Quality of Earnings in M&A – what does the buyer actually check in a company’s results?
Two companies can report the same EBITDA and still be worth very different amounts to an investor. In M&A, what matters isn't just the size of the result, but its quality, recurrence, and ability to convert into cash.
Quality of Earnings – usually shortened to QoE – is one of the main areas of financial due diligence. Its goal isn’t to run another audit of the financial statements, but to answer: what economic result does the business actually generate, and how much of it can be sustained after the deal?
QoE is not an audit
A financial audit focuses on whether the financial statements present the company’s position in line with the relevant accounting standards. QoE looks at the same numbers from a transaction perspective. The buyer cares about run-rate profitability, the one-off nature of costs and revenue, customer concentration, seasonality, cash conversion, and whether accounting policy shifts results between periods.
EY explicitly names analysis of historical results, identifying normalising adjustments, assessing forecast assumptions, and analysing working capital and debt-like items as core elements of transaction diligence.
Six questions QoE answers
Is revenue recurring?
A buyer will want to know how much of sales comes from recurring relationships, how dependent the business is on one-off projects, whether long-term contracts exist, how churn behaves, and whether growth comes from volume, price increases, or a few large clients.
Customer concentration gets particular attention. A company can grow fast, but if 40% of revenue comes from one client, the risk of losing that result post-deal is very different than with a broad, diversified base.
Is the margin durable?
QoE breaks margin down into drivers. EBITDA growth can come from a better product mix, price increases and scale – but also from delayed costs, underinvestment, temporarily lower headcount, or a one-off project with unusually high profitability.
The buyer needs to establish whether the current margin is representative of the business after closing.
Which EBITDA adjustments hold up?
Management adjustments and add-backs are a natural part of the process, but they’re usually the most debated part of QoE. A seller may argue a cost was one-off. A buyer will ask whether a similar cost appeared the year before, and whether it will appear again next year.
- one-off legal or restructuring costs
- expenses directly tied to the sale process
- related-party costs or revenue on non-market terms
- owner compensation diverging from market rate
- costs of vacant roles that will need to be refilled
- unusual capitalisation of expenditure
Does EBITDA convert into cash?
Strong EBITDA alongside weak cash flow is a signal for further analysis. The cause could be rising receivables or inventory, high CAPEX, advance payments, seasonality, or aggressive revenue recognition. That’s why QoE is usually analysed together with working capital, cash flow and net debt.
Does the result depend on accounting judgment?
Cut-off rules, revenue recognition, provisioning, cost capitalisation and accruals all become especially important in a transaction. The buyer wants to know the result isn’t excessively dependent on accounting judgment, and that policies were applied consistently across periods.
Is the budget grounded in history?
Valuation often rests partly on a forecast, so QoE doesn’t stop at history. Financial due diligence compares the forecast against past growth, backlog, sales pipeline, margin trends and cost structure. The bigger the jump between historical results and the plan, the more questions an investor will ask.
What can the QoE outcome change in negotiations?
A QoE outcome can affect several areas at once: normalised EBITDA, the multiple, the target working capital, the net debt definition, the scope of warranties/indemnities, and the price structure itself. If the buyer concludes part of the result is less recurring, they may lower the EBITDA base, expect an earn-out, or increase the share of price tied to future performance.
How to prepare a company for QoE
- keep a monthly P&L and balance sheet that lets trends be reconstructed
- prepare an EBITDA bridge with documentation for every adjustment
- understand the revenue bridge: volume / price / mix / FX / acquisitions
- know your top clients, churn, backlog and concentration
- keep control of working capital and cash conversion
- agree one consistent KPI definition and use it across all investor materials
A well-prepared QoE isn’t about “dressing up” the result. It’s about letting the buyer quickly tell recurring earnings apart from one-off events.
What most often slows due diligence in Polish companies
It’s rarely a lack of profitability – it’s a lack of data in the format an investor expects. Many companies have solid financial accounting and weak management accounting: they can show an annual statement, but not monthly margin by product, client or project. The buyer will ask anyway, and reconstructing it under time pressure rarely works in the seller’s favour.
A second common issue is a mismatch between the numbers in the memorandum and the books. If investment materials use a different cost structure than the reports, every discrepancy invites questions. One consistent definition of EBITDA and KPIs, used from the first presentation through to closing, saves weeks of process.
This material is for informational purposes only and does not constitute legal, tax or valuation advice.
Sources used: EY (Due Diligence Services; Boosting carve-out sale value with financial management), PwC (Transaction Services; Quality of Earnings, Net Debt, normalized working capital).
