What does a quality of earnings report show?

A quality of earnings report is a review of a business’s financial results, written by an accountant, that asks whether the reported profit is real, repeatable and fairly stated. It is not an audit and it is not a price. Most reports follow a similar order, so once you know the sections you can read one with a pencil in hand and know which pages deserve your questions.

The earnings bridge

The centrepiece is a bridge that starts at the profit on the financial statements and walks, line by line, to an adjusted figure. Each step is a reasoned change: a one-time cost removed, an owner’s personal expense taken out, a missing market-rate wage for the owner added back in. Read the bridge for direction as well as size. A bridge that only ever moves profit upward deserves a harder look than one that moves in both directions.

The add-back schedule

Behind the bridge sits a schedule that lists each adjustment, its amount, the support the accountant saw and whether the item is likely to recur. Look for evidence beside every line, such as invoices or bank records, rather than the owner’s explanation alone. Ask what the accountant could not verify and how that item was treated. Unsupported items are often shown separately, and you can ask the lender and your advisers how they would handle them.

Revenue, customers and working capital

Revenue analysis looks at timing, mix and concentration: which customers, products or months carry the results, and whether sales were recognized in the right period. Working capital sections show what cash the business normally ties up in receivables, inventory and payables, which matters when you agree what is delivered at closing. Debt-like items, such as overdue taxes, unpaid bonuses or customer deposits, are flagged so they are not missed in the price discussion.

How to read it

Start with the summary of findings, then trace each finding back to its schedule. Note what the scope excluded, since a report only covers what it was asked to cover. Send your questions to the accountant who wrote it, and bring the findings to your lawyer, because they often shape the protections written into the agreement.