A quality of earnings (QoE) report looks for patterns in the numbers that need an explanation before a buyer pays a multiple on them. The ones that come up most often are revenue that does not tie to bank deposits or filed tax returns, add-backs with no support, "one-time" costs that show up year after year, related-party activity, cash withdrawals, and margins that move because inventory moved. A red flag in this sense is a question, not a finding of wrongdoing. The report states what was tested, what the documents show, and the difference that remains.
A red flag is a result that does not match what the books, the Confidential Information Memorandum (CIM) or the business owner say it should be. It is found by testing, not by reading. The QoE starts from the company's general ledger and checks it against records the company did not prepare: bank statements, filed tax returns, payroll reports, merchant processor statements and invoices.
Most red flags have ordinary explanations. A bookkeeper coded a transfer as revenue. A processor deposited sales net of fees. A cost was labeled one-time because it felt that way. The point of flagging the pattern is to get the explanation, and the support for it, before closing rather than after.
| Pattern | How it is tested | What it can point to |
|---|---|---|
| Revenue does not tie to deposits | Monthly proof of cash across the company's bank accounts | Transfers or loan proceeds in revenue, uncollected sales, a missing account |
| Revenue does not tie to tax returns | Book income bridged to the filed return line by line | Year-end entries, a different basis of accounting, or a return filed from different numbers |
| Add-backs with no support | Invoices, statements and payroll records behind the adjustment | An adjustment based on the owner's description only |
| Recurring "one-time" costs | The same account and vendor across the full review period | A normal cost of running the business |
| Related-party activity | Payments to and from entities and people connected to the owner | Rent, wages or sales that are not at market terms |
| Cash withdrawals | ATM, counter and check-to-cash activity in the bank statements | Owner draws or expenses with no record of what was bought |
| Margin change from inventory | Gross margin trend against purchases and inventory counts | A business selling down stock rather than improving |
Revenue is tested first because the rest of the report depends on it. The proof of cash starts with total deposits, removes what is not revenue (loan proceeds, owner contributions, transfers between accounts, refunds) and compares what is left to reported revenue, month by month. The procedure is covered in more detail in proof of cash in a quality of earnings report.
The tax return tie-out is a second, separate test. The QoE bridges net income on the books to the income on the filed return and lists the reconciling items. Some differences are expected, such as depreciation methods or meals. A revenue figure on the profit and loss that is higher than the revenue on the return, with no reconciling item to explain it, is one of the questions buyers and lenders ask about first.
Add-backs are where most of the adjusted earnings in a small business deal come from, so they get tested line by line. An add-back holds up when a document supports it: a payroll record for owner pay, a lease for related-party rent, a bank or card transaction for a personal expense. An add-back supported only by a note in a spreadsheet is presented in the report as unsupported, with the amount stated.
One-time costs are tested by looking across the full review period. A legal fee, a repair or a consulting project that appears in two or three of the last three years is presented as recurring. The report shows the years and amounts and leaves the reader to see the pattern. More on which adjustments tend to hold up is in which add-backs survive diligence.
Related-party activity is common in owner-operated businesses and is not a problem by itself. The company may rent its building from an entity the owner controls, employ family members, or buy from or sell to a business a relative owns. The QoE identifies these payments and asks whether the terms would continue after a sale. If rent paid to the owner's entity is below market, the earnings a buyer inherits may be lower once a market lease is signed. If a relative is on payroll and does not work in the business, the wages may be an add-back.
Cash withdrawals are tested from the bank statements. ATM withdrawals, counter withdrawals and checks written to cash have no vendor attached, so the books often place them in an expense account by estimate. The QoE totals them by month and asks the company what they paid for. Where no record exists, the report says so plainly rather than estimating a business purpose.
On cash-basis books, cost of goods sold is what was paid for inventory in the period, not the cost of what was sold. A company that stops restocking and sells from existing inventory shows lower purchases and a higher gross margin, even if sales are flat or falling. The buyer then pays for that margin and inherits the need to rebuild stock.
The QoE compares the gross margin trend to purchases and to inventory counts at the start and end of the periods. A margin that rises while inventory falls is flagged with the amounts. A worked example of the pattern is in the inventory selloff case study.
These are round, invented numbers for illustration only. A company reports revenue of $2,400,000 for the year on its profit and loss. The bank statements show deposits of $2,600,000.
| Line | Amount |
|---|---|
| Total deposits, all operating accounts | $2,600,000 |
| Less loan proceeds | ($150,000) |
| Less transfers between company accounts | ($80,000) |
| Less owner contributions | ($20,000) |
| Revenue per deposits | $2,350,000 |
| Revenue per profit and loss | $2,400,000 |
| Difference | $50,000 |
The QoE asks the company about the $50,000. The company provides merchant processor statements showing $30,000 of card fees taken out before the sales were deposited, which explains that part. The remaining $20,000 has no document behind it yet. The report shows the $30,000 with its source, states the $20,000 as the remaining difference, and the question goes to the Q&A for the company to answer.
Usually not. Many items close when the company produces a document that was not in the first request. Others change the adjusted earnings, and the buyer and lender decide what that means for the price, the structure or the loan. The QoE does not make that decision and does not give an opinion on the business.
The way findings are laid out, next to the source documents and the management Q&A, is shown on the sample report page. The procedures behind them are listed on the quality of earnings page.
No. A QoE is not an audit or a forensic investigation, and it gives no opinion. It tests the company's numbers against outside records and describes what the documents show. It does not assign intent. Questions about legal remedies belong with your attorney.
Yes. Open items are recorded in the Q&A, and the company's responses and any new documents are added there. Buyers should review the full Q&A rather than relying on the summary alone, since it holds open items that the summary does not repeat.
It depends on who engaged the report. Under SBA SOP 50 10 8.1, effective October 1, 2026, Initial Acquisition and Business Expansion loans where the business purchase price is $3 million or more need a QoE from an independent financial professional engaged by and acting on behalf of the lender. On those deals the lender has the findings. On other deals, ask your lender what it requires.
Our fee is $7,500 flat for SBA-sized deals, whether or not SBA financing is used, and larger deals are scoped and priced to the work after a call, with the fee quoted before work starts. There is no hourly billing. The work generally takes two to four weeks from receipt of documents. Details are on the pricing page.