40 percent of Quality of Earnings findings come from the same six items. Per Embarc Advisors and Bonadio Group practitioner data, a small set of "critical" QofE items consistently drives the bulk of findings across LMM deals. Sellers who scope their QofE to address these items pre-launch close faster and retrade less.

This post walks the six critical items, what to include in the QofE engagement letter, how seller-side QofE prep changes buyer diligence, and the cost-benefit of doing QofE early.

The TL;DR

• Sell-side QofE typically costs $30K to $80K and runs 4-6 weeks
• Critical items drive 40 percent of findings: working capital normalizations, customer concentration, revenue recognition, EBITDA add-backs, AR aging, inventory valuation
• Important items add another 35 percent of findings; optional items the remaining 25 percent
• Sellers with sell-side QofE close 1-2 weeks faster than peers without it
• The engagement letter is where scope gets pinned. Loose scope = generic findings = wasted spend

What QofE actually does

Quality of Earnings is an accounting analysis that normalizes the seller's financials for items that distort run-rate EBITDA. The output is a "normalized EBITDA" number that the buyer uses to apply their multiple.

Common normalizations:

• Owner compensation above market
• Personal expenses run through the business
• One-time items (legal settlements, special projects)
• Discontinued operations
• Acquisition impacts (pre vs post)
• Working capital adjustments

Without QofE, the buyer does this analysis themselves and the result tends to be conservative (i.e., the buyer arrives at a lower normalized EBITDA than the seller's QofE would have shown). The lower EBITDA times the same multiple equals a lower bid.

Sell-side QofE is the seller anchoring the negotiation on a higher normalized EBITDA before the buyer's analysis runs.

The six critical items

1. Working capital normalizations

The QofE analyzes working capital across multiple periods to set a defensible target for the closing balance sheet. This is one of the most-scrutinized items in buyer diligence because it directly affects the closing transfer.

Critical sub-items:

• TTM 12-month working capital trend
• Seasonality analysis
• Customer prepayment / deferred revenue treatment
• Inventory valuation methodology
• Accrual classification (which line items count)

QofE-prepared working capital methodology usually saves the seller $200K to $1M in closing transfer disputes.

2. Customer concentration

The QofE quantifies customer concentration (top 10 by revenue), churn history, contract length, and revenue stability. It also flags concentration risk for the buyer's investment committee.

Sellers who get ahead of concentration in QofE present it as a managed risk. Sellers who don't, get it surfaced by the buyer in week 5 of diligence as a discovery, which triggers retrade conversations.

3. Revenue recognition

Especially for SaaS, services, and subscription businesses, revenue recognition methodology can swing reported revenue 10-15 percent. The QofE confirms the methodology is GAAP-compliant and defensible.

Critical sub-items:

• Recognition timing (upfront, ratable, milestone)
• Treatment of multi-year contracts
• Setup fee allocation
• Discounts and credits

4. EBITDA add-backs

The seller's adjusted EBITDA includes add-backs for non-recurring items, owner compensation normalizations, and one-time costs. The QofE quantifies and documents each add-back.

Buyers haircut add-backs they can't substantiate. A QofE-supported add-back stands; an unsupported add-back gets reduced.

Common add-backs that need documentation:

• Owner compensation above market salary
• Family member compensation
• Personal travel and expenses
• Non-recurring legal or consulting fees
• Acquisition-related costs
• Software conversion costs
• Severance or restructuring

5. Accounts receivable aging

The QofE reviews AR aging, write-off history, and bad debt reserves. Buyers want to ensure receivables are collectible and reserves are adequate.

Critical sub-items:

• Aging by customer (anonymized)
• Write-off history (% of revenue annually)
• Reserve methodology
• Concentration in older buckets

6. Inventory valuation

For inventory-heavy businesses (manufacturing, distribution, retail), inventory valuation is a critical QofE item. Includes obsolete inventory analysis, valuation methodology (FIFO, LIFO, weighted average), reserve adequacy, and physical count history.

For asset-light businesses (services, SaaS), this is not material.

What goes in the engagement letter

The QofE engagement letter is where scope gets pinned. Vague engagement letters produce generic findings; specific engagement letters produce findings that move the deal.

Standard scope items (every QofE)

• Period covered: typically 3 fiscal years plus current YTD
• Normalized EBITDA calculation with full add-back schedule
• Working capital analysis with target methodology
• Revenue recognition review
• Quality of revenue (recurring vs project, customer concentration)
• AR aging and reserve analysis
• Inventory analysis (if applicable)
• Major contracts review
• Tax compliance overview

Scope items to negotiate

Some scope items are commonly excluded by default but should be added if relevant:

• Pre-acquisition vs post-acquisition financials (if seller has done acquisitions)
• Pro forma adjustments for recent acquisitions
• Treatment of new customer cohorts vs base
• Specific add-back substantiation (e.g., owner compensation benchmarking)
• Sub-segment P&L (if business has multiple segments)

Scope items to confirm are out

Some items belong in legal or commercial diligence, not QofE:

• Customer interviews
• Competitive positioning analysis
• Forecast review (forecasting is the seller's job, not the QofE provider's)

If a QofE provider tries to expand scope into commercial or strategic analysis, push back. That's outside QofE and adds cost without adding deal value.

QofE provider tiers

Three common tiers for LMM deals:

Tier 1: large national / Big 4 ($50K-$150K)

Deloitte, EY, KPMG, PwC, Grant Thornton, BDO. Used when the seller anticipates an upper middle market buyer who expects a recognized name on the report. Brand recognition and deeper data analytics, but for most LMM processes the Tier 2 boutique produces equivalent quality at half the cost.

Tier 2: regional / boutique ($30K-$60K)

Embarc Advisors, Bonadio Group, Lutz, regional CPA firms with M&A practices. The right fit for most LMM deals. Practitioner-level depth, faster turnaround than Big 4, lower cost.

Tier 3: small / specialist ($15K-$30K)

Smaller firms or solo practitioners. Can work for sub-$15M deals or specific industry verticals (healthcare, dental). Quality varies; vet the specific firm's deal experience.

The right tier matches the deal size. A $50K Big 4 QofE on a $10M deal is overspending. A $15K boutique QofE on a $40M deal undershells the analysis.

When to do QofE

Three options:

Option A: pre-launch QofE (sell-side) The seller commissions QofE before the data room goes live. Cost ~$30-80K, time 4-6 weeks. The QofE is included in the data room day 1.

Option B: at-LOI QofE The seller commissions QofE when an LOI is signed. The QofE is provided to the lead bidder during exclusivity.

Option C: no sell-side QofE The buyer does QofE after LOI. Their analysis tends to be more conservative; the seller has less anchor.

Practitioner observation: deals with pre-launch QofE close 1-2 weeks faster and capture 5-10 percent more on the EBITDA multiple than deals without. The $50K cost typically returns multiples on a $25M+ deal.

Tools and references

The free QofE Scope Worksheet walks the critical, important, and optional items with a self-scoring template. Use it before signing the engagement letter.

For working capital methodology that the QofE analysis informs, see the Working Capital Calculator.

For broader diligence prep that QofE feeds into, see the Sell Side Diligence Prep Checklist.

Bottom line

40 percent of QofE findings come from six items. Working capital normalizations. Customer concentration. Revenue recognition. EBITDA add-backs. AR aging. Inventory valuation.

Scope these items specifically in the engagement letter. Use the right tier of provider for the deal size. Do the QofE pre-launch when deal economics support it.

A QofE-prepared seller closes faster, retains more on EBITDA, and avoids the buyer-favorable analysis the buyer's accountants would otherwise produce.

FAQ

How long does sell-side QofE take? Typically 4-6 weeks from engagement to final report. Faster (3-4 weeks) for clean businesses with organized financials. Longer (6-8 weeks) for complex businesses with multiple segments or recent acquisitions.

Do buyers always accept the seller's QofE? Buyers don't accept it as final. They use it as a starting point and often run their own confirmatory QofE during exclusivity. The seller's QofE serves as the anchor for the buyer's analysis; it doesn't replace it.

What's the difference between QofE and an audit? An audit verifies the financial statements per GAAP. QofE analyzes the financials to identify normalizations and adjustments that reflect run-rate EBITDA. Audits are about compliance; QofE is about economic substance. Both can be valuable; QofE is what M&A buyers want.

Can the seller share QofE with multiple bidders? Yes. QofE is typically distributed in the data room post-NDA. Some sellers provide it pre-NDA to qualified bidders to anchor the IOI; others wait until exclusivity. Practitioner standard is in-room post-NDA.

Does QofE include forward projections? Standard QofE is historical. Some QofE providers include "EBITDA bridge" analysis showing how historical run-rate translates to forecast assumptions, but the forecast itself is the seller's responsibility. Don't expand QofE scope to include forecasting.

Should the QofE provider be the same as the seller's auditor? Avoid this. Independence matters for credibility with buyers. Use a separate firm for QofE. Even if the seller's auditor offers the service, use a different firm.

What if the QofE finds something problematic? Better to find it now than have the buyer discover it. QofE findings are a fact pattern the seller can address (anonymize concentration disclosure, document add-backs, fix bookkeeping issues) before going to market. Discovery by buyer mid-diligence is much worse.

Is sell-side QofE worth it for sub-$10M deals? Marginal. The QofE cost is large relative to the deal value. For sub-$10M deals, a more focused "EBITDA quality assessment" (lighter analysis at $10-20K) may pencil better than a full QofE.