What is a Quality of Earnings (QofE) Report and Do You Need One?
A Quality of Earnings (QofE) sounds technical, but we’re here to break it down in plain language: what a QoE report actually is, why it matters, and whether you truly need one for your transaction. Spoiler alert: you might not!
What is a Quality of Earnings (QofE) Report?
Think of a QoE report as a thorough financial checkup for your business. Unlike traditional financial statements - like your profit and loss statements - that may not tell the whole story, a QoE digs deeper. It verifies whether the earnings reported are stable and realistic, rather than relying on any one-time revenues or unusual expenses that might give an overly optimistic picture.
For small business owners, a QoE report helps to present a clear and honest view of your business’s true financial health. This can be reassuring for buyers, who want to understand where your revenue is coming from, how steady cash flow is, and what the real costs are. It helps build trust by adjusting the numbers to reflect your business's earnings more accurately, giving potential buyers confidence in what they’re buying.
Why Does a QofE Exist?
In the acquisition process, a buyer wants to make sure they’re buying a business that can truly support its asking price. By getting a QofE report, buyers (and sometimes sellers) can:
- Identify Risks and Red Flags: A QofE reveals any hidden issues in the financials, like unusual revenue sources or excessive personal expenses, that might make the business less profitable than it appears.
- Validate Earnings: It ensures that the revenue is sustainable, meaning that the earnings are expected to continue after the acquisition.
- Strengthen Buyer Confidence: For buyers, a QofE adds a layer of assurance that they’re making a sound investment and paying a fair price.
Is a Quality of Earnings Necessary for Every Deal?
A Quality of Earnings (QoE) report can be useful, but it’s not always essential - especially for smaller deals. If you’re looking to sell or buy a business valued under $500,000, for example, a full QoE might not be worth the cost. In these cases, working with an accountant to review key financials can provide much of the assurance you need at a fraction of the price.
However, for larger transactions or businesses in complex industries, a QoE report can be a smart investment. It can help reduce financial risks and give both parties a clearer picture of the business’s financial health. This added layer of due diligence can be especially helpful if you’re dealing with complicated financials or want more certainty before completing the sale.
How Much Does a QofE Cost?
QofE reports aren’t cheap. On average, a QofE for a small business can cost anywhere from $10,000 to $30,000, depending on the business size and complexity. Given the cost, it’s typically more common in larger transactions where a deeper financial analysis is warranted.
Is a QofE Worth It for Small Business Transactions?
Here’s the bottom line: for smaller transactions, a full QofE might not be necessary. You could instead rely on detailed due diligence with the help of an accountant to spot any potential issues. For larger or more complex deals, however, a QofE is often worth the investment.
In these cases, a QofE can provide peace of mind by revealing whether the business is likely to remain profitable in the future, ensuring you’re making a smart investment.
