An audit says whether the financial statements are fairly presented under GAAP; a quality of earnings report says what the business sustainably earns, and that is the figure acquisition lenders size the loan on. The QoE adjusts reported EBITDA for owner compensation, one-time items and run-rate changes, tests revenue against cash, and sets out normal net working capital. Companies commission audits for shareholders and lenders; buyers or sellers commission QoEs for a transaction. An audit provides neither adjusted EBITDA nor a working capital analysis, so an audited company being sold still usually needs a QoE.
- Audit answers
- Are the statements fairly presented under GAAP?
- QoE answers
- What does the business sustainably earn, and what working capital does it need?
- Commissioned by
- Audit: the company. QoE: the buyer or the seller, for a deal
- Lenders size acquisition debt on
- The QoE's adjusted EBITDA
- SBA from 1 October 2026
- QoE required on acquisitions of $3 million or more, excluding real estate
Two different questions
An audit asks whether a company's financial statements present its financial position and results fairly, in all material respects, under an accounting framework, usually GAAP. The auditor tests transactions and balances, confirms cash and receivables with third parties, observes inventory and evaluates the estimates management made. The product is an opinion on statements that already exist. It is backward-looking, bound by accounting rules, and deliberately silent on whether the earnings will continue.
A quality of earnings report asks what the business actually earns on a recurring basis, and what it needs to keep earning it. It starts from reported EBITDA and makes adjustments: owner compensation brought to market, personal expenses removed, one-time costs and gains taken out, the full-year effect of changes already made. It tests whether reported revenue became cash, looks at customer and margin trends, finds debt-like items that reduce the price, and measures the normal level of working capital. The product is an analysis for a specific transaction, not an opinion.
An audit tells a lender the numbers are right under GAAP. A QoE tells a lender which numbers to lend against.
Side by side
| Audit | Quality of earnings | |
|---|---|---|
| Purpose | Opinion that statements follow GAAP | Normalized, adjusted EBITDA and working capital for a deal |
| Governed by | Auditing standards; formal opinion | No single standard; scope agreed with whoever commissions it |
| Starting point | The general ledger and supporting evidence | The reported statements, audited or not, and tax returns |
| Output | Audited statements and opinion | Adjusted EBITDA bridge, net working capital analysis, debt-like items, proof of cash, findings |
| Time frame | One fiscal year, as of year-end | Usually the last two or three years plus the trailing twelve months |
| Commissioned by | The company, for owners, investors, lenders | A buyer (buy-side) or a seller (sell-side), for a transaction |
| Who relies on it | Shareholders, lenders under reporting covenants | The buyer, its lenders and investors, sometimes through a reliance letter |
| Forward-looking? | No | Partly: run-rate and pro forma adjustments |
| Independence | Required | Not required in the same sense; the provider works for its client |
Why acquisition lenders need what only the QoE provides
An acquisition loan is sized on earnings. Senior cash-flow lenders to lower-middle-market companies commonly lend 2x to 3.5x EBITDA, and SBA and bank lenders test debt service coverage of the business's cash flow against the payments on the new debt. The earnings figure they use is not the audited net income or even audited EBITDA. It is adjusted EBITDA: what the business earns once the seller's personal expenses, above- or below-market pay, and non-recurring items are taken out, and once the buyer's own costs are put in. An audit does not calculate that number. A QoE does, line by line, with support for each adjustment.
The second thing lenders need is working capital. A buyer that pays for a business and then discovers it must fund a large build in receivables or inventory has borrowed against cash flow it does not have. The QoE's net working capital analysis sets the peg in the purchase agreement and tells the lender how much working capital the business needs at close. The audited balance sheet shows working capital on one day; the QoE shows what is normal across the year, month by month.
Third, the QoE carries a proof of cash: reported revenue tied to bank deposits. For a business whose books have never been audited, that single test often does more for a lender's confidence than any other document. For one that has been audited, it confirms that the trailing months since the last audit hold up.
Lenders also carry QoE adjustments into the loan agreement. The covenant definition of EBITDA typically permits the same kinds of add-backs the QoE accepted, and lenders are wary of add-backs the QoE did not support. See EBITDA add-backs.
Where an audit still counts
An audit is not wasted in a sale. A QoE provider working from audited statements spends less time establishing that the base numbers are right and more on the adjustments, so the QoE is usually faster and cleaner. Lenders give audited history more weight, particularly on the balance sheet. After closing, the loan agreement may require audited statements every year; see audited vs reviewed vs compiled financials.
What the audit does not do is replace the QoE. A clean opinion can sit on statements whose earnings include a one-time contract, a below-market rent paid to the owner, or a customer that has just left. None of those make the statements wrong under GAAP. All of them change what a lender will lend.
Buy-side, sell-side, and what lenders do with each
A buy-side QoE is commissioned by the buyer, scoped to the buyer's concerns, and is the one lenders most often rely on. A sell-side QoE is commissioned by the seller before going to market, to put a defensible earnings figure in front of buyers and reduce surprises later. Lenders read a sell-side report with interest but tend to test its adjustments harder, since the seller paid for it, and a buyer may still commission its own.
Where a lender will rely on a QoE, it may ask the provider for a reliance letter permitting that reliance. It may also ask for scope beyond the standard adjusted EBITDA and working capital work, such as customer concentration or a margin analysis by product line. The QoE should run through the target's latest full year; lenders do not size an acquisition on an older year. See quality of earnings for acquisition loans and how lenders read a QoE.
SBA's rule from 1 October 2026
Under SOP 50 10 8.1, from 1 October 2026 SBA requires financial due diligence on every change of ownership it finances, and a quality of earnings report on acquisitions of $3 million or more excluding real estate. Below that size financial due diligence is still required, and in practice lenders look for the seller's statements reconciled to its tax returns and bank statements, with support for each adjustment to earnings. A target's audit helps with that work but is not a substitute for the QoE, because the rule is not asking whether the statements follow GAAP; it is asking whether the earnings are real. From the same date, a change of ownership must also show debt service coverage of 1.25x on historical results, which puts more weight on exactly the adjustments a QoE tests.
Which one does your deal need?
| Situation | Audit | QoE |
|---|---|---|
| Buying a business with acquisition debt | Helpful if the target has one | Expected by most cash-flow lenders; required by SBA from 1 October 2026 at $3 million or more, excluding real estate |
| Selling a business | Helpful; speeds the buyer's work | A sell-side QoE reduces re-trading on price |
| Refinancing an owned business | Sometimes required on larger credits | Rarely needed unless earnings are heavily adjusted |
| Line of credit or ABL | Sometimes required on larger lines | Rarely; the lender relies on the field exam |
| Company with outside shareholders | Often required by the investors | Not relevant outside a transaction |
For a buyer, the practical sequence is: sign the letter of intent, commission the QoE, and give the lenders the same adjusted EBITDA and working capital figures the QoE supports. Transparent's financing model starts from those figures and the underwriting memo explains each adjustment, so every lender sees the same earnings base with its support attached. See the lender package.
Common questions
- Is a quality of earnings report an audit?
- No. It is a financial due diligence analysis done for a transaction. It gives no opinion on GAAP compliance, and its scope is agreed with whoever commissions it.
- My company is audited. Will a buyer still want a QoE?
- Usually, if the buyer is using acquisition debt; on a smaller deal a lender may accept a narrower financial due diligence review instead. The audit confirms the statements; the QoE produces the adjusted EBITDA and working capital figures the loan and purchase agreement are built on.
- Who pays for the QoE?
- Whoever commissions it. A buy-side QoE is usually paid by the buyer as part of deal costs; a sell-side QoE by the seller before going to market.
- Does SBA require a quality of earnings report?
- From 1 October 2026, under SOP 50 10 8.1, SBA requires a QoE on acquisitions of $3 million or more excluding real estate, and financial due diligence on every change of ownership.
- Can a lender rely on a QoE the seller commissioned?
- Some will read it and test its adjustments, and may ask for a reliance letter. Many buyers and lenders still commission their own, or a narrower confirmatory review.
- What if the QoE's adjusted EBITDA is lower than the seller's figure?
- Lenders will size on the QoE figure. The buyer then renegotiates price or structure, adds equity or seller financing, or walks. See will a lender finance the purchase price.