INSIGHT

Quality of earnings vs audit: What business owners need to know

Craig Hamm • March 25, 2025

Services: Quality of Earnings

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When preparing for a potential M&A transaction, middle-market business owners often hear the terms “audit” and “quality of earnings” used interchangeably. However, these financial analyses serve fundamentally different purposes, and understanding the distinction is crucial for anyone considering selling their business.  

This article explores the key differences between quality of earnings reports and financial audits, explains why quality of earnings analyses are often more valuable in transaction scenarios and provides guidance on how to prepare for this important aspect of the M&A process. 

What is a quality of earnings report? 

A quality of earnings (QoE) report is a specialized financial analysis designed specifically for transaction purposes. Rather than focusing on compliance with accounting standards, a QoE analyzes the true economic earnings of a business by normalizing financial results and removing non-recurring or unusual items that might distort performance. 

The primary focus of a QoE is adjusted EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization), which serves as the foundation for most middle-market business valuations. By examining monthly financial data typically spanning three years plus the trailing twelve months, QoE providers can identify trends, seasonality and anomalies that impact the sustainable earning power of a business. 

Key components of a QoE report include: 

• Normalized EBITDA adjustments 
• Working capital analysis 
• Monthly performance trends 
• Business risk assessment 
• Transaction-specific financial considerations 

What does an audit provide? 

A financial statement audit serves a different purpose altogether. Audits are compliance-focused examinations that determine whether financial statements are fairly presented in accordance with Generally Accepted Accounting Principles (GAAP). 

Unlike QoEs, audits concentrate on reported financial results rather than normalized earnings. They typically review annual periods aligned with the company’s fiscal year and involve detailed testing of account balances and transactions to ensure material accuracy. 

An audit delivers: 

• An opinion on GAAP compliance 
• Verification of reported historical results 
• Assessment of internal controls 
• Annual financial statement validation 

QofE vs audit: Critical differences that matter in M&A transactions 

The distinctions between these financial tools become particularly important during business sale processes. While both provide valuable insights, they serve vastly different functions in the M&A context. 

First, QoEs focus on adjusted EBITDA—the metric most buyers use to value businesses—while audits focus on net income and GAAP compliance. Second, QoEs analyze monthly data over a longer period, providing deeper visibility into performance patterns than annual audit reviews. 

Perhaps most importantly, QoEs address transaction-specific concerns like working capital requirements and business risks relevant to potential buyers. Audits, while valuable for general governance and compliance, rarely address these transaction-critical elements. 

“In a perfect world, you would have both a QoE and an audit. However, time is often the enemy of M&A deals. By the time audits are completed, the information has become stale and reflects only year-end financial results, missing crucial transaction-specific insights.” – Craig Hamm, Partner – Advisory 

Why buyers value QoE reports in transactions 

In almost every middle-market M&A transaction, buyers conduct some form of financial due diligence regardless of whether audited financial statements exist. This happens because buyers require different information than what audits provide. 

Buyers primarily care about future earning potential and the sustainability of those earnings. A QoE directly addresses these concerns by: 

• Identifying one-time or non-recurring items that affect reported results 
• Analyzing owner compensation and discretionary expenses 
• Assessing customer concentration risks 
• Evaluating working capital requirements 
• Providing monthly trend analysis to spot seasonality or growth patterns 

This transaction-focused approach means buyers most often rely on QoEs for their financial due diligence rather than audits alone. Even companies with clean audit opinions typically undergo a QoE process during a sale. 

Strategic advantages of sell-side QoE reports 

While buyers commonly commission QoE reports during due diligence, forward-thinking sellers can gain significant advantages by conducting their own QoE before going to market. This “sell-side” QoE provides several benefits: 

• Identifies financial adjustments that enhance business value 
• Uncovers potential issues before buyers discover them 
• Creates more accurate financial expectations for the transaction 
• Accelerates the due diligence process 
• Strengthens negotiating positions on valuation 
• Reduces the risk of price reductions later in the process 

Preparing for a successful QoE process 
For business owners contemplating a future transaction, several steps can help prepare for a smooth QoE process: 

• Maintain detailed monthly financial statements 
• Document non-recurring expenses and revenues
• Track owner-related expenses separately 
• Implement consistent accounting practices 
• Retain supporting documentation for significant transactions
• Consider a sell-side QoE before marketing the business  
   

Choosing the right partner for transaction advisory 

Understanding the difference between quality of earnings and audits is essential for business owners considering a transaction. While audits serve important compliance functions, quality of earnings reports provide the transaction-specific insights that drive valuation discussions and facilitate successful deals.  

Working with BPM gives you access to professionals who can guide you through this critical process, helping to maximize value and minimize surprises throughout your transaction journey. To find out more, contact us.