Quality of Earnings Report: What Sellers Should Expect and Prepare

A buy-side report is commissioned by the buyer, usually after the letter of intent, to confirm the earnings the price is based on. Its findings can lead to a lower price, a different structure or a walk-away.

A sell-side report is commissioned by you before going to market. It lets you find and fix problems, present a documented adjusted EBITDA and shorten the buyer's diligence. A buyer will normally still run its own review, but a credible sell-side report gives them a starting point and reduces the chance of a surprise.

The trade-off is cost and timing against control. If your books are clean and your add-backs are few, a buy-side review alone may be fine. If you have complex revenue, customer concentration or messy books, a sell-side review pays for itself by surfacing issues while you can still fix them.

Expect the review to cover these areas:

• Earnings adjustments: owner pay above or below market, one-time legal or restructuring costs, related-party rent and pro forma changes. Each adjustment needs support.
• Revenue quality: recurring versus one-time, customer concentration, cut-off at period ends, and how contracts and deferred revenue are treated.
• Proof of cash: reconciling reported revenue and expenses to bank activity.
• Working capital: the normal level the business needs, monthly trends and seasonality.
• Debt and debt-like items: loans, deferred compensation, unpaid taxes, customer deposits and accrued bonuses.
• Capital expenditures: whether reported EBITDA hides spending the business must make to keep running.

Buyers also put your margin in context. US EBITDA margins in January 2026 data ranged from 8.98 percent for computer services to 35.93 percent for software¹, so an adjusted margin far from your industry's norm invites questions.

Add-backs raise adjusted EBITDA, and buyers apply a multiple to that number, so each dollar they accept or reject is multiplied.

Say adjusted EBITDA is $2,000,000 and the buyer's multiple is six times, which puts the price at $12,000,000. If you lose $100,000 of add-backs in review, adjusted EBITDA falls to $1,900,000 and the price falls by $600,000.

That is why documentation matters more than the size of the add-back. An add-back is easier to defend when it is one-time, backed by invoices or contracts, and clearly unrelated to future operations. Weak candidates include recurring expenses relabeled as one-time, aggressive owner-comp adjustments and pro forma revenue that has not yet been signed. For the difference between adjusted EBITDA and seller earnings, see SDE versus EBITDA, and for the add-back list, preparing for buy-side QofE audits.

The purchase agreement sets a target level of net working capital, called the peg, usually based on a trailing average. At closing, the actual level is compared with the peg, and the price adjusts dollar for dollar for any difference.

Say the peg is set at $800,000, based on twelve months of average working capital. If you close with working capital of $700,000, the price falls by $100,000. If a seasonal business closes at a low point in its cycle, a peg based on a full-year average can hurt the seller, so review the monthly pattern before you agree.

Definitions decide the outcome. Agree in writing which accounts count, how cash and debt are treated so they are not counted twice, and how items like deferred revenue and accruals are handled. Then ask your CPA to model the peg under a few closing dates.

A little preparation shortens the review and reduces re-trades:

1. Produce monthly financial statements for the last several years and reconcile them to tax returns and bank statements.
2. Build a customer-level revenue schedule and a list of contracts with renewal dates.
3. Prepare a supported add-back schedule with one line per adjustment and a document for each.
4. Compile monthly balance sheets so working capital trends are visible.
5. List debt and debt-like items and any commitments, such as leases or earnouts.
6. Document your close process and revenue recognition policy.
7. Assign one person to manage the request list and respond quickly.

Closing tools can keep reconciliations and support in one place, as compared in the close software comparison, and ledger systems are compared in the accounting system comparison. Use the seller due diligence checklist for the wider process.