The Role of Quality of Earnings in Smarter, More Confident Transactions

In this episode of The Transaction Abstract Podcast, Joe Hellman sits down with Nonye Thompson, Managing Director in Redpath’s Transaction Advisory Services practice, to break down one of the most important, and often misunderstood, components of the deal process: the Quality of Earnings (QoE).

Drawing from years of experience leading buy-side and sell-side diligence engagements for transactions ranging from $5 million to over $1 billion, Nonye explains what a QoE actually is, why it matters, and how it helps both buyers and sellers make smarter, more confident decisions.

What Is a Quality of Earnings and Why Does It Matter?

While many first-time buyers focus on net income or cash flow, EBITDA is the most common metric used in M&A. As Nonye explains, what really matters is the reliability and sustainability of those earnings, and that’s exactly what a QoE uncovers.

A QoE evaluates whether EBITDA is:

• Reported correctly (cash vs. accrual)
• Driven by recurring operational activity rather than one-time events
• A true reflection of ongoing business performance

The goal is to understand whether the profit is real, repeatable, and transparent. It’s not just about how much EBITDA a company generates. It's about how the EBITDA is created.

Why EBITDA, Not Net Income, Drives Most Deals

EBITDA eliminates differences in financing structure, ownership, and tax treatment, giving stakeholders a clearer view of operational performance. That makes it a more useful baseline for comparing companies and determining valuation.

For investors, a QoE validates the financial health of the business before capital is committed. For lenders, it aims to provide insight into cash-flow consistency and repayment capacity across certain industries. For buyers, it’s essential for uncovering risks hidden behind top-line financial statements.

Do All Deals Require a QoE?

While smaller companies sometimes assume they don’t need one, Nonye explains that almost every transaction benefits from a QoE, regardless of size.

At its core, a QoE helps uncover what you don’t know, and in M&A, what you don’t know can cost you. Even when a company has audited financials, audits focus on the balance sheet at a point in time. A QoE digs into month-by-month performance, trends, normalizations, and one-time events that impact valuation. When you’re making a major investment decision, not knowing the story behind the numbers is a risk most buyers shouldn’t take.

What Does a QoE Report Actually Look Like?

The output typically comes in two formats:

• Excel Data Book - A detailed file that bridges reported financial statements to normalized EBITDA, highlighting key findings, working capital trends, accounting policies, and operational considerations.
• A PowerPoint Report (optional) - A supplement to the data book, often providing expanded commentary on adjusted financial statements along with supporting schedules.

A thorough QoE includes:

• EBITDA adjustments and normalization
• Working capital analysis
• Accounting policies and process evaluation
• Red flags that could affect valuation or post-close operations

It becomes a roadmap for understanding the business beyond the P&L.

Why Sellers Should Consider a QoE, Too

While QoEs are often buyer-driven, Nonye emphasizes that sellers gain a real advantage by performing one before going to market:

• It strengthens credibility with buyers
• It increases the certainty of close
• It helps defend valuation
• It identifies issues early, reducing surprises during diligence
• It speeds up competitive processes when multiple parties are involved

Sellers also benefit from uncovering operational or reporting inconsistencies that can be corrected before buyers find them.

Common Misunderstandings About QoEs

Nonye notes two frequent misconceptions:

1. “We’re a small company. There won’t be much to analyze.” Even small businesses have normalization adjustments, timing issues, or owner-related expenses that materially impact valuation.
2. “If we have an audit, we don’t need a QoE.” Audits attempt to ensure the financials are materially correct, but they don’t answer whether the earnings are reliable or repeatable. QoEs focus on exactly that.

Key Takeaways

• A QoE helps determine whether earnings are real, recurring, and accurately reported.
• EBITDA matters because it creates a common baseline for valuation and decision-making.
• Nearly all transactions benefit from a QoE, regardless of size.
• QoEs help uncover the operational story behind the numbers.
• Sellers can significantly strengthen their position by conducting a QoE before going to market.

Listen to the full episode of The Transaction Abstract Podcast to hear Nonye Thompson and Joe Hellman share more real-world examples and insights into how QoEs shape better, smarter transactions.