Sign inWhat is a quality of earnings report?
A quality of earnings report is an accounting diligence exercise that tests whether reported EBITDA reflects sustainable, recurring cash earnings.
How practitioners use it
The report rebuilds EBITDA from the ground up, separating recurring performance from one-off items, accounting policy effects, and owner-specific costs. The output is an adjusted EBITDA a buyer is willing to pay a multiple on.
Because purchase price is usually a multiple of EBITDA, every unit of adjustment is leveraged. On a 10.0x deal, a 5 disagreement about add-backs is a 50 disagreement about price.
This is why the quality of earnings process, not the model, often decides the final negotiation.
Worked example with round numbers
01
A seller presents adjusted EBITDA of 100 including 8 of owner compensation add-backs.
02
Diligence accepts 5 and rejects 3 as ongoing cost.
03
At 10.0x, that single conclusion moves enterprise value by 30.
Where people get it wrong
- Taking management add-backs at face value in a model.
- Ignoring working capital normalisation, which affects the cash purchase price.
- Assuming a clean audit removes the need for a quality of earnings review.
Learn it by using it
Definitions stick once you have run the numbers yourself. The desk below is free and needs no signup.
Practise screening a deal