Quality of Earnings Reports for SMB Acquisitions: When You Need One, When You Don't

A Quality of Earnings report is the most-cited and least-understood document in SMB acquisitions.

Buyers ask for one because their lender or investor told them to. Sellers complain about the cost because their broker called it overkill. The CPA firm running it produces a 40-page deliverable that takes the deal team a week to digest. And by the time it lands, the LOI has been signed, the price has been agreed, and everyone is operating under the assumption that whatever the QoE says won't move the deal much.

That assumption is usually wrong. The QoE often moves the deal, and the buyers who do the most damage to themselves are the ones who treated it as paperwork.

Here's what a QoE actually is, when it's worth the money, and how to read it when you get one.

What Is a Quality of Earnings Report

A Quality of Earnings report is an independent financial analysis that tests whether the earnings a seller is using to set the asking price are sustainable and defensible.

In SMB acquisitions, a QoE is usually commissioned by the buyer (sometimes by the seller, in which case it's called a "sell-side QoE") and produced by a transaction-services CPA firm or a tech-enabled QoE provider. The deliverable is a written report — typically 25 to 60 pages — that walks through:

1. A normalized earnings statement. What SDE or EBITDA looks like after the analyst's adjustments, compared to what the seller is presenting.
2. A revenue quality analysis. Customer concentration, retention, recurring vs. one-time, top-customer trends.
3. A gross margin trend. Year-over-year, segment-by-segment, with an explanation of any compression.
4. A working capital analysis. AR aging, inventory turnover, payables stretching, customer deposits.
5. An add-back schedule with the analyst's opinion on each item — accepted, partially accepted, rejected, or unverifiable.
6. A list of "matters for the buyer's consideration" — flags that aren't dollar adjustments but should affect the buyer's pricing or structure.

The headline number is the analyst's view of "normalized" or "quality of" earnings. That number is what the multiple should be applied to. It's almost never the same as the number the seller presented.

How a QoE Differs From an Audit

This is the most common confusion in SMB deals. A financial audit and a Quality of Earnings report answer different questions.

An audit asks: Do these financial statements comply with the applicable accounting standard? The output is an opinion — clean, qualified, adverse, or disclaimed — on whether the books are fairly stated under GAAP or another framework.

A QoE asks: Is the earnings number we're using to value this business the right one to use?

Those are not the same question. An audit can produce a clean opinion on financial statements that still bury customer concentration, fake add-backs, or revenue that won't recur. The audit isn't trying to surface those things — they don't violate GAAP.

For SMB deals, the audit question is mostly irrelevant because most SMBs aren't audited at all. Their books are reviewed by a tax CPA, compiled quarterly, and reconciled when the tax return is filed. The buyer's question — what should I pay for this — is exactly what a QoE is designed to answer, and what an audit is not.

How a QoE Differs From a Buyer-Prepared SDE Schedule

If you've worked through our piece on how to calculate SDE, you've already seen what a thorough SDE schedule looks like. A buyer-prepared schedule done well can cover 70–80% of what a QoE covers.

What a QoE adds that a buyer-prepared schedule typically can't:

• Independence. Lenders, investors, and equity partners want the analysis to come from a named third party, not from the buyer's own spreadsheet.
• Field-tested methodology. A QoE firm has done this hundreds of times and knows where SMB sellers tend to misstate things by industry. A buyer doing their first deal doesn't.
• A defensible deliverable. When the loan committee asks the lender how confident they are in the earnings number, the lender wants a document to point at. A buyer spreadsheet rarely passes that test.
• Customer-level interviews and accounting subledger access. A full QoE often includes interviews with top customers and a pull of the GL detail, not just the financial summary the seller provides. Buyers rarely get that level of access on their own.

The trade-off is cost. A buyer-prepared SDE schedule costs you time and maybe $3,000 to $8,000 if you hire a transaction CPA to review it. A QoE costs $15,000 to $50,000 and takes three to six weeks.

For most SBA-financed deals under $1.5M in price, a buyer schedule reviewed by a transaction CPA is enough. Above $1.5M, the math starts to favor a QoE.

The Five Things a QoE Catches That Surface-Level Diligence Misses

1. Non-Recurring Revenue That Inflates Trailing Twelve Months

The most common QoE finding in SMB deals is a one-time revenue event that the seller didn't isolate. A large one-off project, a contract that paid in arrears all in one quarter, a customer that prepaid an annual contract during the year being measured, a settlement payment treated as revenue, a forgivable loan booked above the line.

When that revenue is added to a trailing twelve months number and then a multiple is applied to it, the buyer is paying a multiple of cash that won't recur. The QoE pulls those items out and recomputes the multiple base.

Consider a residential services business with a single large insurance restoration job that runs $180K of revenue and $90K of contribution margin through the trailing year. At a 3x SDE multiple, that one item moves the supportable price by roughly $270K — money the buyer would overpay if a QoE didn't surface and isolate it.

2. Customer Concentration That Won't Transfer With the Business

A QoE doesn't just compute the top-customer percentage — it tests whether those customers will stay after the seller exits.

The typical SMB seller will say "all our customers are loyal" and "I haven't lost an account in five years." A QoE tests that by reviewing the customer subledger month over month, identifying churn, computing retention by cohort, and — in deeper engagements — interviewing top customers under a confidentiality wrapper.

What the QoE finds is often a customer base that's loyal to the owner, not to the business. A 25% concentration in two customers who only do business with the founder is materially different from a 25% concentration in two customers under multi-year contracts. The dollar impact on the offer can be substantial — see our piece on customer concentration risk in SMB deals for the framework.

3. Gross Margin Compression Masked by Absolute Dollar Growth

Sellers present top-line revenue growth. QoE analysts look at margin trends.

A business that grew revenue from $3.2M to $3.8M over two years looks healthy on the surface. If gross margin compressed from 42% to 36% during the same period because of input cost increases or pricing pressure, the dollar contribution may have grown only slightly — and the trajectory may be negative.

The QoE charts gross margin by year, by quarter, by product line if the data exists, and asks the seller to explain compression. The buyer who doesn't have this view goes into negotiation assuming the business is growing. The QoE-equipped buyer goes in knowing the business is growing top-line but compressing on the line that actually pays the multiple.

4. Add-Backs That Wouldn't Survive Lender Scrutiny

Buyers handle add-backs poorly because they want the deal to work. Sellers handle add-backs aggressively because every dollar of add-back is roughly three dollars of price at a 3x multiple.

A QoE provides an independent opinion on each add-back: accepted, partially accepted, rejected, or unverifiable. That opinion column is what the lender's underwriter reads. If the QoE rejects an add-back, the lender is going to reject it too — and that flows directly to the financeable purchase price.

Take a $1.2M deal where the seller presents $185K of add-backs to move SDE from $390K to $575K. A QoE that accepts $112K, partially accepts $38K, and rejects $35K lands normalized SDE at $530K — $45K below the seller's number. At the seller's proposed 3.2x multiple, that gap is a $144K change in the supportable price.

This is the most common QoE outcome by far: a moderate downward revision in SDE that produces a meaningful change in the price the buyer should pay.

5. Working Capital Balances That Move Money at Closing

Working capital is usually settled at closing via a peg mechanism. The QoE establishes the historical working capital level — the "normal" balance the business has operated at — and that becomes the peg against which the actual close-date balance is measured.

If the buyer doesn't have a QoE-derived peg, the seller's broker will propose one. And the broker's peg tends to be set low — which means the seller keeps more cash and receivables at close and the buyer steps in with less working capital than the business actually needs to operate.

Working capital adjustments at closing routinely move $50K to $200K between buyer and seller in mid-sized SMB deals. See our companion piece on working capital adjustments at closing for the full mechanism — it's the most overlooked single dollar leak in first-time-buyer deals.

When You Actually Need a QoE

The list of situations where a QoE earns its keep:

• Deal price above $1.5M. Below that, the absolute dollar risk usually doesn't justify the spend.
• SDE above $400K. Same logic — bigger SDE base means a single percentage-point adjustment moves more dollars.
• Add-back schedule above $100K. Concentrated risk in the add-back column means the analyst's opinion has high dollar impact.
• Multiple revenue streams or product lines. More complexity means more places for the seller's number to be wrong.
• Customer concentration above 20%. Concentration risk needs to be quantified independently.
• SBA lender requires one. Some lenders require a QoE above certain deal sizes. Don't argue the requirement — the lender's underwriting committee has reasons.
• Outside equity in the deal. Search fund operators, ETA-backed buyers, and investor-funded acquisitions almost always require a QoE for the capital partner's diligence.
• The seller has been operating the business for less than five years. Shorter operating history means trailing financials may not reflect a stable run rate.

When You Don't Need One

Situations where a transaction-CPA-reviewed SDE schedule is usually enough:

• All-cash deals under $750K with simple revenue mix.
• Seller-financed deals where the buyer can negotiate a meaningful holdback or claw-back tied to revenue retention.
• Deals where the buyer has direct industry experience and can validate revenue quality from operating knowledge.
• Owner-operator transitions where the buyer is essentially buying a job and pricing accordingly.
• Deals where the seller is willing to share full GL detail and the buyer has the CPA bench to dig through it.

In those situations, the right move is a focused SDE schedule prepared by the buyer with a transaction CPA second-checking the add-back column. Budget $3,000 to $8,000 for that work. The QoE-grade output you'd get for $25,000 is overkill for the dollar exposure.

What a QoE Costs and How Long It Takes

The market has split into three layers over the past two years.

Big 4 transaction advisory. Rarely takes deals under $10M. When they do, the price starts at $75,000 and runs higher. They use this work as training ground for junior associates, and the deliverable can be excellent — but for the deal sizes most SBA buyers operate at, the price-to-value ratio doesn't work.

Boutique CPA firms specializing in SMB transactions. $25,000 to $50,000 for deals between $1.5M and $10M. Four to six weeks from kickoff to deliverable. Strong industry expertise in specific verticals (HVAC, dental, professional services, e-commerce) is common. This was the default tier for SMB acquisitions until about 2024.

Tech-enabled QoE providers. $10,000 to $25,000 for deals under $5M. Three to four weeks. Examples include Finsider.ai (AI-assisted QoE with a 74-point automated scan, launched 2025) and Bedrock Quality of Earnings (institutional-quality methodology on smaller deals). The methodology is increasingly defensible and lender-acceptable, though buyers should verify in advance that their specific lender will accept the provider.

For most SBA-financed deals between $1.5M and $5M, the tech-enabled tier has become the dominant choice — same defensibility for half the cost and a quarter less wait time.

How to Read a QoE Report

When the QoE lands, the order to read it in:

1. Executive summary first. Read the analyst's "normalized SDE" or "adjusted EBITDA" number and the bridge from the seller's presented number. That's the headline.
2. Add-back schedule second. Read every item the analyst rejected or partially accepted. Each one is a price negotiation.
3. Matters for the buyer's consideration. These are flags that aren't dollar adjustments — concentration concerns, accounting irregularities, key-person observations, regulatory exposures. Triage them.
4. Customer detail. Look at the top-customer concentration, retention, and revenue trend by customer. Compare what's there to what the seller represented.
5. Working capital analysis. Find the analyst's proposed peg level and compare it to the seller's number.
6. Quality of revenue. Recurring vs. project, contracted vs. discretionary, multi-year vs. one-off.

Things to be alert to inside the report itself:

• "Unable to verify" or "client did not provide" language. These are red flags about the seller's cooperation, not just about the analyst's coverage.
• Wide ranges in proposed adjustments. When the analyst presents a low and high estimate that span $50K or more, the seller's accounting probably doesn't support a single defensible number — and that's its own finding.
• Footnotes that contradict the body. Read footnotes. They often contain the disclaimers the analyst couldn't put in the main text.
• Comparison to industry benchmarks. Most QoEs now include benchmark comparisons. If the target's gross margin is materially below industry, that's a red flag even if year-over-year is flat.

Worked Example: A $1.8M HVAC Scenario

To make the mechanics concrete, walk through an illustrative scenario showing how a QoE can move price on a deal of this size.

The Bottom Line

A Quality of Earnings report is the highest-leverage piece of diligence work most SMB buyers can commission. It costs less than the legal fees on the LOI and often moves the price by more than the legal fees move every other clause combined.

The question isn't whether earnings need to be tested — they always do, because the seller's number is the seller's number, not an independent one. The question is whether the testing needs to be independent and named, or whether a buyer-prepared analysis is sufficient given the deal size, the lender's posture, and who else is at the table.

For deals above $1.5M, the answer is almost always: yes, get the QoE. For deals below that threshold with a single revenue stream and a transparent seller, a focused buyer-prepared SDE schedule is usually enough.

What matters most is that you've actually tested the earnings number — independently or otherwise — before you sign a price. The buyers who get hurt are the buyers who treated the seller's SDE schedule as the answer instead of as a starting point.