{"concept_id":"ALTSS-PE-027","slug":"quality-of-earnings","canonical_name":"Quality of Earnings","acronym":"QoE","aliases":["QoE","QofE report","quality of earnings report"],"kind":"process","authority":"industry","facets":["DDL","DTM"],"domains":["PRIVATE-EQUITY","DUE-DILIGENCE"],"display_title":"Quality of Earnings (QoE)","search_aliases":["what is a quality of earnings report","qoe report private equity","quality of earnings vs audit","sell-side qoe vs buy-side qoe","what does a qoe include","qoe net working capital peg"],"disambiguation":"In accounting research, \"earnings quality\" is a broader idea, measured through proxies such as earnings persistence, accruals and smoothness, whose meaning depends on the decision being made; this entry covers the transaction due diligence report.","one_sentence_definition":"A quality of earnings (QoE) report is a transaction-focused financial due diligence analysis that tests whether a target's reported and adjusted EBITDA reflect sustainable, cash-generating earnings and quantifies normalisation adjustments, working capital and debt-like items.","plain_english":"Before buying a company, a buyer and its lenders want to know whether the profit figure they are paying for is real and repeatable. A QoE report, usually prepared by an accounting firm's transaction team, rebuilds earnings from the accounting records, removes one-off and non-business items and checks that profit turns into cash. It is not an audit and does not give an opinion on the financial statements.","parent_concepts":[],"child_concepts":[],"related_concepts":["adjusted-ebitda","purchase-price-adjustment","net-debt","ebitda","due-diligence","representations-and-warranties-insurance","auction-process","debt-to-ebitda"],"comparison_concepts":[],"not_the_same_as":[{"slug":"due-diligence","distinction":"Due diligence is the buyer's whole investigation, of which financial due diligence is one workstream; the QoE report is that workstream's main deliverable on earnings, working capital and net debt."},{"slug":"adjusted-ebitda","distinction":"Adjusted EBITDA is a figure; the QoE is the analysis that tests it and produces a diligence-adjusted version."}],"formula_ids":[],"worked_examples":[{"title":"Illustrative leverage on management's adjusted EBITDA ($ millions)","paragraphs":["A target reports EBITDA of 80. Management presents adjusted EBITDA of 100, after 20 of add-backs. The financing package proposes 500 of debt, which is **5.0x** adjusted EBITDA."],"calc":{"fn":"leverage","inputs":{"total_debt":500,"ebitda":100},"expected":{"gross_leverage":5,"net_leverage":5},"tol":0.005}},{"title":"The same debt on reported EBITDA","paragraphs":["Measured on reported EBITDA of 80, the same 500 of debt is **6.25x**. The add-backs are the whole difference between a leverage level a lender may accept and one it may not."],"calc":{"fn":"leverage","inputs":{"total_debt":500,"ebitda":80},"expected":{"gross_leverage":6.25,"net_leverage":6.25},"tol":0.005}},{"title":"After the QoE","paragraphs":["The QoE accepts 8 of the 20 of add-backs, giving diligence-adjusted EBITDA of 88. The debt is now **5.68x** EBITDA. At a 10x valuation multiple, the 12 of rejected add-backs is worth 120 of enterprise value, which is what the buyer will seek to take off the price."],"calc":{"fn":"leverage","inputs":{"total_debt":500,"ebitda":88},"expected":{"gross_leverage":5.6818,"net_leverage":5.6818},"tol":0.001}}],"sections":[{"heading":"What a QoE covers","paragraphs":["Scope is set by engagement letter and varies, but a buy-side or sell-side QoE in a private equity deal usually covers:","- **EBITDA normalisation.** A bridge from reported EBITDA to [adjusted EBITDA](/glossary/adjusted-ebitda), testing each management add-back against evidence and classifying it as accepted, rejected or adjusted, plus adjustments management did not propose.\n- **Net working capital.** Monthly working capital over the review period, seasonality, a recommended definition and a proposed target level (the peg) for the [purchase price adjustment](/glossary/purchase-price-adjustment).\n- **Net debt and debt-like items.** Financial debt plus items a buyer will argue reduce equity value: unpaid bonuses and taxes, deferred capital expenditure, customer deposits, deferred consideration from past acquisitions, pension deficits, transaction costs. Classification of items such as deferred revenue and leases depends on the deal definitions.\n- **Proof of cash.** Reconciling reported revenue and costs to bank statements over selected periods.\n- **Revenue quality.** Customer concentration, retention and churn, price versus volume, recurring versus one-off revenue, cohort behaviour and cut-off.\n- **Trends and run-rate.** Monthly results, last-twelve-month build, margins by product or site."]},{"heading":"A QoE is not an audit","paragraphs":["An audit is an assurance engagement that ends in an opinion on whether financial statements are fairly presented under an accounting framework. In market practice, a QoE is an advisory engagement for a specific transaction. It looks forward to the sustainability of earnings, often works on management accounts and last-twelve-month periods that are not audited, relies on information management provides, and gives no opinion. A company with clean audit opinions can still have large add-backs rejected in a QoE, because the questions differ: the audit asks whether the historical numbers are fairly stated; the QoE asks what earnings a buyer can rely on going forward and what the deal definitions should be."]},{"heading":"Sell-side and buy-side QoE","paragraphs":["A sell-side QoE (vendor due diligence) is commissioned by the seller before an [auction process](/glossary/auction-process) to establish the earnings story, find problems early and shorten buyers' diligence. Buyers commonly use it as a starting point, obtain the provider's agreement that they and their lenders may rely on it, and re-test the largest adjustments themselves, since the seller paid for it. A buy-side QoE is commissioned by a bidder, with scope tailored to its concerns. Lenders financing a leveraged acquisition commonly require a QoE, either their own or reliance on one of the others, before committing."]},{"heading":"How QoE findings move price and debt","paragraphs":["Three findings matter most. Changes to EBITDA move enterprise value at the valuation multiple: each unit of EBITDA removed at 10x removes ten units of price. Changes to EBITDA also move debt capacity, because lenders size and test leverage on it. The working capital peg and debt-like items move equity value directly, unit for unit, through the purchase agreement definitions. In practice, QoE findings also feed [representations and warranties insurance](/glossary/representations-and-warranties-insurance) underwriting, where insurers review the diligence reports when deciding exclusions."]},{"heading":"Where QoE sits in due diligence","paragraphs":["In market practice, the QoE is the core output of financial [due diligence](/glossary/due-diligence) and runs alongside the commercial, tax and legal workstreams. Its findings are cross-checked against them: commercial diligence tests whether projected growth is plausible, tax diligence examines exposures that may become debt-like items, and legal diligence reviews contracts behind revenue concentration and change-of-control risks."]}],"classification_rules":[],"calculation_rules":[],"common_mistakes":["Treating a QoE as assurance comparable to an audit opinion.","Relying on a sell-side QoE without re-testing the largest add-backs or obtaining a reliance letter.","Mixing historical normalisation adjustments with pro forma and run-rate adjustments in a single \"QoE EBITDA\" figure.","Overlooking debt-like items that do not appear as borrowings on the balance sheet."],"edge_cases":["Carve-outs: replacing services the parent provided produces negative adjustments, and the QoE builds standalone EBITDA rather than normalising existing results.","Project or milestone businesses: last-twelve-month EBITDA can be distorted by timing, so the QoE may present several periods and backlog analysis.","Revenue that does not reconcile to cash receipts in the proof of cash is a potential irregularity to investigate, not an adjustment."],"external_standard_mappings":[],"source_ids":["SRC-ACAD-DECHOW-GE-SCHRAND-2010","SRC-IAASB-ISA-200"],"citations":[{"source_id":"SRC-IAASB-ISA-200","pinpoint":"paras. 3, 5, 11","supports":"An audit enhances users' confidence through the auditor's opinion, based on reasonable assurance, on whether the financial statements are prepared, in all material respects, in accordance with an applicable financial reporting framework (for most general purpose frameworks, whether they are presented fairly)","source":{"source_id":"SRC-IAASB-ISA-200","title":"International Standard on Auditing (ISA) 200, Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with International Standards on Auditing","publisher":"International Auditing and Assurance Standards Board (IAASB), via IFAC","document_type":"auditing standard","url":"https://www.ifac.org/_flysystem/azure-private/publications/files/A008%202013%20IAASB%20Handbook%20ISA%20200.pdf","publication_date":"2013 IAASB Handbook edition; effective for audits of financial statements for periods beginning on or after 2009-12-15","jurisdiction":"intl","status":"in force","last_verified":"2026-10-01"}},{"source_id":"SRC-ACAD-DECHOW-GE-SCHRAND-2010","pinpoint":"Abstract","supports":"In accounting research, earnings quality is measured through proxies such as persistence, accruals and smoothness, and its meaning depends on the decision context","source":{"source_id":"SRC-ACAD-DECHOW-GE-SCHRAND-2010","title":"Understanding earnings quality: A review of the proxies, their determinants and their consequences","authors":"Patricia Dechow; Weili Ge; Catherine Schrand","publisher":"Journal of Accounting and Economics, vol. 50, no. 2-3, pp. 344-401","document_type":"journal article (peer-reviewed)","url":"https://econpapers.repec.org/RePEc:eee:jaecon:v:50:y:2010:i:2-3:p:344-401","year":2010,"publication_date":"2010","jurisdiction":"intl","status":"published","last_verified":"2026-10-01"}}],"faq":[{"q":"Who pays for a quality of earnings report?","a":"The party that commissions it: the seller for a sell-side QoE, the bidder for a buy-side QoE. Lenders often rely on one of those rather than commissioning their own."},{"q":"Is a QoE required to get acquisition financing?","a":"No rule requires one, but lenders to leveraged acquisitions commonly make a QoE, or reliance on one, a condition of their commitment."}],"seo":{},"first_published":null,"last_reviewed":"2026-10-01","last_modified":"2026-10-01","content_version":"2.0.0","url":"https://altss.com/glossary/quality-of-earnings","json_url":"https://altss.com/reference/concepts/quality-of-earnings.json","title":"Quality of Earnings (QoE)","formulas":[],"sources":[{"source_id":"SRC-ACAD-DECHOW-GE-SCHRAND-2010","title":"Understanding earnings quality: A review of the proxies, their determinants and their consequences","authors":"Patricia Dechow; Weili Ge; Catherine Schrand","publisher":"Journal of Accounting and Economics, vol. 50, no. 2-3, pp. 344-401","document_type":"journal article (peer-reviewed)","url":"https://econpapers.repec.org/RePEc:eee:jaecon:v:50:y:2010:i:2-3:p:344-401","year":2010,"publication_date":"2010","jurisdiction":"intl","status":"published","last_verified":"2026-10-01"},{"source_id":"SRC-IAASB-ISA-200","title":"International Standard on Auditing (ISA) 200, Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with International Standards on Auditing","publisher":"International Auditing and Assurance Standards Board (IAASB), via IFAC","document_type":"auditing standard","url":"https://www.ifac.org/_flysystem/azure-private/publications/files/A008%202013%20IAASB%20Handbook%20ISA%20200.pdf","publication_date":"2013 IAASB Handbook edition; effective for audits of financial statements for periods beginning on or after 2009-12-15","jurisdiction":"intl","status":"in force","last_verified":"2026-10-01"}]}