Definition
What is a quality of earnings analysis?
A quality of earnings analysis determines how much of a company's stated EBITDA is real, recurring, and sustainable — as opposed to inflated by non-recurring items, aggressive accounting, or one-time events that will not repeat under new ownership.
Every acquisition is priced as a multiple of earnings. If the earnings are wrong, the price is wrong. A quality of earnings analysis is the discipline of testing whether the number the seller puts on the table — the EBITDA the purchase price is based on — reflects the actual, recurring earning power of the business. When it doesn't, the gap is real money: at a 5x multiple, every $100K of overstated EBITDA costs the buyer $500K in purchase price.
What does a QoE report actually examine?
A quality of earnings report works through the P&L line by line, testing each component of the seller's stated EBITDA against four questions:
- Is it recurring? A one-time insurance settlement, a litigation recovery, or a PPP loan forgiveness inflates the year it lands and will not repeat. These are added back to normalize earnings.
- Is it operating? Gains on asset sales, investment income, or foreign exchange windfalls are real income but not operating earnings. They should not be valued at an operating multiple.
- Is it arm's length?Owner compensation above market rate, rent paid to a related entity at non-market terms, or family members on payroll who won't be there post-close — these are owner-specific items that adjust out under new ownership.
- Is it sustainable?A customer that represents 40% of revenue and has signaled it's going to RFP. A pricing structure that hasn't been adjusted since 2021. Revenue recognized in the current period that belongs in the next. These don't appear in the EBITDA bridge — they appear in the risk findings.
What is an EBITDA bridge?
The EBITDA bridge is the central output of a QoE analysis. It walks from the seller's stated EBITDA to the buyer's adjusted EBITDA, adjustment by adjustment. Each line shows: what was adjusted, by how much, from which source document, and whether the adjustment is undisputed or requires further verification from the seller.
Example: A seller states EBITDA of $2.1M. The QoE identifies $180K in non-recurring legal fees, $90K in above-market owner compensation, $45K in a one-time equipment sale gain, and $35K in a PPP loan forgiveness. Adjusted EBITDA: $1.75M. At a 5x multiple, the adjustments represent $1.75M of purchase price the buyer should not be paying.
What is adjusted EBITDA?
Adjusted EBITDA is what remains after stripping out everything non-recurring, non-operating, and owner-specific. It represents the sustainable, normalized earning power of the business under new ownership — the number the purchase price should actually be based on. The gap between stated EBITDA and adjusted EBITDA is where deals get repriced, renegotiated, or walked away from.
How is a QoE different from an audit?
An audit asks: "are the financial statements materially correct under GAAP?" A QoE asks: "what are these earnings actually worth to a buyer?" An audit can give a clean opinion on statements that contain $500K of non-recurring items — those items are legitimately recorded under GAAP. A QoE flags them because they will not recur under new ownership and should not be priced into the multiple.
The audit protects the accountant. The QoE protects the buyer.
Who commissions a quality of earnings?
Buy-side: Private equity firms, strategic acquirers, family offices, and search funds. The QoE is typically the first piece of financial due diligence after the LOI is signed. For PE firms doing mid-market acquisitions, the QoE is the foundation the investment committee memo is built on.
Sell-side (vendor due diligence):Sophisticated sellers commission their own QoE before going to market — identifying and addressing issues before the buyer finds them. This typically results in higher realized multiples and fewer re-trades, because the buyer's diligence confirms rather than discovers.
What does a QoE cost — and how long does it take?
Traditional QoE from a Big Four firm (Deloitte, PwC, EY, KPMG) or a mid-market advisory firm (FTI Consulting, Alvarez & Marsal) costs $150,000-$300,000 and takes 4-6 weeks. For lower middle market deals ($5M-$50M enterprise value), regional accounting firms offer QoE for $30,000-$80,000 in 3-4 weeks.
AI-powered QoE changes the economics. Navos delivers a first-pass analysis within days of document upload — not weeks — with findings that deepen as additional data is provided. The speed advantage matters in competitive deal processes where the acquirer who moves faster has leverage.
How Navos delivers quality of earnings analysis
Navos Due Diligence runs a 33-module analysis pipeline that covers revenue quality, expense quality, working capital, balance sheet, LOI cross-referencing, and forensics. The output includes:
- EBITDA bridge with every adjustment sourced, categorized, and confidence-scored
- Structured findings ranked by severity (deal-killer, price-mover, monitor) with evidence trails
- Customer concentration analysis with Herfindahl index computation
- Working capital normalization with AR/AP aging trends
- Deal Advisor — a conversational AI the partner can query about any aspect of the deal in real time
The central object is a thesis of claims— each claim starts as unassessed and evolves to supported, at-risk, or failed as evidence accumulates. This is thesis-driven diligence: the system doesn't just flag issues, it tests the investment thesis.
Frequently asked questions
- What is a quality of earnings analysis?
- A quality of earnings (QoE) analysis examines a company's reported earnings to determine how much of the stated EBITDA is real, recurring, and sustainable. It identifies non-recurring items, aggressive accounting, owner-specific expenses, and revenue quality issues that inflate or distort the earnings a buyer is paying for.
- Why is quality of earnings important in M&A?
- Because the purchase price is almost always a multiple of EBITDA. If the seller's stated EBITDA of $2.1M includes $180K in non-recurring legal fees and $90K in above-market owner compensation, the real recurring EBITDA is $1.83M. At a 5x multiple, that $270K in adjustments represents $1.35M of purchase price — money the buyer pays for earnings that will not recur.
- What does a QoE report include?
- A full EBITDA bridge from the seller's stated number to the adjusted figure, with each adjustment categorized (non-recurring, non-operating, owner-specific), sourced to specific line items, and assigned a confidence level. Supporting analysis includes customer concentration (Herfindahl index), revenue quality and cutoff testing, working capital normalization, and a data quality score reflecting how much of the source data was verified.
- What is an EBITDA bridge?
- An EBITDA bridge is a structured reconciliation that walks from the seller's stated EBITDA to the buyer's adjusted EBITDA, item by item. Each adjustment is a line showing what was added back (non-recurring expenses) or removed (non-recurring revenue), with the source document, the amount, and whether the adjustment is undisputed or requires further verification.
- What is adjusted EBITDA?
- Adjusted EBITDA is the company's earnings before interest, taxes, depreciation, and amortization after removing items that are non-recurring, non-operating, or specific to the current owner. It represents the sustainable, recurring earning power of the business under normalized ownership — the number the purchase price should actually be based on.
- How long does a quality of earnings analysis take?
- Traditional QoE from a Big Four or mid-market advisory firm takes 4-6 weeks and costs $150,000-$300,000. AI-powered QoE from Navos delivers a first-pass analysis within days of document upload, with findings that deepen as additional data is provided. The speed advantage matters because deal timelines are compressed and competitive — the acquirer who moves faster has leverage.
- What is the difference between a QoE and a financial audit?
- An audit asks "are the financial statements materially correct under GAAP?" A QoE asks "what are these earnings really worth to a buyer?" An audit can give a clean opinion on statements that contain $500K of non-recurring items — those items are legitimately recorded. A QoE flags them because they will not recur under new ownership and should not be priced into the multiple.
- Who needs a quality of earnings analysis?
- Any acquirer paying a multiple of earnings: private equity firms, strategic acquirers, family offices, and search funds. On the sell side, sophisticated sellers commission vendor due diligence (including QoE) before going to market to identify and address issues before the buyer finds them — which typically results in higher realized multiples and fewer re-trades.
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