What Is a Quality of Earnings Report? A Buyer's Guide

A quality of earnings report is how you find out which is which before you close. Here is what it is, what it tests, when a lender requires one, and how it changes the price you should pay.

Why a quality of earnings report matters to a buyer

You do not buy revenue. You buy the cash the business will produce after you own it. Your lender sizes the loan on that cash, and your price is a multiple of it.

So every dollar of earnings that does not hold up costs you twice. It weakens coverage on the debt. And it was already priced into what you agreed to pay.

The SBA now writes this into the rules. Under SBA SOP 50 10 8.1, effective October 1, 2026, the lender must use the earnings from the QoE in its debt service coverage calculation. If that coverage does not support the valuation and the proposed debt, the loan amount must be reduced. Additional equity can fill the gap.

In plain terms, the report's number becomes the deal's number.

What a quality of earnings report tests

The SOP defines a QoE as a financial due diligence report that examines the reliability, sustainability and accuracy of a business's historical and projected earnings. An independent, experienced financial professional has to perform it.

Here is what the lender's version must cover:

Reconciliation. The report ties together accountant prepared statements, tax returns, internal financials and IRS transcript data. The output is one normalized earnings figure that reflects recurring, arm's length operations.
A Cash Proof. The analyst rebuilds cash receipts and disbursements from bank statements and reconciles them to the income statement and tax return. It runs on a trailing 12 month basis and for the last two fiscal years. This is where unreported income and undisclosed expenses show up.
Every add back. Each adjustment to the seller's earnings has to be identified and documented. The SOP names non recurring revenue or expenses, above or below market owner pay, related party deals, deferred maintenance, and cash versus accrual differences.
Revenue that lasts. The report assesses customer concentration, contract continuity and whether revenue and margins are likely to hold after the sale.

Notice the list cuts both ways. A seller who pays themselves less than a replacement manager would cost has overstated earnings. A seller who skipped repairs to protect margin has left you a bill.

A good report reads like the list of questions you should have asked. Each finding is a line item you can take back to the seller.

When the SBA requires one

For Initial Acquisitions and Business Expansions, the lender must obtain a QoE when the purchase price is $3 million or more. That is on top of the required business valuation.

The $3 million line is measured before buyer equity, seller debt or any other financing. Structure does not get you under it.

Owner Buyouts and ESOP deals are exempt, because the existing owners stay and already know the business. A deal built around an owner occupied special purpose property, such as a hotel or a storage facility, is exempt as well.

Three related rules sit beside it:

Coverage on an Initial Acquisition must be at least 1.25 times.
Total debt, including seller debt that is not on full standby, is limited to the business valuation.
If you pay more than the valuation, the difference has to come from equity.

Buy side, sell side, and whose report counts

The SOP is blunt. The lender's QoE must not be prepared by or for the seller. A sell side report can still be useful reading. It cannot replace the lender's.

If you commission your own report before you approach a lender, the lender may have one of its approved vendors review it instead of starting over. The review findings go in the loan file with the original. Without that review, the lender cannot rely on a report prepared by another party.

That makes the timing practical. Commission the work after the letter of intent and before you spend heavily on legal documents. You want the findings in hand while price is still open. Our guide on how to renegotiate a deal after due diligence covers what to do with them.

Above the SBA line, the same test applies. A Standard 7(a) loan tops out at $5,000,000. Larger deals usually go to private equity, family offices, independent sponsors or conventional bank debt. None of them is bound by the SOP, and all of them commission their own quality of earnings work. They set price and leverage on normalized earnings, often with a close look at working capital. The format changes. The question does not.

Worked example: how $260,000 of add backs moved the price

This example is illustrative. The company, the multiple and the findings are assumptions for the math, not market data. It ignores closing costs, SBA fees and working capital.

The ask. A services company has $3,600,000 in revenue. The seller shows adjusted EBITDA of $1,100,000, a 30.6% margin, and asks 4.25 times, or $4,675,000. That price is above $3 million, so the lender needs a QoE.

The financing. The Federal Reserve H.15 release showed the bank prime rate at 7.00% through November 4, 2026. The SOP caps variable rates on 7(a) loans above $350,000 at prime plus 3.0%, so the ceiling is 10.00%. Change of ownership loans amortize over no more than 10 years. At 10.00% over 120 months, each dollar borrowed costs about 15.86 cents a year.

The loan. With the 10% minimum equity injection for an Initial Acquisition, you put in $467,500 and borrow $4,207,500. Annual debt service is about $667,230. Coverage on the seller's number is $1,100,000 / $667,230 = 1.65 times. It looks comfortable.

The QoE findings.

$140,000 of "one time" consulting fees appear in all three years. They recur, so they come back out.
The owner takes $110,000 a year. A general manager to replace them costs $180,000. That is a $70,000 reduction.
A contract that ended during the trailing 12 months contributed $50,000 of margin. It will not be there after closing.

Total: $260,000. QoE EBITDA is $840,000, a 23.3% margin.

The coverage. $840,000 / $667,230 = 1.26 times. It clears the 1.25 floor, barely. At 1.25 times, $840,000 supports $672,000 of debt service, which caps the loan at about $4,237,600 on these terms. One more finding of roughly $6,000 and the loan has to shrink.

The price. At the same 4.25 times, $840,000 supports $3,570,000. That is $1,105,000 below the ask, which is $260,000 times 4.25. If the business valuation comes back near that figure, anything you pay above it has to come from your equity.

Now you have three options:

Walk away.
Renegotiate to the supported number.
Bridge part of the gap with a seller note on full standby, which SBA treats as equity, so the seller waits behind the lender to collect it.

Read it backward, too. The margin the seller showed was 30.6%. The margin you would own is 23.3%. That gap is the whole reason the report exists.

Frequently asked questions

What is included in a quality of earnings report?

A reconciliation of the financial statements, tax returns and bank data, a Cash Proof, a documented schedule of every add back, and an assessment of whether revenue and margins will hold after the sale. The output is one normalized earnings figure.

Is a quality of earnings report the same as an audit?

No. An audit gives an opinion on whether financial statements are fairly presented. A QoE asks the buyer's question: how much of these earnings will recur under new ownership.

Does an SBA loan require a quality of earnings report?

For an Initial Acquisition or Business Expansion priced at $3 million or more, yes. Owner Buyouts and ESOP deals are exempt, and smaller deals still need a business valuation.

Can a buyer's lender use the seller's quality of earnings report?

Not as the lender's report. Under SOP 50 10 8.1 it must not be prepared by or for the seller. A report the buyer commissioned can be reviewed by the lender's vendor instead.

Where FM fits before you sign

I have owned companies since 1999. The number that survives diligence is the number you are buying. Everything else is the seller's opinion.

If you are buying, test the earnings before you commit to a price. Our acquisition strategy work helps you scope diligence, and the capital and lending page explains how lenders size the debt. The buyer cohort is where buyers learn to read these reports together. To see the kind of businesses FM looks at, start with deals and deal flow.

If you are the seller, our guide on how to prepare a business for sale shows how to rehearse this test on your own books.

Here is what I buy. Cash flowing, stable, profitable businesses with $3 million to $15 million in revenue and 30% or better margins. The other criteria are three years or more of profitable history a third party can verify, control with a majority stake preferred, a United States location, and under 25% of revenue from any one customer.

If your business is below the box, under $3 million in revenue or under 30% margin, start with fractional C-suite advisory. That is the right first step for a business outside the box.

This communication is for informational purposes only and does not constitute an offer to sell or a solicitation of an offer to buy any securities, financial instruments, or investment products. FM Enterprises is not a licensed business broker, a registered broker-dealer, an investment advisor, or a financial planner, and does not place outside capital. Any discussions regarding business strategy, scalability, or introductions are strictly for educational and strategic purposes. Please consult with a licensed financial or legal professional before making any investment or financial decisions.