Quality of Earnings for Buyers: What It Covers, What It Costs, When to Skip It

A quality of earnings report, or QoE, is an independent accounting firm's test of whether the earnings a seller wants you to pay for are real, recurring, and backed by cash. It is not an audit. It is a rebuild of the earnings number from source records, and it is the document your price, your lender, and your negotiation all lean on.

The seller hands you SDE: net profit plus one owner's full compensation plus documented add-backs. The QoE firm rebuilds that figure from the general ledger, bank statements, payroll registers, tax returns, and customer and vendor detail. It tests four things.

• Cash proof. Do the deposits in the bank statements reconcile to the revenue on the books and on the tax returns? SBA SOP 50 10 8.1 requires this for the trailing twelve months and the last two fiscal years.
• Normalization. Which add-backs hold up? A personal vehicle with a paper trail holds up. A family member on payroll who does real work does not come back as an add-back, because someone has to be paid to do that job. Our page on which add-backs a buyer will accept walks through the usual arguments.
• Run-rate quality. Is revenue recognized in the right period? How concentrated are the customers? Did a price increase or a one-time project inflate the last year? Are workers classified correctly, and is sales tax collected and remitted?
• Working capital and debt-like items. What level of receivables, payables, and deposits does the business need to run, and what obligations (unpaid taxes, customer deposits, accrued payroll) sit outside the balance the seller shows you?

Two earnings measures matter here, and you should label which one you are using. SDE is the owner-operator measure. EBITDA is SDE minus a market-rate salary for a replacement manager. The SBA coverage test uses EBITDA divided by post-transaction debt service, so the QoE has to speak to that figure, not just to the seller's SDE. Apply SDE multiples only to SDE and EBITDA multiples only to EBITDA.

One boundary to hold. Recurring operating costs change earnings. Capital items do not. If diligence shows a fleet that needs replacing or equipment that is past its life, that comes off the price in dollars. It does not get netted out of SDE or EBITDA before the multiple is applied.

Before you engage anyone, confirm with your lender which of these tests it will rely on, because the lender must use the QoE's normalized earnings in its debt service coverage calculation.

An SBA lender requires a QoE when the business purchase price is $3,000,000 or more on an Initial Acquisition or a Business Expansion, under SOP 50 10 8.1, in force for loans numbered on or after October 1, 2026. Business purchase price here means the purchase price less appraised owner-occupied real estate, before the equity injection and before seller notes.

Three mechanics sit inside that table.

• The QoE may not be prepared by or for the seller. A report the seller commissioned to market the business does not satisfy the rule.
• The lender must use the QoE's normalized earnings in the DSCR calculation. If the QoE lowers earnings, the coverage math moves whether or not the seller agrees.
• The September 25 technical update lets a lender review a buyer-ordered QoE through a qualified vendor if it meets SBA minimums. That is why you ask the lender about scope before you sign an engagement letter.

On cost: we do not publish a fee figure here because the fee depends on the scope and on how clean the books are. Two things you should know. First, expenses for advisory services you pay as the applicant do not count toward the equity injection under 8.1, so plan that cash on top of your 5% cash portion. Second, get a written quote against a defined scope from at least two firms, and compare each quote to the price you are putting at risk.

Ask each firm for a scope that names the cash proof periods, so you can compare quotes on the same work and confirm your lender will accept the deliverable.

You can skip a formal QoE when the SBA does not require one and you can do the cash proof yourself. That means the business purchase price is below $3,000,000, or the deal is an Owner Buyout, and the books tie out without help.

Skipping is a decision, so test it. Run this check before you decide.

1. Tie deposits to revenue. Add up bank deposits for the trailing twelve months and the last two fiscal years. Compare them to the P&L and to the tax returns. If you cannot explain every gap, do not skip.
2. Price the add-backs. List each add-back in the seller's SDE. If a few items carry most of the difference between net profit and SDE, one of them failing changes your price. That is the case for a QoE.
3. Check the lender path. At a purchase price of $350,000 or less between unrelated parties, the lender may value the business in-house. Above that, the lender orders an independent valuation, and that appraiser will test earnings anyway. A thin file shows up there.
4. Compare exposure to fee. If the price at risk from a bad earnings number is small next to the fee, a targeted review of the add-backs by your own CPA can replace a full report.

Skip the full QoE only if the bank deposits, tax returns, and P&L reconcile without unexplained gaps, and put a CPA review of the largest add-backs in its place, with the findings written into your purchase agreement representations.

A QoE that removes unsupported add-backs lowers the earnings base, and a buyer who holds the seller's price-to-earnings ratio constant lowers the price in the same proportion. Here is the arithmetic on a round example. It uses SDE throughout, and the numbers are illustrative inputs, not a market benchmark.

The deal. Purchase price $3,000,000. Seller-stated SDE $650,000. No owner-occupied real estate, so the business purchase price is $3,000,000.

Step 1, does the SBA require a QoE? The business purchase price is $3,000,000 or more, so yes, for an Initial Acquisition. The report needs a cash proof for the trailing twelve months and the last two fiscal years, and it cannot be prepared by or for the seller.

Step 2, equity injection at the stated price. 10% of $3,000,000 is $300,000. Split as 5% buyer cash and 5% seller note on full standby: $150,000 cash and $150,000 standby note. The standby note stays on standby for the life of the SBA loan.

Step 3, what the QoE finds. Suppose it rejects two add-backs: $40,000 for a relative's payroll where the relative does real work, and $25,000 for a repair the seller called one-time that appears in the ledger again. $40,000 plus $25,000 is $65,000.

Step 4, adjusted SDE. $650,000 minus $65,000 is $585,000. That is 90% of the seller's figure, since $585,000 divided by $650,000 is 0.9.

Step 5, adjusted price. Same ratio of price to SDE, so $3,000,000 times 0.9 is $2,700,000. That is $300,000 below the ask.

Step 6, equity injection at the adjusted price. 10% of $2,700,000 is $270,000, split into $135,000 cash and $135,000 standby note. Your cash requirement drops by $15,000, since $150,000 minus $135,000 is $15,000, and that is before you pay the QoE firm, whose fee does not count toward the injection.

Two limits on this example. The reprice is your opening ask, not a result. The seller can accept it, split it, or produce documents that put an add-back back in. And the lender's coverage test runs on EBITDA, so the replacement-manager salary comes out of the $585,000 before the 1.25x test. Run your own inputs through the SBA 7(a) loan calculator to see where coverage lands.

If the QoE also finds equipment due for replacement, that amount comes off the $2,700,000 as a separate dollar credit, because capital items are priced outside the earnings multiple.

Whoever holds documents wins each point, and the structure of the SBA process gives the buyer an edge on the earnings number itself, because the lender must use the QoE's normalized earnings in coverage and the seller does not control that.

Points that come up after the report lands:

• Disputed add-backs. A buyer wins when the QoE shows a cost recurring in the ledger across periods. A seller wins when they produce invoices, contracts, or board minutes that show a cost truly ended. Paper decides it, not argument.
• Timing items. Revenue pulled forward or pushed back is a fair debate. A seller wins when the shift reverses within the periods tested. A buyer wins when it does not.
• Working capital peg. The QoE sets the level of working capital the business needs. Set the peg at the QoE's normalized figure, not at the closing-month balance, so the seller cannot strip cash or receivables before closing.
• Price versus structure. When the seller will not move on price, you can move risk instead: a larger seller note on full standby (only up to half of the required injection counts as equity), or more buyer equity. Total acquisition debt cannot exceed the lender's independent valuation, so a price above that figure needs equity or full-standby debt to fill the gap.
• Exclusivity and timing. Your letter of intent should reserve the right to reprice on QoE findings and should run exclusivity long enough to cover the report. See how to write a letter of intent to buy a business.

A seller note on full standby also helps your side of the table. It counts toward the injection, it carries no payments while the SBA loan is outstanding, and it gives the seller a reason to stand behind the numbers they presented.

Before you sign the LOI, add one sentence that lets you adjust price for QoE findings above an agreed dollar threshold, and ask the seller's advisor to initial that clause.

The most costly mistake is ordering the report before you know what your lender will accept. Each of the following can cost you a second fee or a failed financing.

• Hiring before checking scope with the lender. A buyer-ordered QoE can be reviewed by the lender's qualified vendor only if it meets SBA minimums. A report without the cash proof periods does not.
• Using the seller's report. The rule says the QoE may not be prepared by or for the seller. A sell-side report is a source of questions, not a substitute.
• Counting the fee as equity. Advisory fees you pay do not count toward the 10% injection. Your 5% cash has to come from unborrowed cash or another unlimited source, and the lender will verify it with bank statements showing funds available for at least 30 days.
• Mixing SDE and EBITDA. An SDE multiple applied to EBITDA, or the reverse, misprices the deal by the size of the replacement manager's salary.
• Netting capital items out of earnings. Deferred maintenance and equipment replacement come off the price. Taking them out of SDE before the multiple multiplies a one-time cost across the whole valuation.
• Ordering the QoE after exclusivity is nearly gone. You lose the time to reprice or restructure.
• Treating the report as a pass or fail. It is a set of findings. Each one is either a price item, a structure item, or a walk-away item, and you decide which before you reopen the conversation.
• Skipping the cash proof when no QoE is required. A deal under the threshold still needs deposits tied to revenue before you wire anything.

Write down each finding as a price item, a structure item, or a walk-away item before your next call with the seller, so the conversation runs on your list and not theirs.

Start by sorting your deal into one of three paths, then act on it this week.

1. Business purchase price of $3,000,000 or more, Initial Acquisition. A QoE is required. Call your lender, confirm in writing what scope it will accept, and get two quotes against that scope before the LOI is signed.
2. Above $350,000 but below $3,000,000. No SBA-required QoE, but the lender will order an independent valuation. Run the cash proof yourself and decide whether the add-backs justify a targeted review.
3. Owner Buyout. The QoE rule exempts it, and the coverage minimum is still 1.25x. Test the number on historical results.

Then model the financing. The SBA 7(a) loan calculator shows payment and coverage, and the SBA 7(a) acquisition financing index collects the rules on injection, standby notes, and valuation in one place.

If you are still looking for the business, Acquisition Launch is how we source off-market deals for buyers and introduce lenders. Tell us your target size and we will tell you which of the three paths you land on before you spend on a QoE.