Quality of Earnings Report Example: What's Actually Inside (Section by Section)

Why see the inside, not just the summary

Most coverage of quality of earnings tells you whether you need one — our companion guide on when a QoE is worth the spend covers cost, timing, and the thresholds. This piece does the opposite: it walks the anatomy of an actual report, exhibit by exhibit, so you know what you're paying for and what to push on when it lands.

A QoE for an SMB deal is usually a 30-to-80-page document built from three to five years of tax returns, the general ledger, bank statements, and management interviews — many of the same records on the due diligence request list. Here's what's in it.

1. Executive summary

The first page or two states the adjusted earnings figure the rest of the report supports — adjusted EBITDA or SDE — and the headline findings: revenue quality, concentration, margin trend, and any material risks. Read it, but don't stop here. The summary is the conclusion; the value is in the exhibits that justify it.

2. The adjusted-earnings bridge (the centerpiece)

This is the exhibit you're really buying. It's a waterfall from reported net income to adjusted EBITDA/SDE, with every adjustment itemized:

What to challenge: every add-back is the seller's assertion that an expense won't continue under new ownership. The owner-labor add-back should be net of a market-rate replacement if the owner actually works in the business — adding back a full owner salary without subtracting a manager's cost is the single most common way SDE gets inflated. "One-time" items that appear in multiple years aren't one-time. Each line should footnote its supporting document.

3. Quality of revenue

This section tests whether the revenue is durable: recurring versus one-time, customer concentration (top-10 customers as a percentage of revenue), retention and churn, and contract terms. A business with 60% of revenue in one customer is a structurally different asset than one with the same earnings spread across hundreds of accounts — and the QoE quantifies it rather than asserting it.

4. Gross margin trend

A multi-year gross-margin analysis catches margin compression masked by dollar growth — revenue rising while the percentage quietly erodes, often a sign of pricing pressure or rising input costs the headline trend hides.

5. Net working capital analysis

This exhibit builds the trailing-twelve-month working capital schedule and proposes the peg — the normalized level of working capital the buyer should receive at closing. It matters more than buyers expect: the peg quietly moves cash between the parties at closing, and a poorly-set one is the most common source of a closing-table re-trade.

6. Proof of cash

The proof of cash reconciles reported revenue to actual bank deposits over the period. It's the cleanest test for overstated or unverifiable revenue — if booked revenue doesn't tie to deposits, the report says so. For owner-operated SMBs with informal bookkeeping, this is often where the surprises live.

7. Debt and debt-like items

A schedule of interest-bearing debt plus debt-like items — deferred revenue, customer deposits, accrued payables, unpaid taxes, deferred maintenance — that should reduce the price or be settled at closing. These are easy to miss on the surface and material to what the buyer actually inherits.

What a QoE is not

A QoE is not an audit. It doesn't issue a clean opinion that the books comply with a standard, and it doesn't guarantee the numbers. It is an investigative analysis that tests whether the earnings are defensible and flags what it couldn't verify. For SMB deals — where the seller was almost certainly never audited and the real question is valuation — that investigative posture is exactly what you want. Pair it with the rest of your due diligence and the Form 8594 allocation at closing.