A quality of earnings exercise asks how much of your reported profit is real, repeatable and attributable to the business rather than to the owner. It is the single most consequential piece of work in a private company sale, because the number it produces is the number the price is built on.
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What a quality of earnings analysis tests
Whether revenue is recognized consistently and supported by cash. Whether costs are complete, including anything the owner has absorbed personally. Whether one off items have been correctly separated from recurring ones. Whether the owner's compensation reflects the market cost of replacing them. And whether working capital has been managed in a way that flatters a particular period.
How it differs from an audit
An audit asks whether the statements comply with a framework. A quality of earnings exercise asks what the business actually earns on a normalised basis and whether that continues. An audited company can still see a large adjustment, and an unaudited one can come through with almost none if the records are clean and the add backs are evidenced.
Why a seller might commission one
To find the adjustments before a buyer does, while there is still time to fix or explain them. To give bidders a starting point they must argue against. And to avoid the situation where a well supported buyer's analysis lands mid exclusivity and moves the price with no time left to respond.
Questions people ask about quality of earnings
How long does it take?
Two to six weeks for a private company, depending on how many years, how many entities and how clean the underlying records are.
Will it lower my number?
Usually somewhat, and that is the point: the adjusted number is the one a buyer will believe. Finding it early is better than being told it late.
Is it worth it on a small sale?
Often not. A prepared add back schedule with evidence does much of the same work for a fraction of the cost.