Quality of Earnings Report Guide: Insights for 2026
- Riley Johnston
- Jan 20
- 12 min read
Are you preparing for a business sale, acquisition, or investment in 2026? The quality of earnings report is now a must-have tool for any serious dealmaker.
This guide explains what a quality of earnings report is and why it matters for buyers, sellers, and advisors. You will learn how to spot risks and opportunities that others might miss.
We cover the essentials, show step-by-step analysis, and provide real-world examples. Stay ahead in today’s market by understanding these reports and maximizing your deal’s value.
Ready to make informed decisions? Let’s get started.
What Is a Quality of Earnings Report?
A quality of earnings report is a specialized financial analysis used in mergers, acquisitions, and exit planning to reveal the true sustainability of a company’s profits. Unlike standard financial statements, this report digs deeper to separate recurring, operational earnings from one-time events or accounting anomalies.
Buyers, sellers, and advisors rely on the quality of earnings report to assess whether profits are consistent and reliable. This process is especially critical as business models become more complex and financial reporting standards evolve.
What Sets a Quality of Earnings Report Apart?
The main goal of a quality of earnings report is to help stakeholders understand the difference between what is reported as net income and what truly reflects ongoing business performance.
Key distinctions include:
Focus on recurring revenue and core operations.
Removal of non-recurring gains, such as asset sales or litigation wins.
Identification of customer concentration risks and seasonality.
A traditional income statement may highlight strong profits, but these can sometimes be boosted by temporary or unusual events. The quality of earnings report highlights whether those earnings are repeatable and sustainable.
High-Quality vs. Low-Quality Earnings
Not all earnings are created equal. High-quality earnings stem from core business activities and are likely to continue in the future. Low-quality earnings, by contrast, often result from one-time transactions or aggressive accounting.
Here is a comparison table to clarify the differences:
Factor | High-Quality Earnings | Low-Quality Earnings |
Revenue Source | Recurring (subscriptions) | One-time sales or windfalls |
Customer Concentration | Diversified | Over-reliance on few clients |
Non-Recurring Gains | Minimal | Significant |
Expense Adjustments | Transparent | Frequent, unexplained |
Cash Flow Alignment | Strong | Weak or inconsistent |
For more detail on how to evaluate the quality of financial reports and the impact on business value, see Evaluating Quality of Financial Reports.
Step-by-Step: What Does a Quality of Earnings Report Include?
A typical quality of earnings report covers:
Executive summary of findings and recommendations.
Detailed analysis of revenue sources and trends.
Normalization of EBITDA by removing one-time items.
Review of working capital and cash flow.
Assessment of assets, liabilities, and debt.
Why Are Quality of Earnings Reports Essential in Transactions?
The use of a quality of earnings report is rising fast. In 2025, more than 70% of private equity deals included a formal QoE report. This trend reflects the growing need for clarity and trust in deal-making.
Advantages include:
Reducing post-closing disputes.
Increasing transparency between buyers and sellers.
Supporting better financing and deal terms.
A real-world example: A family-owned business showed positive net income, but a quality of earnings report revealed poor cash flow due to delayed customer payments. This insight helped both buyer and seller adjust expectations and avoid future conflict.
In summary, a quality of earnings report is a critical tool for anyone involved in buying, selling, or advising on private company transactions. It provides a clear, unbiased view of financial health, reduces risk, and helps maximize value.
Why Quality of Earnings Reports Matter in 2026
The business landscape in 2026 is more complex than ever. Companies face evolving financial models, intricate revenue streams, and heightened scrutiny from investors. As a result, the quality of earnings report has become essential for anyone considering a sale, acquisition, or investment.
Complexity and Trends in 2026
Several factors are driving the increased importance of the quality of earnings report:
Diverse business models require deeper financial analysis.
Revenue recognition standards continue to evolve.
Technology and subscription-based models add new layers of complexity.
Investors expect transparency and detailed breakdowns.
According to the 2025 M&A Trends Survey Report, over 70% of private equity deals now require a formal quality of earnings report.
Impact of Regulation and Volatility
Regulatory scrutiny is rising across industries. Compliance requirements have become stricter, demanding more accurate reporting. Economic cycles and market volatility also impact earnings reliability.
Regulations force companies to disclose more detail.
Shifting markets make future earnings less predictable.
Lenders and investors rely on quality of earnings reports for risk assessment.
A quality of earnings report helps highlight stable, recurring income and exposes one-time gains that could distort true performance.
Real-World Examples and Data
Consider a company with impressive net income but weak operating cash flow. The quality of earnings report uncovers that profits are driven by non-recurring events, not sustainable operations.
Key statistics:
Metric | Data Point |
Deals with QoE flagged adjustments | 60% (2025) |
Reduction in deal fall-through rates | Up to 30% |
Deals requiring QoE report | 70%+ |
A private equity firm recently adjusted EBITDA multiples after a quality of earnings report revealed inflated profits from asset sales.
Action Steps for Buyers, Sellers, and Advisors
To leverage the quality of earnings report in 2026:
Start early, before due diligence begins.
Review both reported net income and operating cash flow.
Identify one-time adjustments and recurring revenue streams.
Use findings to negotiate better deal terms.
For buyers, this process avoids overpaying for unsustainable profits. Sellers can address issues before going to market. Advisors build trust by providing transparent, data-driven insights.
A quality of earnings report is no longer optional. It is a critical tool for navigating the complexities of modern transactions.
Key Components of a Quality of Earnings Report
A quality of earnings report is only as strong as its core components. Each element offers unique insights into a company's financial health, value drivers, and potential risks. Understanding these key sections helps buyers, sellers, and advisors make informed decisions and avoid surprises during M&A or exit planning.
Executive Summary and Business Overview
The executive summary in a quality of earnings report distills the most important findings, risks, and recommendations. It provides stakeholders with a snapshot of the company's financial position, management structure, and transaction context.
Includes company history, ownership, and leadership profiles.
Summarizes key risks, such as customer concentration or legal disputes.
Identifies value drivers and red flags for potential buyers.
For example, a family-owned manufacturer planning to sell in 2026 used the executive summary to highlight stable leadership and minimal turnover, boosting buyer confidence. Industry research shows that reports with clear executive summaries reduce negotiation time by 15%. For a deeper dive into industry standards, see Best Practices for Quality of Earnings Reports.
Revenue Quality and Sustainability
A quality of earnings report dissects revenue streams to reveal which are sustainable and which may be at risk. This section analyzes the sources and reliability of income.
Breaks down recurring vs non-recurring revenue.
Identifies customer concentration risks if top five clients account for more than 40% of revenue.
Evaluates seasonality and market trends.
Table: Revenue Breakdown Example
Source | 2024 Revenue | % of Total | Recurring? |
Subscription Sales | $2,000,000 | 50% | Yes |
Project Contracts | $1,200,000 | 30% | No |
One-time Licensing | $800,000 | 20% | No |
A SaaS company with 80% recurring revenue is more attractive to buyers than a firm reliant on one-time deals.
Expense and Margin Analysis
This section normalizes earnings by removing one-time items, revealing the true profitability of the business. The quality of earnings report uses detailed margin analysis to spot trends.
Adjusts for litigation settlements, restructuring, or asset sales.
Reviews gross, operating, and net margins against industry averages.
Flags aggressive cost-cutting that may not be sustainable.
Step-by-Step: Normalizing EBITDA
Identify non-recurring expenses (e.g., $200,000 legal settlement).
Remove these from EBITDA calculation.
Adjust for ongoing costs like leases or stock compensation.
Review impact on margins.
A real-world example: After adjustments, a retailer's normalized EBITDA fell from $1.5M to $1.1M, alerting buyers to potential overstatement.
Working Capital and Cash Flow
A quality of earnings report always assesses operating cash flow compared to net income. This reveals if profits are actually turning into cash.
Examines trends in receivables, payables, and inventory.
Highlights companies with delayed collections or excessive inventory.
Calculates working capital requirements for day-to-day operations.
Example: A distributor with $3M in annual sales but $1.2M in outstanding receivables signals possible collection issues.
Quick Guide: Assessing Cash Flow Health
Calculate cash conversion cycle.
Compare operating cash flow to net income.
Investigate any large discrepancies.
Balance Sheet and Debt Considerations
The final component reviews the balance sheet to uncover hidden risks and future obligations. This section of the quality of earnings report is vital for understanding long-term financial health.
Reviews assets, liabilities, and off-balance-sheet items.
Assesses impact of debt covenants on future earnings.
Identifies recent asset sales, write-offs, or debt restructuring.
Table: High-Quality vs Low-Quality Earnings
Factor | High-Quality Earnings | Low-Quality Earnings |
Recurring Revenue | Yes | No |
Customer Concentration | Low | High |
Non-Recurring Gains | Minimal | Frequent |
Cash Flow vs Net Income | Strong Alignment | Weak/Negative |
For instance, a company with heavy off-balance-sheet liabilities may face future cash flow constraints, reducing its attractiveness to lenders.
How to Prepare a Quality of Earnings Report: Step-by-Step Guide
Preparing a quality of earnings report requires a disciplined, methodical approach. Each step uncovers crucial financial insights, helping buyers, sellers, and advisors make informed decisions. Follow this guide to ensure your quality of earnings report is thorough, accurate, and valuable.
Step 1: Understand the Business and Industry Context
Start your quality of earnings report by analyzing the business environment. A deep dive into the company’s operations, products, and services is essential.
Review the company’s history, mission, and market position.
Assess the competitive landscape and key industry trends.
Identify the target customer base and any concentration risks.
For example, a company operating in a declining sector will face different earnings risks than one in a high-growth field. In 2025, 43% of failed deals cited lack of industry understanding as a primary reason. Without understanding these dynamics, your quality of earnings report may miss critical context.
Step 2: Gather and Organize Financial Data
A comprehensive quality of earnings report depends on robust data collection. Gather at least 3 to 5 years of audited financial statements, tax returns, and bank records.
Collect interim financials, forecasts, and supporting schedules.
Request accounts receivable and payable aging reports.
Obtain details on unusual transactions or non-recurring events.
Use this checklist to keep your process on track:
Document Type | Years Needed | Purpose |
Audited Financials | 3-5 | Trend analysis |
Tax Returns | 3-5 | Verify reported income |
Bank Statements | 1-2 | Confirm cash movements |
Interim Statements | YTD | Spot recent changes |
Contracts/Agreements | 1-5 | Identify obligations |
A thorough exit assessment for selling a business can streamline this step, ensuring nothing is overlooked.
Step 3: Conduct Preliminary Analysis and Identify Red Flags
With data in hand, begin your preliminary quality of earnings report analysis. Focus on:
Spotting inconsistencies in revenue, expenses, or margins.
Reviewing for missing data or unusual accounting practices.
Interviewing management to clarify discrepancies.
Real-world example: One company reported strong revenue growth, but interviews revealed aggressive revenue recognition policies. This red flag led to further scrutiny of their quality of earnings report. In 2025, 37% of M&A deals were delayed due to unresolved data discrepancies.
Step 4: Normalize and Adjust Financial Statements
Next, normalize financial statements to reflect true, sustainable earnings. This is a core component of any quality of earnings report.
Adjust for non-recurring items (asset sales, legal settlements).
Normalize recurring expenses like depreciation or stock compensation.
Document each adjustment with clear rationale and supporting data.
Sample adjustment table:
Item | Reported Amount | Adjustment | Normalized Amount |
Net Income | $2,000,000 | -$300,000 | $1,700,000 |
EBITDA | $2,400,000 | -$250,000 | $2,150,000 |
Example: Removing a one-time gain from asset sales revealed a 15% lower EBITDA, reshaping deal negotiations. In 2025, 60% of deals required at least one major adjustment in the quality of earnings report.
Step 5: Analyze Key Performance Indicators (KPIs)
A high-impact quality of earnings report benchmarks performance against industry standards.
Calculate revenue growth rates, gross margins, and cash conversion cycles.
Compare KPIs to industry averages and prior periods.
Investigate any significant deviations or trends.
Example: A company’s margins declined despite rising revenue. KPI analysis revealed increased discounting to win new business, impacting long-term profitability. According to industry data, 54% of deals in 2025 flagged KPI anomalies during due diligence.
Step 6: Draft the Report and Summarize Findings
Finally, compile your quality of earnings report with clarity and precision.
Write an executive summary highlighting key findings and risks.
Include detailed sections for revenue, expenses, working capital, and debt.
Attach appendices with supporting schedules, adjustment logs, and data tables.
Review the draft with management and stakeholders. A well-prepared quality of earnings report can reduce post-closing disputes by up to 30%. Real-world success: A family business identified $400,000 in hidden liabilities, adjusted their value expectations, and secured better terms.
Interpreting the Quality of Earnings Ratio and Key Metrics
Understanding the quality of earnings report is central to evaluating any business transaction. One of the most important metrics within this report is the Quality of Earnings (QoE) Ratio. This simple measure can reveal the true sustainability of a company’s profits.
What Is the Quality of Earnings Ratio?
The QoE Ratio is a quick way to gauge if reported profits are backed by real cash flow. The formula is straightforward:
<code>QoE Ratio = Operating Cash Flow / Net Income </code> For example, if a company reports $1.5 million in operating cash flow and $2 million in net income, its QoE Ratio is:
QoE Ratio = Operating Cash Flow / Net Income
<code>QoE Ratio = $1,500,000 / $2,000,000 = 0.75 </code> How to Calculate and Interpret the QoE Ratio
QoE Ratio = $1,500,000 / $2,000,000 = 0.75
Follow these steps to use the QoE Ratio in your quality of earnings report analysis:
Obtain net income and operating cash flow from financial statements.
Plug the values into the formula.
Compare the result to benchmarks.
A ratio above 1 signals earnings are well-supported by cash flow. A ratio close to 1 is often considered healthy. Below 1 may indicate issues that warrant a deeper look.
Common Causes for Ratio Differences
Several factors can cause the QoE Ratio to diverge from 1. Typical reasons include:
Aggressive revenue recognition or accounting policies
Timing differences between when revenue is earned and cash is received
Seasonality in the business model
One-time events, such as asset sales
These issues can distort the quality of earnings report and mask underlying risks.
Table: What Your QoE Ratio Means
QoE Ratio Value | Interpretation | Typical Causes |
>1.0 | Healthy | Strong cash flow, conservative accounting |
0.9–1.0 | Normal | Minor timing differences |
0.6–0.9 | Caution | Possible aggressive accounting |
<0.6 | Red Flag | Poor cash flow, unsustainable earnings |
How Stakeholders Use QoE Ratios
Lenders, investors, and acquirers rely on the quality of earnings report to avoid overpaying for inflated profits. A persistently low QoE Ratio often leads to lower valuations or even failed deals. For instance, a private equity buyer walked away from a transaction after discovering the target’s ratio stayed below 0.7 for three years, which revealed hidden cash flow problems.
A recent industry study found that more than 70% of private equity deals now require formal quality of earnings report analysis. This supports why more sellers are using quality of earnings reports for M&A deals as a way to increase transparency, reduce risk, and build trust with buyers.
Understanding the QoE Ratio is an actionable step for anyone involved in M&A. It helps you spot risks early and make better, data-driven decisions.
Emerging Trends and Best Practices for Quality of Earnings in 2026
The landscape for the quality of earnings report is evolving rapidly. In 2026, companies, investors, and advisors must adapt to new technologies, regulations, and market dynamics to stay ahead. Let us explore the most significant trends and actionable best practices shaping the future of earnings analysis.
Use of Technology and Data Analytics
Modern quality of earnings report processes are leveraging technology at an unprecedented pace. Artificial intelligence now scans thousands of transactions to detect anomalies that traditional audits might miss. In 2025, 68% of M&A advisors reported using AI-powered tools to flag irregular cash flows and revenue recognition issues.
Key tech-driven advances include:
Automated benchmarking against real-time industry data
Machine learning algorithms that identify patterns of risk
Cloud-based collaboration platforms for faster report generation
For business owners, these innovations mean deeper insights and fewer surprises. According to a recent survey, deals involving advanced analytics saw a 25% decrease in post-closing disputes. For more on the future of diligence, see exit planning trends for business owners.
Regulatory and Market Developments
The regulatory environment for the quality of earnings report is tightening. New private company reporting standards are rolling out in the US and EU, requiring more detailed disclosure of revenue sources, non-recurring items, and working capital trends.
Key developments to watch:
Tighter controls on EBITDA adjustments
Increased scrutiny on off-balance-sheet liabilities
Mandatory cash flow reconciliation for deals above $10 million
Global economic shifts also play a role. Volatility in interest rates and supply chains has forced acquirers to demand more robust earnings validation. In 2025, 44% of deal term sheets included additional financial covenants based on QoE findings.
Integrating QoE into Exit Planning and Value Enhancement
Integrating the quality of earnings report early into exit planning can significantly increase business value. Leading advisors recommend starting a QoE review 12 to 24 months before a planned sale.
Step-by-step guide:
Conduct a preliminary QoE assessment to identify gaps.
Address recurring vs. one-time revenue issues.
Implement changes to improve working capital management.
Reassess and document earnings improvements.
A family business that followed this approach increased their valuation by 18% after addressing QoE findings. For actionable strategies, see how to maximize business value before selling.
Best Practices for Buyers, Sellers, and Advisors
Adopting best practices is critical to a successful quality of earnings report. Top recommendations include:
Start QoE analysis early, ideally before formal diligence begins.
Assemble a cross-functional team: finance, legal, operations, and IT.
Maintain transparency by documenting all adjustments and their rationale.
Benchmark KPIs against industry standards.
Use scenario analysis to stress-test earnings sustainability.
Step-by-step, this approach reduces risk and builds trust between all parties.
Real-World Examples and Lessons Learned
Learning from past deals is vital. Consider the following table of common pitfalls and their impact:
Pitfall | Impact on Deal |
Overstated recurring revenue | Reduced valuation |
Hidden liabilities | Deal renegotiation |
Aggressive cost-cutting | Lower buyer confidence |
Concentrated customer base | Stricter terms |
Non-recurring gains | EBITDA adjustments |
Case Study: In 2025, a SaaS company’s quality of earnings report uncovered unbilled receivables and one-time contract wins that inflated EBITDA. The buyer adjusted the offer downward, but both sides avoided a post-closing dispute and ultimately closed the deal successfully. As you think about your own exit strategy or prepare for important decisions in 2026, having clarity on your company’s true earnings quality is essential. We’ve explored how a thorough Quality of Earnings report can protect your value, uncover hidden risks, and set you up for a successful transition—on your terms. If you want to take the next step and see where your business stands, you don’t have to navigate this alone. Let’s get you started with a personalized assessment that highlights your strengths and opportunities. Start Your Exit Readiness Assessment
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