By Panoramic Capital Partners
The Report That Can Move Your Deal by Millions: What a Quality of Earnings Actually Is
The Full Picture | Panoramic Capital Partners
Key Takeaways
- A quality of earnings analysis is the buyer’s attempt to answer one question: how much cash will this business produce on an ongoing basis going forward. EBITDA is the shorthand they use to express it.
- It’s not a desk review. A team of accountants spends days going through every general ledger account in the trailing 24 to 36 months to arrive at a normalized run-rate number.
- Adjustments cut both ways. The worked example below shows a $620k EBITDA spread between sell-side and buyer views, which translates to a $5M enterprise value swing at an 8x multiple.
- The QoE covers more than EBITDA. Working capital, customer concentration, supplier concentration, gross profit by customer, and other areas all get scrutinized.
- Some normalizations are clean. Others, like how to treat recently hired salespeople, are negotiated. “True EBITDA” is often a position, not a fact.
- A sell-side QoE flips the burden of proof. The buyer’s team checks your work rather than rewriting it. Cost runs $20k to $300k+ depending on size and complexity.
There’s a moment of exhale after the LOI is signed. After fifteen, twenty, thirty years of building, the number on the offer letter is real. The wire is coming. The finish line is finally close enough to see.
Then the QoE report lands.
A few hours later you’re on a call where the buyer’s team is using phrases like “adjusted run-rate” and “normalized basis,” and the number they’re working with isn’t the number you’ve been working with. The wire amount that’s been quietly settling into the back of your mind, the one you’d let yourself imagine on the longer days, is shifting in real time. And it’s not always clear how to push back, because nobody ever sat you down and explained how this report actually works.
The version of the deal you’d been carrying around for months is not the version on the table anymore.
Most owners first encounter the term “quality of earnings” the same way: too late, and from the other side of it. By the time the report lands, the framework for the rest of the negotiation has already been set. By somebody else.
What a QoE Actually Is
Strip away the jargon and a quality of earnings analysis is a buyer trying to answer one question: how much cash will this business produce on an ongoing basis, going forward?
That’s it. That’s the whole thing.
EBITDA gets used as the shorthand for that cash generation. We’ll set aside for another article whether EBITDA is the right shorthand. It’s imperfect, but it’s the language of the market. What matters here is that the buyer isn’t auditing your historical financials in the way an audit firm would. They’re trying to figure out what the business will look like as a cash machine in the years they own it.
The buyer isn’t trying to catch you out on something. They’re trying to translate your historical results into a forward-looking number they can underwrite. Sometimes that translation moves the number up, sometimes down. Often both at the same time.
What the Process Actually Looks Like
A QoE is not a desk review. In a real engagement, a team of accountants, usually from a transaction advisory practice, sits in a room with your CFO and controller for a full day, often two or three. They have a request list that runs 30+ items long: general ledger detail for the trailing 24 to 36 months, monthly trial balances, payroll registers, customer-level revenue, vendor-level spend, accruals schedules.
They go through it line by line. Every recurring expense category, every lumpy month, every reclassification, every account that has activity in some periods and not others. They ask questions about every transaction that doesn’t match the story management has told. Why was there a $200k charge in March 2024 in this account that’s normally zero? Why did this category step up in July? Who is this vendor?
The output is a normalized EBITDA: their best estimate of what the business generates on a steady-state, run-rate basis. That number becomes the basis for everything else in the deal: price, working capital peg, escrow, earnouts, debt sizing.
Until you’ve sat through one, it’s hard to appreciate how much can move during those two days.
More Than EBITDA: Working Capital and Customer Concentration
While EBITDA normalization is the headline of the QoE, two other workstreams run alongside it, and either one can move the deal in significant ways.
Net working capital. The buyer is also determining the “normal” level of working capital required to run the business. This becomes the working capital peg: the amount that has to be left in the business at close. Set it too high and the seller leaves money on the table. Set it too low and the buyer effectively gets a price reduction post-close. The QoE team builds out monthly working capital trends across the trailing 24 to 36 months to identify seasonality, growth-related changes, and unusual movements. It’s a separate negotiation that quietly costs sellers hundreds of thousands of dollars when it isn’t actively managed. For a deeper look at how the peg is established, negotiated, and trued up after close, see our earlier piece on The Net Working Capital Peg.
Customer concentration. Buyers want to know which customers drive the business and how much risk is sitting in any one of them. The QoE pulls customer-level revenue for the trailing periods, looks at top-10 and top-25 concentration, examines retention and churn patterns, and flags any customers that have grown or shrunk meaningfully. High concentration doesn’t just affect the multiple. It can change the structure of the deal, including escrow size, indemnification terms, and how much of the purchase price ends up tied to post-close performance.
Neither of these gets the same airtime as EBITDA, but both belong on your radar well before going to market. Depending on the business and the buyer, the QoE may also dig into supplier concentration, gross profit by customer, contract structures, and a handful of other areas. The scope flexes with what’s material to the deal.
How EBITDA Moves in Both Directions
The exercise cuts both ways. Some adjustments work in the seller’s favor. Some don’t. Both kinds get found in the same room.
A clean positive adjustment. Imagine a business reporting $5.0M of EBITDA on the trailing twelve months. Six months ago, the owner restructured the management team and eliminated a senior position with a fully loaded cost of $300k per year. Because the change happened mid-period, only six months of the savings is reflected in the trailing twelve. The other $150k of that position’s cost is still sitting in the historical financials. On a normalized, run-rate basis, that’s $150k that should be added back. The business actually generates $5.15M on an ongoing basis, not $5.0M.
That’s a defensible add-back. A good QoE process surfaces it. A good sell-side advisor makes sure the buyer’s team finds it, or better, brings it to them.
A meaningful negative adjustment. Same business, $5.0M reported. Five months ago, the company built out its customer success function, adding a Director of Customer Success and a Senior CS Manager at a combined loaded cost of about $450k per year. Because they were hired partway through the trailing twelve, only about $190k of that cost is in the historical financials. Going forward, the full $450k hits every year.
Then there’s an office expansion that closed three months ago. Annual rent run-rate is $180k higher than what’s reflected in the TTM; only $45k has flowed through so far.
Add a handful of smaller items: an insurance renewal at a higher rate, a couple of software contracts that just stepped up, a wage adjustment that hasn’t fully cycled. Another $80k of normalization.
Combined, the buyer’s QoE normalizes by $475k that hasn’t shown up in the historical numbers. Adjusted EBITDA: $4.53M.
Net it out. The same business, looked at honestly from both directions:
- Sell-side view, with the legitimate restructuring add-back: $5.15M
- Buyer’s run-rate view, with the cost normalizations: $4.53M
- Spread: $620k of EBITDA
That doesn’t sound like a lot. Until you remember what it does on the way out.
The Valuation Impact
A quick word on how this work actually gets done in practice, because it’s relevant to how the rest of the article lands.
This is what we do at Panoramic Capital. We are not the advisor brought in at the moment of sale to execute a single event. By the time someone is in that seat, the advice is bounded by what is still possible, which is rarely as much as the founder had hoped.
We are embedded across the middle. We are shaping the asset itself, not just brokering its eventual sale. Open architecture matters here, the ability to navigate decisions around senior debt, mezzanine debt, growth equity, ESOP structures, minority recaps, and strategic investments, rather than being captive to a single menu of options (or motivated by a single incentive). Simplification matters most of all, because the complexity of holding company strategy, capital structure, family governance, and personal balance sheet integration, all at once, is what most owners are quietly drowning under.
The shift is from advisor as transaction broker at the end to advisor as partner across decisions throughout. That is the relationship we build with the founders we work with, and it is what makes the middle phase navigable.
The Gray Area Nobody Tells You About
Some adjustments are clean. Some are not.
Imagine the same business hired two senior salespeople four months before going to market. Loaded cost of about $250k each, so $500k of new annual sales expense. Only about $167k of that has flowed through the trailing twelve so far. They’ve made introductions and built pipeline, but they haven’t yet closed enough revenue to materially affect the top line.
How does that get treated in the QoE?
The buyer’s view is straightforward and self-interested: run-rate the cost. They’ll pay these people the full $500k next year, so the full annualized cost belongs in normalized EBITDA. That means another $333k of normalization on top of what’s already in the TTM. The expected revenue is uncertain, in the future, and not in any historical period, so it doesn’t get credit yet.
Normalize down by $333k. Move on.
The seller’s view, equally legitimate: the entire reason these salespeople were hired was to drive future revenue. Cost without the corresponding revenue contribution gives a distorted picture of the business model. If you’re going to run-rate the expense, you have to take some view on the revenue these hires were brought on to produce. Otherwise the buyer is buying the future investment for free, after baking the full cost in against the seller.
There is no clean answer here. The accounting doesn’t tell you. The buyer’s QoE will almost always default to the conservative version (cost in, revenue out). A sell-side QoE, or a well-prepared seller, will frame the issue differently and at minimum force a conversation rather than letting the assumption ride.
This is where it stops being arithmetic and starts being negotiation. “What is true EBITDA” is not a settled question. It’s a position, defended with data, against another position, defended with data. The owner who’s never seen the inside of one of these rooms before is at a structural disadvantage. The owner who has, or who has someone in their corner who has, is not.
The Case for a Sell-Side QoE
Almost every problem described above gets smaller when you go through the exercise yourself, before the buyer does.
A sell-side quality of earnings is the same analysis, run by your own team of accountants, on your own books, before the company goes to market. It does three things.
It surfaces your positive adjustments first. That $150k restructuring add-back doesn’t sit in your TTM until the buyer happens to ask the right question. It’s identified, documented, and presented as part of the materials package. The buyer’s QoE then validates what you’ve already shown.
It identifies your negative adjustments before they become surprises. The customer success build-out, the office expansion, the salespeople hired in advance of revenue. These are all going to come up. Going through them yourself first means you have an answer ready for each one, with the data to back it up, instead of being caught flat-footed in the middle of a buyer call.
It shifts the burden of proof. When you arrive at diligence with a defensible normalized EBITDA already established, the buyer’s team is checking your work rather than rewriting it. The conversation moves from “what is this business actually generating?” to “do we agree with the seller’s documented view?” Those end at very different numbers.
The cost of a sell-side QoE typically runs from $20k to $300k+ depending on size and complexity. Set against a deal where a few hundred thousand dollars of normalization can move enterprise value by millions, it’s one of the highest-ROI investments an owner can make before going to market.
The Bottom Line
The QoE isn’t paperwork that happens during diligence. It’s the analytical center of the entire transaction, where the EBITDA that gets multiplied, the number that becomes your enterprise value and your wire amount, actually gets set.
Owners who treat it that way prepare for it the way they’d prepare for any decision worth millions. Owners who don’t, find out the hard way that the number on their P&L is not the number that ends up in the purchase agreement.
Panoramic Capital Partners (“Panoramic”) is a registered investment advisor.
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