Quality of earnings (QoE) for an accounting firm

Quality of earnings, or QoE, is an investigation of reported financial performance, supporting records, adjustments, and cash conversion to assess the earnings relevant to a proposed acquisition. Its scope and conclusions should fit the actual accounting practice and buyer’s operating plan.

What question should an accounting-practice QoE answer?

It should explain how the reported results connect to supportable earnings after transfer, identifying what is verified, adjusted, uncertain, or dependent on buyer assumptions. It is more useful than an unexplained adjusted-profit number.

The archived 2014 Journal of Accountancy diligence discussion addresses investigation of accounting-firm combinations. Apply the underlying discipline to the present records and transaction rather than treating an old publication as evidence of current market values. The buyer needs to understand both the financial bridge and the work required to deliver the associated fees.

Use the valuation hub to connect that evidence with price and financing. QoE informs underwriting; it does not automatically determine the purchase price, guarantee client retention, or certify a buyer’s integration plan. A conclusion has practical value when its period, perimeter, evidence, and limitations are clear.

How is QoE different from a revenue roster or tax return?

A roster describes clients and fees, while tax returns report under their applicable framework. QoE reconciles relevant evidence and investigates whether adjustments and future earnings assumptions are supportable.

Compare the ledger, bank records, invoices, credits, receivables, payroll, contracts, and tax filings for the same period and entity. Differences are questions to resolve, not automatic fraud findings or adjustments. Cash and accrual timing, entities, excluded service lines, and unusual receipts can explain legitimate differences.

Document the accounting basis used for each schedule. A cash-basis practice can collect old receivables while performing current work not yet billed. A subscription practice can receive advance cash for future service obligations. The amount deposited this year may therefore differ from work performed or earnings available to a successor.

Which adjustments matter most in a small practice?

Owner labor, unusual expenses, missing successor costs, revenue timing, and service obligations often require investigation. Each adjustment needs evidence and an explanation that matches the buyer’s proposed model.

Read adjusted EBITDA for the owner-replacement analysis. If the replacement estimate already includes the review duty, remove a duplicate review adjustment. The purpose of the bridge is to make those overlaps visible, not to maximize the result by adding every proposed benefit.

How should fee cohorts and work timing be tested?

Trace a defined work cohort through delivery, billing, credits, and collection. Separate work performed before closing from the successor’s obligations and keep the client perimeter consistent.

A tax client who files on extension should not be declared lost solely because an interim report lacks a completed return. Conversely, a retained active status in software does not prove the client will return. Compare full cycles and investigate unusual fee changes with appropriate evidence.

Use write-ups and write-downs to distinguish time-based work records from recoverable fees. WIP can contain unbillable excess effort, unfinished deliverables, or amounts requiring further work. Determine who must finish each engagement and who owns the related receivable before assigning economic value to the balance.

Does normalized EBITDA equal cash available for acquisition debt?

No. A debt model needs additional cash obligations and timing assumptions. QoE should help explain those items without confusing them with the EBITDA bridge.

Using the illustrative $168,000 result, assume $115,000 annual acquisition debt service, $15,000 capital spending, and a $20,000 usable cash-tax reserve. The residual is $18,000 before changes in working capital and other obligations. Every amount here is hypothetical and requires transaction-specific review; the calculation is not a lender approval metric.

Prepare a monthly schedule when collections are seasonal. A positive annual residual can coexist with an early-year payroll shortfall. Do not deduct debt principal inside EBITDA or count the same expense again in the financing model. Keep operating earnings, capital needs, taxes, working capital, and financing in separately reconciled sections.

When does current SBA policy specifically require QoE?

Check the applicable ownership-change category and current lender requirements. Do not treat all acquisitions or all SBA loans as having identical evidence rules.

SBA’s SOP 50 10 8.1 effective October 1, 2026 requires QoE for Initial Acquisition and Business Expansion transactions with a purchase price of at least $3 million, measured before equity, seller debt, or other funding reduces the amount financed. It specifies independent preparation for the lender and addresses review of buyer-commissioned reports.

That threshold does not prevent a lender or buyer from seeking financial diligence in another transaction. Have the lender confirm category, scope, preparer independence, and acceptable reliance before ordering the work. A report commissioned for a seller’s marketing package should not be assumed to satisfy the lender’s current requirement.

What operating risks belong beside the earnings conclusion?

Document the conditions needed to sustain the earnings, including staff capacity, owner dependencies, service scope, client concentration, technology, and professional permissions. Numbers alone do not explain whether those conditions can be maintained.

The client concentration analysis identifies exposure to related client groups and contribution. Model the effect of losing a material account using avoidable costs and remaining service commitments. Avoid subtracting lost revenue from profit dollar for dollar unless the cost assumptions justify it.

Ask who approves returns, resolves exceptions, sells new work, and manages difficult relationships today. Identify whether those duties move to retained staff, the buyer, or new hires. An adjustment that removes the owner’s compensation without replacing the duties can materially overstate sustainable earnings.

How should confidential records be handled during the review?

Use appropriately scoped access and confirm the legal and professional basis for disclosure. A financial investigation does not authorize unrestricted copying of sensitive tax-client records.

IRS tax-professional security guidance emphasizes protecting client information. Organize the review so necessary evidence is available through controlled permissions, appropriate redaction, authorized disclosure, and secure handling. Assign responsibility for access logs and incident escalation. Do not send complete client files merely because a reviewer asks for a large export.

1. Define the financial questions, periods, entities, and required evidence.
2. Confirm disclosure authority and the least information needed to answer those questions.
3. Reconcile records and document tested adjustments with their limitations.
4. Discuss unresolved findings with authorized parties and update the buyer model.
5. Preserve approved conclusions and handle retained copies under the agreed protocol.

What should the final report make easy to assess?

It should make the financial bridge reproducible and expose remaining uncertainty. Identify evidence reviewed, exclusions, accounting conventions, adjustment support, open questions, and dependencies relevant to the decision.

Distinguish verified historical facts from proposed successor assumptions. A supported unusual expense is different from an untested efficiency forecast. An identified software contract is different from a hoped-for future discount. Keep forecasts explicit so readers can change an assumption without rewriting the historical reconciliation.

The buyer should leave the review knowing which earnings figure is being used, why it differs from the books, what further work is required, and how the downside affects liquidity. That is more useful than a report whose confident conclusion cannot be traced to the records.