taxes, Depreciation, and Amortisation — is the most common metric for valuing a business. But reported EBITDA can be misleading because it includes:
- Non-recurring revenue — a one-time large contract that won't repeat
- Non-recurring expenses — a lawsuit settlement, office move, or equipment write-off that is unlikely to recur
- Owner compensation adjustments — owners of private businesses often pay themselves above or below market rates; an acquirer will replace the owner, so the compensation needs to be normalised to market
- Related-party transactions — rent paid to a related-party entity at above- or below-market rates
- Accounting discretion — timing of revenue recognition, depreciation choices, and capitalisation decisions that affect EBITDA mechanically
Adjusted EBITDA — sometimes called "normalised EBITDA" — removes these distortions. The difference between reported EBITDA and adjusted EBITDA is the quality of earnings analysis.
Structure of a QoE report
1. Earnings bridge
A waterfall chart or table that starts with reported EBITDA and reconciles each adjustment to arrive at adjusted EBITDA. Every adjustment should have a clear rationale and supporting evidence.
2. Non-recurring adjustments
Each add-back or deduction documented with:
- Category (non-recurring revenue, non-recurring expense, owner comp, related party, other)
- Amount (positive = adds to adjusted EBITDA; negative = reduces it)
- Supporting rationale and evidence
3. Revenue quality analysis
An assessment of how reliable and recurring the revenue base is:
- Customer concentration — what percentage of revenue comes from the top 1, 5, and 10 clients?
- Repeat vs one-time revenue — what share is contractual, subscription, or repeat business vs project-based?
- Month-over-month trend — is revenue growing, flat, or lumpy?
4. AR quality
An aging analysis that assesses how collectable the reported accounts receivable balance is. High concentration in 60+ day buckets signals collection risk that reduces the quality of reported revenue.
5. Year-over-year comparison
Trailing twelve months (TTM) vs the prior year — showing growth rate on a normalised basis and flagging any year-on-year anomalies that need explanation.
Common QoE adjustments
| Adjustment Type | Direction | Example |
|---|---|---|
| Non-recurring revenue | Deduct | One-time government grant included in revenue |
| Non-recurring expense | Add back | Legal fees for a completed lawsuit |
| Owner compensation | Add back / deduct | Owner paid $400K where market rate is $150K → add back $250K |
| Related-party rent | Add back / deduct | Company pays rent to owner's LLC at 2× market → deduct excess |
| Severance / one-time HR | Add back | Restructuring severance not expected to recur |
| COVID-related items | Add back / deduct | PPP loan forgiveness classified as income |
When do you need a QoE report?
- Selling your business — a sell-side QoE strengthens your asking price and reduces surprises during buyer due diligence
- Raising growth capital or PE investment — investors will commission their own QoE; better to prepare yours first
- Securing a business acquisition loan (SBA 7(a), bank debt) — lenders require normalised earnings to underwrite the loan
- Buying a business — commission a buy-side QoE to verify the seller's representations
Preparing your own QoE with TallyArc
TallyArc's Quality of Earnings report lets you generate a QoE directly from your live financial data. Navigate to Reports → Quality of Earnings, select your period (TTM is standard), and the report auto-populates an earnings bridge from your GL data. You can then add, document, and categorise manual adjustments — and the adjusted EBITDA updates in real time.
The report also includes revenue by client (for concentration analysis), AR aging, a monthly revenue trend, and a year-over-year comparison — giving you the full QoE package ready for a potential buyer or lender's review.
Note: A TallyArc-generated QoE is a management-prepared analysis suitable for internal use and preliminary discussions. Formal due diligence for a transaction typically requires a QoE prepared or reviewed by an independent accounting firm (Big 4 or regional CPA).