The Basics
- A Quality of Earnings (QofE) report is not an audit; it is a deep-dive analysis into the sustainability and repeatability of a target’s earnings.
- Normalized EBITDA is the deal’s north star, removing one-time spikes or non-operating expenses to find the true cash-flow engine of the business.
- Working capital analysis ensures a fair “peg” at closing, preventing sellers from stripping cash or buyers from overpaying for a depleted balance sheet.
______________________________________________________________________________________________
A QofE Report: The Financial Engine of M&A Deal Success
The “sticker price” of a merger or acquisition is rarely the final cost, especially given the volatility of M&A activity in 2025 and early 2026.
That’s where a QofE report comes in.
What is a QofE Report?
A financial analysis that evaluates the sustainability and repeatability of a target company’s earnings, a QofE report provides a foundational understanding of a deal’s true cash flow.
While a standard audit confirms that financial statements follow accounting rules, a QofE report asks if those profits are real and repeatable. The process moves beyond the trial balance to uncover the true health of the target, identifying unrecorded liabilities and pro-forma adjustments that directly impact the purchase price.
The technical depth of a QofE lies in the bridge from reported EBITDA to Adjusted EBITDA. Professionals look for “secondary” financial impacts, such as the normalization of owner-lifestyle expenses or below-market related-party leases, where personal or non-operating costs have been run through the business. These practices hide the true profitability that a new owner would actually realize post-closing. By quantifying these add-backs, we can transition a confusing P&L into a clear, defensible valuation.
Deep-Dive: Analyzing the Quality of Revenue
A critical component of the QofE process is a granular analysis of the revenue stream. It is not enough to see that revenue is growing; the objective is to understand exactly why and how that growth is being achieved.
An analysis of revenue stream quality should entail:
- Customer concentration stress testing. Determining the financial impact if a top client were to depart post-closing, going well beyond a simple list of the top 10 customers.
- Relationship depth and duration. Reviewing the length of each key customer relationship alongside the specific profit margins associated with each client.
- Contract expiration exposure. Identifying upcoming contract renewal dates and flagging situations where a significant portion of profit is tied to a single client whose contract expires shortly after closing, which materially lowers the quality of those earnings.
- Revenue stickiness. Evaluating contract terms, renewal rates, and historical pricing power to assess how reliably revenue will carry forward after the transaction.
- Non-recurring revenue identification. Isolating one-time project fees, windfall sales, or other anomalies that won’t repeat, ensuring buyers aren’t paying a premium for a temporary spike in performance.
- Pricing trend analysis. Distinguishing between sustainable volume-driven growth and aggressive, one-time price increases that could alienate customers over the long term.
- Revenue recognition policy review. Scrutinizing whether the target’s policies align with GAAP and confirming that revenue hasn’t been pulled forward from future periods to inflate current-year results.
- Proof of cash reconciliation. Reconciling reported revenue against actual bank deposits to confirm that every dollar of income being valued is fully supported by real cash inflows.
What is a Working Capital Peg?
A working capital peg is a normalized target established during due diligence to prevent cash manipulation before closing. One of the most frequent areas of post-deal friction is the net working capital adjustment. A QofE study analyzes 12 to 24 months of historical data to establish a normal level of working capital required to operate the business.
This peg prevents the seller from accelerating collections or delaying payables just before the deal closes to artificially boost cash. By setting a clear, data-driven expectation, both parties can move toward closing with a shared understanding of the balance sheet’s health.
Strategic Value: The Seller’s Multiplier
For a seller, sell-side QofE is a proactive strategy to clean house before going to market. By identifying financial issues early, sellers can prevent “price chips,” where a buyer discovers an issue mid-diligence and demands a lower purchase price or a larger escrow. A clean QofE report, backed by professional analysis, builds the credibility needed to accelerate the closing timeline and secure a higher valuation multiple from suitors and their lenders.
Your Takeaway
In mergers and acquisitions, financial surprises rarely work in anyone’s favor. A reliable QofE report removes the guesswork, giving both buyers and sellers a reliable picture of business performance, a more defensible deal value, and a stronger foundation for what comes after closing.
Taking a proactive stance on financial risk isn’t just good practice. It’s one of the most effective ways to protect the deal, reduce friction at the closing table, and set both parties up for lasting success.
Don’t Let Hidden Risks Derail Your Transaction
A QofE report is only as good as the team that prepares it. Rehmann’s transaction advisory team brings the objectivity, technical depth, and hands-on deal experience needed to assess the true financial health of any business. Whether you’re buying or selling, we go beyond the numbers to uncover what’s really driving performance — and what could derail your deal.
Here’s what a QofE report from Rehmann means for your M&A deal:
- Hidden risks, identified early before they become costly surprises at closing
- Real opportunities, clearly mapped so you negotiate from a position of strength
- Unbiased analysis grounded in experience across hundreds of M&A transactions
To discuss your deal and find out how a rigorous QofE analysis could protect your investment and sharpen your decision-making, contact Rehmann’s transaction advisory team today.
Frequently Asked Questions
Q: Can I use an audit in place of a QofE study?
A: No. Audits look at historical accuracy; a QofE looks at future sustainability. They are separate tools for separate goals.
Q: Is due diligence necessary for small transactions?
A: Yes. Financial risk is not always proportional to deal size. Smaller businesses often have less formal internal controls or sophisticated accounting departments, which can result in significant errors in revenue recognition or unrecorded expenses. A QofE analysis ensures that a buyer isn’t inheriting these structural risks, regardless of the purchase price.
Q: When should the QofE process begin?
A: Ideally, as soon as a Letter of Intent (LOI) is signed. This allows ample time for thorough analysis and potential remediation.