Part of the Private equity and the finance function series.
The conversation usually ends the same way. An adviser looks up from the management accounts, says the books are not deal-ready, and the room goes quiet. You leave, open a browser, and type quality of earnings. What you find is largely written by US advisory firms quoting their own price lists. This article is written for UK group CFOs - on either side of a transaction - who want a straight account of what the process actually involves.
What is a quality of earnings assessment?
A quality of earnings (QoE) assessment is an investigation into whether reported EBITDA is real, repeatable, and stated on a consistent basis - carried out by an independent adviser on behalf of a buyer or a seller ahead of a transaction. It is not an audit. The auditor gives an opinion on whether the financial statements comply with the applicable reporting framework; the QoE adviser asks a harder commercial question: of this reported profit, how much would a rational buyer pay a multiple on? The two exercises can produce very different numbers from the same set of accounts, and experienced deal teams know it.
What does a QoE actually examine?
The scope varies by transaction, but the core workstreams are consistent across the market.
Sustainability and quality of reported EBITDA. The adviser rebuilds EBITDA from source, stripping out accounting policy choices that inflate the number and identifying whether margins are genuinely structural or driven by one-off conditions - a pandemic-era contract, a temporary cost reduction, or a favourable currency move that has since reversed.
One-off and owner adjustments. Management accounts almost always carry a schedule of adjustments - legal costs, restructuring charges, owner remuneration above or below a market rate, personal expenses run through the business. The QoE adviser tests every one of these. Adjustments that cannot be evidenced or that recur year after year are added back into EBITDA; adjustments that management has omitted are introduced. The adjusted EBITDA figure that emerges is the one the buyer will anchor the valuation to.
Revenue recognition. For groups with long-term contracts, milestone billing, or SaaS-style subscription arrangements, the timing of revenue recognition can move material amounts between periods. The adviser traces revenue to the underlying contracts and tests whether the group's policy is consistent with the economic substance of the arrangements.
Customer concentration. A group where three customers represent sixty per cent of revenue carries a risk that does not appear in the profit and loss account. QoE work maps revenue by customer, flags concentration, and - where data allows - analyses customer tenure and churn. Buyers use this to size the commercial risk; it frequently appears as a price chip or an earnout condition.
Working capital normalisation. Valuation multiples are applied to EBITDA, but the cash a buyer actually receives on day one depends on working capital. The adviser calculates a normalised working capital peg - typically a trailing twelve-month average adjusted for seasonality and one-off movements - and any shortfall against that peg at completion flows through to the price. This is one of the most frequently disputed items in UK mid-market transactions.
Reliability of the underlying consolidation and data. For a group with multiple entities, the consolidation workpapers are themselves under review. Inter-company eliminations, minority interest accounting, and the treatment of acquired entities are all examined. If the consolidation is produced in spreadsheets and the auditors have raised consistency points, that surfaces in the QoE report and creates negotiating leverage for the buyer. A group whose consolidation is produced in a controlled, auditable system - reconciled month to month rather than assembled under pressure at year-end - passes this workstream with far less friction.
Why do buyers commission a QoE - and why are sellers running one before going to market?
Buyers commission a QoE because lenders require it and because the adjusted EBITDA figure sets the enterprise value. A two-percentage-point reduction in adjusted EBITDA margin, applied to a six-times multiple, is a material movement in price on any deal of substance. The QoE report also gives the buyer's lawyers a structured basis for representations and warranties.
Sellers increasingly commission a sell-side QoE before launching a process for a different reason: control. A vendor who has already worked through the adjustments schedule, quantified the working capital peg, and stress-tested the revenue recognition policy can respond to buyer diligence quickly and from a position of confidence. Surprises discovered by the buy-side adviser mid-process are the single most common cause of price re-negotiations and deal collapse. A sell-side QoE does not eliminate buyer diligence - buyers will always run their own - but it narrows the gap between the two versions of the truth.
How does a QoE differ from a statutory audit?
A statutory audit and a quality of earnings assessment are designed to answer different questions and they carry different levels of assurance. The audit is addressed to shareholders and regulators; it gives reasonable assurance that the financial statements give a true and fair view under the applicable standard. The QoE is addressed to a specific party in a specific transaction; it is an agreed-upon-procedures or advisory engagement, not a regulated assurance opinion. The audit tests compliance with accounting standards. The QoE tests commercial repeatability. A clean audit opinion provides no protection against a QoE that reveals EBITDA is overstated by adjustments the auditor was not engaged to question.
What drives the fee for a quality of earnings engagement?
Advisory fees for QoE work are driven by four variables, and any estimate that ignores them is not a serious quote.
Group size and complexity. The number of reporting entities in the consolidation is the primary driver of scope. A single-entity business is a fundamentally different exercise from a group of twelve subsidiaries across three jurisdictions.
Entity count and inter-company volume. More entities means more inter-company flows to trace, more eliminations to test, and more local GAAP-to-group-policy adjustments to review. Entity count multiplies work faster than revenue does.
Data quality and availability. A group that produces clean, documented management accounts with a controlled consolidation tool requires far less reconstruction work than one that assembles its numbers in Excel under year-end pressure. Poor data quality is the single largest driver of fee overrun on QoE engagements.
Scope of the brief. A buy-side QoE focused on EBITDA quality and working capital is a narrower engagement than a full financial and commercial diligence combining QoE, revenue quality, and net debt analysis. The scope is agreed in the engagement letter, and material additions to scope mid-engagement carry additional cost.
Fee ranges quoted online almost always originate from US advisory firms publishing their own price lists into a market with different deal sizes, different accountancy cost structures, and different regulatory context. They are not a reliable guide to UK fees.
Clean consolidation is already most of the work
A finance function that closes the month cleanly, eliminates inter-company balances on a controlled basis, documents its adjustments schedule, and keeps its consolidation in a system rather than a spreadsheet is already most of the way to deal-ready. The QoE process does not invent problems; it finds the ones that are already there. Groups that have invested in the discipline of their month-end close and consolidation routine find that the QoE workstreams on data reliability and EBITDA sustainability move quickly - because the evidence is already there to be read. That is the operational case for treating consolidation quality as a standing finance priority, not a pre-deal emergency.
Common questions
What is a quality of earnings assessment?
A quality of earnings assessment is an independent examination of whether a company's reported EBITDA is sustainable, consistently stated, and free from one-off or owner-specific distortions. It is commissioned by buyers or sellers ahead of a transaction to produce an adjusted EBITDA figure that both sides can anchor a valuation to. Unlike a statutory audit, it is not a regulated assurance opinion - it is an advisory engagement focused on commercial repeatability rather than accounting compliance.
How does a quality of earnings report differ from an audit?
A statutory audit gives an opinion on whether financial statements comply with the applicable reporting standard and are free from material misstatement. A quality of earnings report asks whether reported profit is real and repeatable from a buyer's perspective. The two exercises can produce materially different EBITDA figures from the same set of accounts, because the audit is not designed to identify adjustments that are technically compliant but commercially misleading.
Why do sellers commission a sell-side quality of earnings before going to market?
Sellers run a sell-side quality of earnings to identify and resolve issues before a buyer's adviser does, reducing the risk of price re-negotiations or deal collapse mid-process. A vendor who has already documented the adjustments schedule and normalised working capital can respond to buy-side diligence quickly and from a position of confidence. It does not replace buy-side diligence, but it narrows the gap between the two versions of the financials.
What is working capital normalisation in a quality of earnings context?
Working capital normalisation is the process of calculating a fair, transaction-specific working capital peg - typically a trailing average adjusted for seasonality and one-off movements - against which actual working capital at completion is measured. Any shortfall below the peg flows through to the purchase price. It is one of the most frequently disputed items in UK mid-market transactions and is always within scope of a quality of earnings engagement.
Does the quality of a consolidation process affect a quality of earnings outcome?
Yes, directly. The reliability of the group's underlying consolidation and data is a standard workstream in any multi-entity quality of earnings engagement. Groups that consolidate in a controlled system with documented inter-company eliminations and consistent accounting policies pass this workstream faster and with less adviser intervention than those that assemble the consolidation in spreadsheets. Poor data quality is also the most common driver of fee overrun on quality of earnings engagements.