Quality of Earnings Report: What Buyers Must Know

Most buyers hear “quality of earnings” and assume it is a formality. Something the accountants handle before closing. A box to check.

It is not. A quality of earnings report is where deals die, prices drop, and sellers get exposed. If you are using SBA 7(a) financing to fund your acquisition, the findings in that report directly affect whether a lender will approve your deal at all.

Here is what a quality of earnings report actually does, what it costs, and how to turn its findings into real negotiating power.

What a Quality of Earnings Report Actually Is

A quality of earnings report is an independent financial analysis of a target company’s reported earnings. A third-party CPA firm prepares it before closing, and it goes far deeper than a standard audit.

An audit confirms that financial statements follow accounting standards. A QoE answers a different question entirely: are the earnings real, repeatable, and reliable?

The accountants doing the work pull apart three to five years of financials. They examine revenue recognition practices, cost structures, claimed add-backs, customer concentration, and working capital trends. If something affects whether the cash flows you think you are buying will actually materialize post-close, it shows up in this report.

The output runs 30 to 80 pages. It either confirms the seller’s numbers or tells you exactly how far off they are.

Why It Matters for SBA 7(a) Deals

If you are financing through an SBA 7(a) loan, the quality of earnings report is not optional on most deals above $500K. Lenders require it for good reason.

SBA lenders underwrite to DSCR (debt service coverage ratio). They want to see at least 1.25x as an absolute floor, but that number is dangerously thin. At Regalis we target 2x on our deals, with 1.5x as the minimum when accounting for synergies. A deal skating by at 1.25x has almost no margin for error, and in our experience, businesses with that little cushion are one bad quarter away from a covenant issue.

That DSCR calculation is built on the company’s adjusted earnings. And here is where buyers need to be careful: SDE and EBITDA are not interchangeable, even though brokers and some lenders use them loosely as if they were. SDE (seller’s discretionary earnings) includes the owner’s compensation and various add-backs that inflate the number. We discount reported SDE by 15% to 50% to approximate real cash flow, depending on the business. EBITDA, while more standardized, still requires normalization. The quality of earnings report is what bridges the gap between the seller’s claimed number and reality.

Consider this. A seller claims $400K in SDE, but the QoE reveals that $80K came from a one-time contract that ended 18 months ago. Your real SDE drops to $320K. And that is before you apply any discount for unreliable add-backs. That changes the loan amount the business can support. It changes the purchase price you should pay. Sometimes it kills the deal.

The lender will factor in QoE findings before issuing credit approval. If adjusted earnings shrink after the report comes back, expect the loan offer to shrink with it.

What the Report Actually Looks At

A quality of earnings analysis is not one thing. It is a collection of distinct investigations rolled into a single document.

Revenue quality. Is revenue recurring or lumpy? Are there multi-year contracts, or is everything transactional? Strip out one-time events and look at the trend line underneath.

Add-back verification. Sellers add back expenses to inflate SDE: personal vehicles, family payroll, above-market owner compensation, one-time legal fees. A QoE provider goes line by line and challenges every add-back with documentation. Some survive. Some do not.

Customer concentration risk. If one customer represents 35% of revenue, that is a material risk the report will quantify and flag. SBA lenders care about this, a lot.

Normalized working capital. What is the typical cash cycle of this business? How much working capital keeps operations running post-close? This number feeds directly into your SBA loan structure and your closing day cash requirements.

Non-recurring items. Did the business have a one-time expense two years ago that makes current margins look artificially clean? Or a one-time revenue event that inflated the trailing twelve months? Both distort the picture. Both need adjusting.

Accounting method issues. Cash versus accrual accounting, aggressive revenue recognition, deferred revenue that will reverse after you take over. These surface in QoE and can dramatically change normalized earnings.

How Much a Quality of Earnings Report Costs

For a business in the $500K to $2M purchase price range, expect $8,000 to $15,000 for a buy-side QoE. Larger transactions in the $3M to $5M range can push $20,000 to $35,000.

Those numbers sound painful until you run the math the other direction.

Say you are acquiring a $2M business and the quality of earnings report reveals that adjusted SDE is $75K lower than the seller claimed. At a 3.5x multiple, that is a $262,500 reduction in justifiable purchase price. The report paid for itself many times over.

The buyer almost always pays for the QoE. Some sellers commission a sell-side QoE before going to market to signal that the numbers are clean. That is useful context but not a substitute for your own independent analysis. A sell-side report was commissioned by the person trying to maximize the sale price. Get your own.

When to Order a Quality of Earnings Report

Timing matters more than most buyers realize.

Order it too early and you waste money on deals that fall apart during LOI negotiations. Order it too late and you are burning weeks when you should already be in underwriting with your lender.

The right window opens after you have a signed letter of intent, after basic due diligence confirms the deal is worth pursuing, and before you submit the full loan package. In practice, that is around week 3 to 4 of the diligence process.

You want the QoE findings in hand before the purchase price is locked in any binding document. Use the findings to negotiate. That is what they are for.

If the report comes back clean, it accelerates your SBA process. Your lender has verified earnings to underwrite against. If it comes back with adjustments, you now have independent, third-party documentation to support a price reduction. Or a walk-away.

How QoE Findings Affect Your Negotiation

This is where buyers leave money on the table. They receive a quality of earnings report showing $50K in unsupported add-backs and just accept it. They assume the seller will push back. Not worth the fight.

Wrong.

When the report documents that a claimed add-back is unsupportable, that is no longer your opinion. It is a third-party CPA firm’s professional finding. Take it back to the seller with the report attached.

The conversation changes fast.

We have seen QoE findings reduce purchase prices by 10% to 20% on deals where the seller had aggressively presented their numbers. We have also seen deals where the QoE confirmed everything and we moved to close with confidence. Both outcomes are wins. In one case you paid less. In the other you confirmed you were not overpaying.

What Makes a QoE Firm Worth Hiring

Not all QoE providers deliver the same quality, and for SBA-financed acquisitions the differences matter more than you might expect.

You want a firm that has specific experience with small to mid-market transactions in the $500K to $5M range. They need to understand SBA underwriting standards and DSCR requirements. They need to turn the report around in 2 to 3 weeks, because slow providers kill deal timelines. And the output needs to be clear, lender-ready documentation, not a 60-page academic exercise.

Big Four accounting firms are not the right call for most SBA deals. Expensive, slow, and accustomed to engagements ten times this size. Look for regional CPA firms or boutique transaction advisory shops that specialize in lower-middle-market M&A.

Your acquisition advisor should have a short list of vetted providers. If they do not, that tells you something about their process.

What Happens When You Skip It

Buyers sometimes try to skip the quality of earnings report to save $10K or shave two weeks off the timeline. Here is what tends to happen.

The deal closes. Six months later, the buyer discovers that $90K in SDE was tied to a personal expense account the previous owner ran through the business. That expense disappears when the owner leaves, and so does the cash flow the debt service was modeled on.

Now the business cannot cover the SBA loan payments. The bank is calling. The seller is unreachable.

And SBA loans come with a personal guarantee. You are on the hook. Not the broker who sold you the deal. Not the attorney who drafted the APA.

You.

A quality of earnings report will not protect you from every possible problem. But it is the most reliable way to verify that the earnings you are buying are real before you sign your name to a 10-year debt obligation.

Frequently Asked Questions

What is a quality of earnings report in a business acquisition?

A quality of earnings report is an independent financial analysis prepared by a third-party CPA firm. It verifies whether a target company’s reported earnings are accurate, sustainable, and repeatable by examining add-backs, revenue quality, customer concentration, and accounting practices. Buyers and SBA lenders use the report to confirm that cash flows supporting a purchase price are real.

Does an SBA 7(a) loan require a quality of earnings report?

Most SBA lenders require one on acquisitions above $500K. Even when not formally required, lenders use QoE findings to finalize underwriting. Because SBA loans are sized based on the business’s ability to service debt, findings that reduce adjusted earnings will reduce the loan amount the lender offers.

How much does a quality of earnings report cost for a small business acquisition?

For acquisitions in the $500K to $2M range, a buy-side quality of earnings report typically costs $8,000 to $15,000. Larger transactions from $3M to $5M can run $20,000 to $35,000. The buyer almost always pays. Given that findings regularly reduce purchase prices by far more than the cost of the report, most experienced buyers treat it as a non-negotiable line item.

What is the difference between a QoE report and an audit?

An audit confirms financial statements comply with accounting standards. A quality of earnings report asks whether those earnings are real and repeatable. A QoE challenges add-backs, flags one-time items, assesses customer concentration, and models normalized cash flows. For M&A purposes, a QoE is significantly more useful than an audit and is specifically designed for deal underwriting.

When should a buyer order a quality of earnings report?

Order after signing a letter of intent and completing initial due diligence, but before submitting your SBA loan package. That window is typically weeks 3 to 5 of the diligence period. You want findings in hand before any purchase price is locked in a binding document so you can use them to negotiate.

Ready to Acquire a Business the Right Way?

Most buyers find out too late that they needed a better process. We have one.

Regalis Capital runs a done-for-you acquisition advisory service. We identify deals, run the financial models, manage due diligence (including quality of earnings coordination), negotiate terms, and guide the full SBA process from LOI to close.

If you are serious about buying a profitable business and want a team that has done this across hundreds of deals, start here.