What is a quality of earnings report?

What is in a quality of earnings report?

Six things, in most reports, covering the last two or three fiscal years and the trailing twelve months. The report is written by a CPA firm's transaction team for whoever hired it, the buyer or the seller, and it reads as findings, not as an opinion. The parts that move the price are the first two.

Smaller reports drop the last two sections; a "limited-scope" or "QoE-lite" engagement is usually the EBITDA bridge, the proof of cash and a working-capital schedule. For the businesses we represent, $1 million to $15 million in revenue in Cook and the collar counties, that limited scope is what a buyer's accountant actually runs, and the full report appears only when the price passes about $3 million or the buyer is a private-equity platform.

How is a quality of earnings report different from an audit?

An audit asks whether the financial statements follow the accounting rules and ends in an opinion. A quality of earnings report asks whether the earnings are real and will continue, and ends in a set of findings and an adjusted number. CLA puts the two questions side by side: a QoE asks "Are these earnings sustainable?" where an audit asks "Are these numbers accurate?" (CLA, June 2026). BPM makes the same distinction: "Unlike an audit, which confirms that financial statements follow accounting rules, a QoE digs into whether reported earnings reflect the real, ongoing earning power of the business" (BPM, September 2026).

Three practical consequences for an owner. First, a QoE is not an audit, a review or a compilation and gives no assurance on the statements themselves; it is a due-diligence engagement run on agreed procedures, and it is written for whoever commissioned it (Lutz, 2023). Second, a QoE can be run on cash-basis books that could never be audited, which is most of the companies we see, though the fee goes up for it. Third, having audited statements does not replace a QoE. A buyer who is paying for earnings wants the earnings rebuilt, and an audit of a $4 million company costs more than the QoE and answers the wrong question; the documents page explains why an audit is rarely worth its cost to a seller at this size.

When does a seller need a quality of earnings report?

Three situations, in order of how firm the rule is.

1. The price is $3 million or more and the buyer is using an SBA loan

   The SBA's SOP 50 10 8.1, effective for 7(a) loans approved on or after October 1, 2026, requires the lender to obtain a quality of earnings report with a cash proof for any change of ownership with a purchase price of $3 million or more. The cash proof reconciles the bank statements to the income statement and the tax return for the trailing twelve months and the last two fiscal years, and the lender must use the report's earnings, not the seller's, in the 1.25 times debt-service test (SBA Information Notice 5000-880695, Appendix 15). That is a rule, not a preference, and it applies to the individual buyer with a bank loan as much as to a fund.

2. The buyer is a private-equity platform, a roll-up or a well-advised strategic

   These buyers run a buy-side QoE at any price, because their own lenders and investment committees require it. The question for the seller is not whether a QoE will be run but whether to run one first, which is the sell-side decision below.

3. An individual buyer under $3 million

   No QoE. The lender orders an independent valuation from a credentialed appraiser, the buyer's CPA rebuilds the earnings from the returns and the bank statements, and the lender verifies the figures against the seller's IRS transcripts. The work is a lighter version of the same thing, and where a buyer wants something formal at this size, an agreed-upon-procedures engagement at roughly $10,000 to $15,000 is the usual substitute (CT Acquisitions, 2026). How the appraisal and the coverage test work is on how to value a small business.

What does a quality of earnings report cost, and how long does it take?

Published fee schedules put a standard buy-side report at $20,000 to $35,000 for a company under $5 million in enterprise value, usually at limited scope, and $25,000 to $50,000 from $5 million to $15 million; a sell-side report runs 10 to 30 percent more than the same scope on the buy side (BD Emerson, July 2026). A separate 2026 survey of national and regional firms puts the full report for a company with $5 million to $25 million of EBITDA at roughly $25,000 to $75,000, median near $45,000, which is above the size we work in (CT Acquisitions, January 2026, updated October 2026).

What moves the fee, from the same schedule: cash-basis or hybrid books add 20 to 50 percent; each additional entity, accounting system or point-of-sale system adds roughly $5,000 to $15,000; a two-week turnaround carries a 15 to 40 percent premium; audited financials cut the fee by 10 to 25 percent, and a data room organized before kickoff cuts it by 10 to 20 percent. Middle-market reports typically take three to four weeks of fieldwork once the data is in (Warren Averett, 2023), and the seller's own time runs 45 to 100 hours, most of it in the second to fourth week answering requests (CT Acquisitions, 2026). On an owner-run company with one entity, clean returns and a deal file already assembled, the low end of each band is realistic; on cash-basis books with three entities and a shoebox of add-backs, it is not.

Should I order my own quality of earnings report before going to market?

If the price will be over $3 million, the buyer pool is platforms and strategics, the add-backs are large, or the books are cash-basis, yes, and three to six months before launch. If the price is under about $2 million and the buyer will be an individual with an SBA loan, usually no; a documented add-back schedule and a deal file do the same job for a fraction of the fee.

The reason to pay for a sell-side report is the re-trade. Roughly one in three signed letters of intent never reaches a closing, and QoE findings and EBITDA discrepancies account for nearly half of the deals that fail (CLA, June 2026). A buyer's accountant who finds the earnings $150,000 short of the offering memorandum does not walk away quietly; the buyer comes back with a lower price, an earnout for the difference, or both, six weeks into exclusivity when the other buyers have moved on. A sell-side report finds the same $150,000 before the first buyer sees the numbers, so the price is set on earnings that survive diligence.

A worked example, hypothetical and with the assumptions stated. A Kane County mechanical contractor goes to market at 3.0 times a claimed $900,000 of seller's discretionary earnings and signs a letter of intent at $2.7 million. The buyer's QoE strikes $140,000 of add-backs: a brother-in-law on payroll at $45,000 whose work would cost $85,000 to replace, a $60,000 "one-time" compressor rebuild that the ledger shows every other year, and $40,000 of vehicle and travel expense with no logs. SDE is restated at $760,000. At the same 3.0 multiple the price is $2.28 million, $420,000 below the letter of intent, and the buyer offers the difference as an earnout on next year's revenue. Every one of those three items was findable from the general ledger six months earlier, and two of them could have been fixed. The add-backs a buyer's accountant accepts and rejects are listed on seller's discretionary earnings.

What does the buyer's accountant find first?

The same five things, in roughly the same order, on almost every owner-run company in Chicagoland.

• Add-backs without support. An add-back is accepted when it ties to a ledger account and a receipt and would not continue under a new owner. "Owner discretionary, $90,000" with no detail is removed in full, and the accountant then doubts the rest of the schedule.
• The proof of cash does not tie. Deposits that exceed recorded revenue (undeposited cash sales reported late, or not at all), owner draws run through expense accounts, and transfers between accounts booked as income. Each one is a question the seller answers in writing, and each unanswered one is an adjustment.
• Revenue timing. Contractors and manufacturers with jobs that span a year-end get their revenue restated to percentage of completion; a company that books customer deposits as sales gets them moved to a liability. Both lower the trailing-twelve-month earnings and both are normal; the surprise is what costs money.
• Customer concentration. Revenue by customer for three years is the first schedule requested. One customer over about 20 percent is priced as a risk, usually as an earnout or a holdback tied to that customer's renewal, and a customer that left during the trailing twelve months becomes a pro forma deduction.
• Working capital and debt-like items. The report proposes a normal working-capital level from the monthly history and lists everything that behaves like debt. In Cook County and inside the City of Chicago that list includes unpaid county and City taxes, because under the bulk-sales rules a buyer can be held liable for them when the notices are not filed on time; the buyer wants them settled or escrowed at closing. The notices and their deadlines are on selling a business in Illinois.

How do I prepare for a quality of earnings review?

Assemble the file the accountant will ask for before anyone asks. Three years of federal returns and the current-year interim statements; 36 months of bank and credit-card statements; a general-ledger export for the same period; receivables and payables agings at each year-end and the latest month; revenue by customer by year; the add-back schedule with the ledger account and the document behind every line; the debt schedule; the lease; and the payroll register with related parties marked. The full list, with how long each item takes to produce, is on the documents needed to sell a business, and the twelve-month version of getting the books ready is on how to prepare a business for sale.

Then settle three things before the letter of intent rather than after. The earnings basis: SDE for a deal under about $2 million, EBITDA above it, because the buyer's report will restate whichever one you did not use. The working-capital target: propose a number from your own monthly history so the buyer's accountant is reacting to yours. And the related parties: family payroll and rent set to market in the schedule, with the market figure documented, so the adjustment is yours and not the buyer's.

Do I need a quality of earnings report to sell a business under $3 million?

Usually not, and we will not sell you one. What a seller at that size needs is the owner-side version of the same work: earnings rebuilt from the federal return rather than the internal P&L, reconciled to the deposits, with every add-back documented and the two or three items a buyer's accountant would strike identified while there is still time to fix them. That is what Lakeshore's Exit-Readiness Review does over two weeks for a flat $4,500, credited against our success fee if we later list the business. It is not a quality of earnings report and it is not written for a lender, and we say so in the engagement letter. Where the price will clear $3 million, or the buyer pool is platforms, we tell you to commission a sell-side report from a CPA firm that produces them, and we price the business off that report. A free, CPA-prepared confidential value range is the place to find out which side of the line you are on.