Quality of Earnings (QoE): what it is and what it tests

Published October 25, 2026 · Rules checked against SBA and IRS sources as of October 2026

"Quality of earnings" started as an analyst's phrase for how much of a company's profit is backed by cash and likely to repeat. In deals it became a report: the document a buyer or lender commissions to find out whether the EBITDA in the pitch is the EBITDA they'll actually get. Since October 1, 2026, it's also an SBA requirement on larger acquisition loans.

What a QoE answers

1. Are the numbers real? Do the financial statements agree with the tax returns, IRS transcripts and bank statements?
2. Are they recurring? What's one-off (a lawsuit, a big order that won't repeat, PPP income) and what's normal?
3. Are they arm's length? Owner pay above or below market, family on payroll, rent paid to the owner's LLC.
4. Will they last? Customer concentration, contracts that end, pricing, deferred maintenance.
5. What's the right working capital? How much the business needs to run, which feeds the purchase agreement.

How it's built

Reconciliation

The QoE ties internal financials, accountant-prepared statements, tax returns and IRS transcript data together. Small business books are often cash basis or prepared mainly for taxes; differences are normal, but each has to be explained.

Proof of cash

The analyst rebuilds receipts and disbursements from bank statements and reconciles them to reported revenue and expenses, period by period. It's how a QoE finds revenue that isn't deposited, personal expenses run through the business, or deposits that aren't revenue. SBA requires it for the trailing 12 months and the last two fiscal years. See how a proof of cash works.

Normalization adjustments

Each adjustment moves reported EBITDA toward what a buyer will earn: non-recurring items, owner compensation to market, related-party rent to market, run-rate effects of price changes, cash-to-accrual timing, deferred maintenance. Good QoEs show each with evidence and say which were rejected. See QoE adjustments.

Revenue quality and risks

Customer concentration, contract terms and renewals, churn, pricing, seasonality, margins by product, supplier dependence. For SBA, the QoE must assess "the likelihood that existing revenue and margins will be maintained post-sale."

QoE vs audit vs valuation

A worked example

Illustration, not a real deal

Say a regional landscaping company is listed with $1,050,000 of "adjusted EBITDA" on a $4.2 million price. The QoE finds:

The listing's $1,050,000 becomes $844,000, about 20% lower. On an SBA deal, the lender must use $844,000 for DSC, and if coverage doesn't support the structure the loan shrinks. That's the point of the report: it's cheaper to learn this before closing.

When SBA requires a QoE

• Initial Acquisitions and Business Expansions with a Business Purchase Price of $3 million or more, before equity or seller financing, excluding owner-occupied real estate.
• Not required for Owner Buyouts, ESOP and Cooperative deals, or owner-occupied special purpose property acquisitions.
• Independent, experienced financial professional; for the lender's benefit; not prepared by or for the seller.
• A buyer's own QoE may be reviewed by the lender's approved vendor instead; the lender can't rely on it without that review.
• Must include the cash proof, document all adjustments and assess revenue sustainability.
• Lender uses QoE earnings in DSC and keeps the report in the file.

Full detail: the SBA QoE requirement.

What a QoE isn't

• Not an audit opinion.
• Not a fraud investigation, though a proof of cash often surfaces problems.
• Not a valuation or a price recommendation.
• Not a guarantee of future results.

Rules reflect SOP 50 10 8.1 with technical updates, checked October 25, 2026.

The QoE report itself

A quality of earnings report usually contains an executive summary, scope and data sources, an adjusted EBITDA bridge with each adjustment explained, a reconciliation of financial statements to tax returns, a proof of cash, revenue and customer analysis, margin and expense analysis, net working capital, debt and debt-like items, and key findings. For SBA loans, it must also meet SOP 50 10 8.1's specific content rules and be prepared for the lender.

Here's a section-by-section map of a QoE report built for a lender, with the parts SBA explicitly requires marked.

The sections

Executive summary

Headline adjusted EBITDA for each period, the biggest adjustments, and the findings that matter for the decision. A lender should be able to read this page and know whether the deal still works.

Scope and sources

Periods covered (for SBA: TTM and the last two fiscal years for the cash proof), documents received and not received, limitations, and who the report is for.

Adjusted EBITDA bridge

Reported EBITDA to adjusted EBITDA, line by line: owner compensation to market, non-recurring items, related-party rent, accounting method changes, run-rate items, deferred maintenance. Each with evidence and a note on adjustments proposed by the seller or broker that were rejected. See adjustments and a worked calculation.

Reconciliation

Internal financials to accountant-prepared statements to tax returns to IRS transcripts, with differences explained.

Proof of cash

Receipts and disbursements rebuilt from bank statements and reconciled to revenue and expenses for each period. See proof of cash.

Revenue quality

Top customers and their share, contract terms and renewal dates, churn, pricing changes, seasonality, and the likelihood revenue and margins hold after the sale. See customer concentration.

Margins and expenses

Gross margin trends by product or service, fixed vs variable costs, expenses that look underspent (maintenance, marketing, wages below market).

Net working capital

Normal working capital level and seasonality, which informs any working capital target or true-up in the purchase agreement.

Debt and debt-like items

Customer deposits, deferred revenue, accrued bonuses, unpaid taxes, deferred capex: obligations a buyer effectively takes on.

Checklist for a lender receiving an SBA QoE

• Addressed to and prepared for the lender; preparer independent and experienced.
• Cash proof covers TTM and two fiscal years (or full history if younger).
• Reconciles to IRS transcript data.
• Every adjustment documented, including cash vs accrual differences.
• Revenue sustainability addressed.
• A clear adjusted earnings figure to use in DSC.

See an annotated illustrative example.

QoE vs audit vs review vs valuation

A quality of earnings report is not an audit. An audit gives an opinion that financial statements are fairly presented under an accounting framework. A review gives limited assurance. A QoE is transaction due diligence: it tests whether earnings are real, recurring and sustainable, and produces normalized earnings for pricing and lending. A valuation gives an opinion of what the business is worth. SBA requires both a valuation and, at $3 million or more, a QoE.

See the QoE pillar guide and proof of cash.

The quality of earnings ratio (not the same thing)

The quality of earnings ratio is operating cash flow divided by net income. A ratio above 1 means the business converts reported profit into at least as much cash; well below 1 suggests profits are tied up in receivables or inventory or flattered by accounting choices. It's a quick screening ratio from financial statements. A quality of earnings report is something else: a full due diligence engagement that normalizes earnings for a transaction.

Formula

Quality of earnings ratio = Net cash from operating activities / Net income

Ratio vs report

How OKtoLend approaches a lender-side QoE

We build QoE reports for the lender as client, to the SOP's scope: reconciliation of accountant-prepared statements, tax returns, internal statements and IRS transcript data; a cash proof for the trailing twelve months and the last two fiscal years; every adjustment documented with its evidence; and a written view of revenue quality covering concentration, contract continuity and sustainability after the sale. Software handles the reconciliation work; a credentialed analyst reviews and signs. Tell us about the deal and we'll reply with pricing and timing within one business day.

Common questions

Related guides

• SBA Quality of Earnings requirements for lenders on $3 million-plus acquisitions
• Proof of cash reconciliation: how it works in a lender-side QoE
• Quality of earnings adjustments: the categories, with examples
• Quality of earnings report: an annotated example, template and document checklist
• Quality of earnings providers: how to choose, engage and review one

This guide explains rules and practice in plain English. It isn't legal, tax or credit advice, and SBA and IRS rules change. Check the current SOP, regulations and your lender's requirements before you rely on anything here. Examples with made-up businesses are illustrations, not real deals.