Essential Addbacks in a QofE Report

 

When evaluating a business for acquisition, one of the most important, but often misunderstood concepts is the idea of “addbacks.” In a Quality of Earnings (QofE) report, addbacks help buyers and sellers arrive at a more accurate picture of a business’s true profitability.

In this guide, we’ll walk through what addbacks in a QofE report are, why they matter, and how to separate valid adjustments from risky ones.

 

What Are Addbacks in a QofE Report?

 

Addbacks are adjustments made to a company’s earnings to reflect its true operating performance. They remove non-recurring, discretionary, or owner-specific expenses that distort profitability.

In a QofE report, these adjustments help “normalize” EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) or Seller’s Discretionary Earnings (SDE), allowing buyers to assess what future cash flows might actually look like under new ownership.

 

Why Addbacks Matter in a QofE Reports in M&A

 

When you’re buying or selling a business, earnings are everything. Valuations are often based on a multiple of EBITDA or SDE, which makes it essential that the earnings figure is credible.

Valid addbacks help:

• Increase seller valuation by showing higher normalized earnings
• Reduce buyer risk by clarifying recurring vs. non-recurring costs
• Speed up due diligence with clear documentation
• Prevent disputes during negotiation or post-close

 

Poorly justified or aggressive addbacks, on the other hand, can erode trust, delay closings, or even kill deals.

 

Common Types of Valid Addbacks in a QofE Report

 

Below are some of the most commonly accepted addbacks in financial due diligence:

 

1. One-Time or Non-Recurring Expenses

These are expenses that won’t happen again under new ownership.

• Legal fees for litigation or settlements
• Moving or relocation costs
• One-time consulting or rebranding expenses
• Equipment write-offs
• Extraordinary loss or disaster recovery

 

Rule of Thumb: If it only happens once and isn’t related to ongoing operations, it may qualify.

 

2. Owner’s Compensation Adjustments

 

For owner-operated businesses, salaries and perks often don’t reflect market rates.

Examples include:

• Overpaid or underpaid owner salaries
• Personal vehicles, meals, or vacations
• Health insurance or retirement benefits not offered to staff
• Family member salaries not tied to real roles

 

In these cases, a market-rate replacement salary is used to adjust earnings.

 

3. Discretionary Expenses

 

These are costs that may be optional or won’t be part of the company’s future operations.

• Season tickets or club memberships
• Charitable donations
• Conference travel unrelated to the business
• Bonuses or distributions tied to owner lifestyle

 

Buyers will evaluate if these expenses truly won’t recur after acquisition.

 

4. Professional Fees Not Tied to Normal Operations

 

Some professional services are tied to the deal itself or to isolated events.

• M&A advisory fees
• Legal due diligence
• Exit planning consultants
• Tax specialists for one-off filings

 

These are often removed from ongoing EBITDA calculations.

 

Questionable or Aggressive Addbacks to Watch Out For

 

Not every adjustment is valid. Aggressive or poorly documented addbacks in a QofE report can lead to renegotiations or credibility issues.

Examples of risky addbacks:

• Recurring marketing expenses labeled as “one-time”
• Staff bonuses treated as “discretionary” when they recur annually
• Inventory write-offs that actually reflect poor controls
• Technology upgrades that will need reinvestment
• Revenue addbacks without GAAP alignment

 

 Tip: If an addback isn’t clearly documented or seems subjective, it’s better to leave it out—or be ready to defend it thoroughly.

 

How Addbacks in a QofE Report Affect Valuation

 

Let’s say a company reports SDE of $300,000. After justified addbacks—such as removing $50,000 of one-time legal fees and adjusting the owner’s inflated salary—normalized SDE increases to $400,000.

With a 3.5x multiple:

• Without addbacks: $300,000 x 3.5 = $1.05 million
• With addbacks: $400,000 x 3.5 = $1.4 million

 

That $350,000 difference in valuation shows why getting addbacks right is critical.

 

The Role of a QofE Report in Validating Addbacks

 

A QofE report, prepared by an independent third-party (like VASL), validates each addback by:

• Reviewing documentation (invoices, contracts, financials)
• Confirming frequency and materiality
• Comparing to industry norms
• Adjusting only where justified

 

It turns “trust me” addbacks into data-backed adjustments. A well-prepared QofE report is often the difference between a smooth closing and a prolonged negotiation.

 

Addbacks for Buyers vs. Sellers: Different Perspectives

 

Buyers and sellers don’t always see addbacks the same way:

• Sellers want to maximize addbacks to inflate adjusted earnings
• Buyers want to minimize them to stay conservative

 

The key is to ensure transparency and support with solid documentation. That’s why having a third-party QofE firm helps establish credibility on both sides.

 

Addbacks in a QofE Report: What Should You Include?

 

When preparing for a sale, sellers should start identifying and documenting addbacks early.

 

Include:

• Clear descriptions of each adjustment
• Related invoices or payroll reports
• Frequency (one-time, annual, recurring)
• Owner explanations where applicable

 

Avoid:

• Estimations without support
• Double-counting adjustments
• Vague labels like “miscellaneous” or “consulting”

 

 

Final Thoughts on Addbacks in a QofE Report

 

Understanding and correctly applying addbacks in a QofE report is one of the most powerful ways to build trust and support valuation in an M&A transaction.

Done right, addbacks:

• Clarify true earnings potential
• Justify valuation multiples
• Reduce risk for buyers
• Strengthen the seller’s position

 

Whether you’re buying or selling, don’t wait until due diligence to think about addbacks. Start early, get help from M&A experts, and document everything with precision.

 

Email us at: saman@vasl.team

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