Guide
Quality of earnings checklist
A quality of earnings (QoE) review asks whether a company's reported earnings are real, recurring and backed by cash. It's usually commissioned by a buyer or lender during due diligence, but the questions are useful to any board relying on an EBITDA figure.
Use the checklist below on a CIM, a sell-side pack or your own management accounts before you rely on the headline number.
What a QoE is, and isn't
A QoE is not an audit. An audit gives an opinion on whether the financial statements are fairly presented under the accounting framework. A QoE asks a commercial question: what is the sustainable, cash-backed earnings level of this business, and how far is it from the figure being marketed?
The output is usually a bridge from reported EBITDA to diligence-adjusted EBITDA, with each adjustment explained, plus a view on normalised working capital and net debt.
The checklist
Copy and work through it. For each item, record Source in file, Finding, and Status: Evidence / Inference / Gap.
A. REVENUE
[ ] Revenue recognition policy: timing, bill-and-hold, multi-element contracts
[ ] Revenue by customer: top 10 concentration, churn, contract terms
[ ] Revenue by product or channel: mix shift over the period
[ ] One-off or non-recurring revenue identified
[ ] Deferred revenue movement consistent with billings
[ ] Price vs volume split of growth
B. COSTS AND MARGINS
[ ] Gross margin by period: unexplained step changes
[ ] Owner or related-party costs: at market rate?
[ ] Headcount and payroll vs the payroll records
[ ] Capitalised costs (development, commissions): policy changes?
C. MANAGEMENT ADJUSTMENTS (one row per adjustment)
[ ] Description · amount · rationale · supporting document
[ ] Does it recur? (restructuring every year is not one-off)
[ ] Pro forma savings: committed, or planned?
[ ] Run-rate adjustments: based on actuals or forecasts?
D. WORKING CAPITAL
[ ] Monthly receivables, inventory and payables for 24 months
[ ] Seasonality: trough month identified
[ ] Normalised level proposed, and on whose definition
[ ] Aged debtors: bad debt provisioning adequate?
[ ] Payables stretched before the sale?
E. CAPEX
[ ] Maintenance vs growth split, and the basis for it
[ ] Capex vs depreciation over time
[ ] Deferred maintenance indicators
F. ACCRUALS, PROVISIONS AND RESERVES
[ ] Releases that flatter the latest period
[ ] Warranty, returns and legal provisions vs history
G. CASH CONVERSION
[ ] EBITDA to operating cash flow, by period
[ ] Conversion % trend and explanation for outliers
H. NET DEBT AND DEBT-LIKE ITEMS
[ ] Leases, deferred consideration, unpaid tax, customer deposits
[ ] Underfunded pensions, earn-outs, litigation
Reading the adjustments bridge
The most common QoE finding is that adjustments recur. A business that books "one-off restructuring" in three consecutive years has a cost of doing business, not a one-off. The second most common finding is a pro forma saving that is planned rather than done.
A simple rule: an adjustment is evidence only if the supporting document is in the file and the event has happened. Otherwise it is inference at best.
Worked example (fictional)
| Item | Amount | Status | Note |
|---|---|---|---|
| Reported EBITDA | $40.0m | Evidence | Audited accounts |
| Add back: restructuring | +$3.1m | Inference | Booked in 2024 and 2025 as well |
| Add back: owner salary above market | +$0.8m | Evidence | Payroll records plus a market benchmark in file |
| Add back: pro forma procurement savings | +$4.1m | Gap | No signed contracts in file |
| Marketed adjusted EBITDA | $48.0m | ||
| Supported on file | $40.8m | Reported plus the one evidenced adjustment |
The $7.2m difference is the negotiation.
When there's no QoE
Say so. In CFO Sentinel's Northwind example, the absence of a quality of earnings report is listed as a gap, and the desk doesn't treat adjusted EBITDA as established. That one line can change the price, the leverage, or the decision to proceed.
Where CFO Sentinel fits
Attach the CIM, the management accounts and any QoE or vendor due diligence to a matter, then run Review. Each issue comes back with its classification, capital implication, risk and confidence on separate lines. CFO Sentinel is not an audit and doesn't replace a QoE provider. It organises the questions and shows what the file doesn't establish.
Questions
What is a quality of earnings report?
A due diligence report, usually prepared by accountants, that tests whether reported EBITDA is sustainable and cash-backed, and bridges it to a diligence-adjusted figure.
Is a QoE the same as an audit?
No. An audit gives an opinion on the financial statements. A QoE asks what the business sustainably earns.
What are common QoE red flags?
Recurring 'one-off' costs, pro forma savings without contracts, revenue recognised early, stretched payables before a sale, and weak cash conversion.
Can AI do a quality of earnings review?
No. CFO Sentinel can organise the questions and mark what the file doesn't establish, but it isn't an audit or a QoE provider.