- A quality of earnings report is an independent analysis — typically performed by an accounting firm — that looks behind a target business's reported financial statements to assess…
- A target business may already have reviewed or audited financial statements, but a QoE report is a distinct exercise, tailored specifically to the transaction at hand rather than to a…
- From a lender's perspective, an acquisition loan is only as sound as the target business's ability to service the debt going forward.
If you're financing the purchase of an Ontario business through a bank or BDC, don't be surprised if the lender asks for a quality of earnings (QoE) report before it will finalize your loan. For buyers who haven't been through an acquisition before, the request can feel like an extra hurdle — or an unnecessary expense — layered on top of everything else. It usually isn't. It's the lender's way of confirming that the numbers behind your business plan actually hold up.
This article explains what a QoE report generally covers, how it differs from an audit or a simple review of financial statements, and why lenders in particular tend to ask for one.
What a Quality of Earnings Report Is
A quality of earnings report is an independent analysis — typically performed by an accounting firm — that looks behind a target business's reported financial statements to assess whether its earnings are accurate, sustainable, and representative of how the business actually performs going forward. It's less about confirming the numbers add up correctly (that's closer to what an audit does) and more about understanding what those numbers actually mean for a buyer or lender relying on them to project future performance.
A QoE analysis typically looks at things like:
- Normalizing earnings — adjusting reported profit for one-time items, owner-specific expenses, or unusual transactions that wouldn't recur under new ownership.
- Revenue quality — how sustainable and diversified the revenue base is, including customer concentration.
- Working capital trends — how the business's receivables, payables, and inventory have behaved over time.
- Add-backs and adjustments the seller has proposed — testing whether claimed adjustments to profit are reasonable and well-documented.
How It Differs From an Audit or a Basic Financial Review
| Financial Statement Review | Audit | Quality of Earnings Report | |
|---|---|---|---|
| Primary focus | Basic accuracy and consistency of reported statements | Formal opinion on whether statements fairly present the business's financial position | Whether reported earnings are sustainable and representative going forward |
| Typical user | Internal use, basic lender comfort | Regulatory, ownership, or lender requirement for a formal opinion | Buyers and lenders assessing a specific transaction |
| Depth of analysis | Lower | High, but backward-looking and compliance-focused | High, and forward-looking in orientation |
| Common trigger | Routine bookkeeping/reporting | Company policy, external requirement | An acquisition, financing, or investment decision |
A target business may already have reviewed or audited financial statements, but a QoE report is a distinct exercise, tailored specifically to the transaction at hand rather than to a business's general financial reporting obligations.
Why Lenders Ask for One
From a lender's perspective, an acquisition loan is only as sound as the target business's ability to service the debt going forward. A QoE report gives the lender (and often the buyer, since it's usually shared) independent comfort on questions like:
- Are the seller's reported earnings actually representative of what the business will earn under new ownership, or do they depend heavily on one-time events or the departing owner's personal relationships?
- Is the revenue concentrated in a small number of customers or contracts that could walk away after a change of ownership?
- Have working capital needs been properly accounted for in the purchase price and the loan sizing?
Lenders relying primarily on cash-flow analysis to size an acquisition loan — rather than on hard collateral value — tend to lean on a QoE report most heavily, since the entire loan case rests on those earnings being real and sustainable.
What a Quality of Earnings Report Does Not Do
- It is not a substitute for legal due diligence. A QoE report focuses on financial and accounting questions, not on contract review, corporate records, employment matters, or litigation history — those still need to be reviewed separately.
- It does not guarantee the deal will close on the agreed terms. Findings in a QoE report often lead to renegotiation of price or terms, but the report itself is an analysis, not a deal outcome.
- It is not a certification that the business will perform as projected. It assesses historical earnings quality; future performance still carries ordinary business risk that no report can eliminate.
Steps Once You Have a QoE Report in Hand
- Review the findings with your accountant and lawyer together, since financial adjustments the report identifies may also affect representations, warranties, or price terms in the purchase agreement.
- Flag anything material to the seller, particularly normalization adjustments or working capital issues you disagree with.
- Share the relevant findings with your lender, since this is often the document that unlocks final loan approval.
- Revisit your purchase price or deal terms if warranted — a QoE report is a common trigger for renegotiating price, holdbacks, or the working capital adjustment mechanism.
Frequently asked questions
Who pays for a quality of earnings report — the buyer or the seller?
This is a negotiated point in the deal and varies by transaction; either party can commission a QoE report, and in some deals the seller commissions a "sell-side" QoE proactively to support their asking price. There's no fixed rule for who bears the cost.
Is a quality of earnings report required for every business acquisition loan?
No — lenders are more likely to require one for cash-flow-based lending on larger or more complex acquisitions, and less likely to require one for smaller, asset-based loans where the collateral itself carries most of the lender's comfort. Ask your specific lender whether they'll require one for your deal.
How is a quality of earnings report different from my own due diligence?
A QoE report is typically a component of financial due diligence, prepared by an accounting professional and focused specifically on earnings quality. Your overall due diligence is broader, covering legal, operational, and other risks that a QoE report doesn't address.
Can findings in a quality of earnings report kill a deal?
They can, if the report reveals that reported earnings are substantially less sustainable or accurate than represented. More often, findings lead to renegotiated price, adjusted deal terms, or additional representations and warranties rather than an outright collapse of the transaction.
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