Quality of Earnings Report vs Audit: 7 Key Differences Every Buyer Should Know

If you’re evaluating a business for acquisition, you may think a financial audit is enough to ensure the numbers check out. But in most M&A deals especially in the lower middle market it’s not.

That’s where the distinction between a Quality of Earnings Report vs Audit becomes critical.

In this blog, we’ll explain what each one covers, the key differences, and why relying solely on an audit could leave you blind to major risks.

What Is a Quality of Earnings Report vs Audit in M&A?

A Quality of Earnings (QofE) report is a detailed financial analysis tailored specifically for M&A due diligence. Its main purpose is to determine the accuracy and sustainability of a company’s earnings usually adjusted EBITDA or Seller’s Discretionary Earnings (SDE).

Unlike a financial audit, which focuses on GAAP compliance, a QofE is designed to answer this question:

A QofE report helps buyers:

• Normalize earnings for one-time events and owner perks

• Assess customer concentration, revenue trends, and margin consistency

• Spot red flags like aggressive accounting or vendor disputes

• Evaluate cash flow quality and working capital needs

What Is a Financial Audit (and How It Compares to a Quality of Earnings Report)?

A financial audit is a standardized process where a CPA firm tests a company’s financials to ensure they comply with accounting standards such as GAAP or IFRS.

Audits are often conducted for compliance purposes and don’t necessarily focus on transaction-specific risks.

They include:

• Sample testing of transactions

• Balance verification

• Internal controls review

• Compliance assessments

The key difference? An audit verifies if the numbers follow the rules; a QofE determines whether the numbers reflect sustainable earnings.

7 Key Differences: Quality of Earnings Report vs Audit

Here’s a side-by-side breakdown of how these tools differ:

Audits confirm compliance. QofEs reveal economic reality.

Why Buyers Prefer a Quality of Earnings Report vs Audit in M&A

Let’s say you’re buying a $10M business with $1.5M in reported EBITDA. If $400K comes from one-off deals or questionable addbacks, an audit won’t flag it but a QofE will.

Buyers use QofE reports to:

• Distinguish recurring from one-time revenue

• Normalize for owner compensation and discretionary spending

• Uncover revenue concentration risks

• Validate EBITDA used in the valuation

Without a QofE, you’re negotiating blind and possibly overpaying.

What’s Included in a Quality of Earnings Report vs Audit

A QofE includes both financial and operational due diligence. Key elements often include:

• Adjusted EBITDA and normalized financials

• One-time or personal expense addbacks

• Channel-level revenue breakdown

• Gross margin analysis

• Working capital trends

• Commentary on tax exposure and accounting policies

Meanwhile, audits include:

• Formal financial statement review

• Sample testing and controls assessment

• No addbacks or transaction-specific insights

Common Addbacks Found in Quality of Earnings Reports (But Not in Audits)

Buyers often rely on QofEs for normalization of earnings. Examples include:

Legitimate Addbacks:

• Owner salary normalized to market rate

• One-time legal or consulting fees

• Personal vehicle, meals, or travel

• Deferred maintenance

Not Included in Audits:

Audits do not question or remove these items. They review statements “as-is.”

When to Choose a Quality of Earnings Report vs Audit

While a QofE is a must for buyers, audits may still be useful in the following situations:

• Companies with international operations

• PE-backed or public companies

• Lender requirements

But even if audited, smart buyers still commission a QofE to understand true earnings and reduce acquisition risk.

Red Flags a Quality of Earnings Report Can Reveal

Unlike audits, QofEs uncover patterns that impact deal value, such as:

• Customer churn hidden by aggressive sales

• One-time revenue boosting EBITDA

• Unsustainable vendor discounts

• Inflated or unjustified addbacks

• Weak recurring revenue

These insights are essential when structuring earn-outs, holdbacks, or walking away from risky deals.

Who Prepares a Quality of Earnings Report?

A Quality of Earnings Report should always be prepared by a neutral, third-party specialist not the seller’s CPA.

At VASL, our QofE reports are prepared by experienced analysts and CPAs who specialize in:

• Search fund deals

• First-time acquisitions

• Private equity-backed M&A

• Seller-prep QofEs for clean exits

A tailored QofE not only reduces surprises but also strengthens your negotiation position.

Final Thoughts: Quality of Earnings Report vs Audit

If you’re serious about buying a business, think of the audit as a snapshot and the QofE as a full diagnostic report.

A QofE gives you confidence in:

• True EBITDA

• Real cash flow

• Customer stickiness

• Risk-adjusted valuation

Skipping a QofE because the business is audited is one of the most expensive mistakes buyers can make.

Want help evaluating a deal or preparing for acquisition?

Email us at saman@vasl.team
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