Quality of Earnings: Introduction for the FDD Analyst
Understand what Quality of Earnings means in financial due diligence, how a QoE report is structured, and what analysts look for.
Quality of Earnings (QoE) is the analytical framework that sits at the centre of every Financial Due Diligence engagement. For any analyst joining a Transaction Services team, understanding QoE — not just as a concept but as a structured process — is the first real competency to develop.
What Does "Quality of Earnings" Mean?
The term refers to the degree to which a company's reported earnings reflect its true, sustainable, recurring economic performance. Earnings are considered "high quality" when they are:
- Derived from core operations rather than one-off events
- Consistent across reporting periods
- Supported by real cash generation
- Free from accounting manipulations or aggressive policies
A QoE analysis answers the question: Is the EBITDA we see in the P&L the EBITDA we can rely on going forward?
The QoE Report in Practice
In an FDD engagement, the QoE section of the report typically covers three main areas:
1. Adjusted EBITDA Bridge
This is the core output. The bridge starts from reported EBITDA and applies a series of adjustments — non-recurring items, run-rate changes, pro forma items — to arrive at an adjusted EBITDA figure that is defensible to both buyer and seller.
2. Revenue Analysis
Analysts assess the quality and sustainability of revenue:
- Breakdown by customer, product, geography
- Concentration risk (top 5 or top 10 customers as % of total)
- Recurring vs. one-off revenue
- Contract terms, renewal rates, churn rates (particularly in software businesses)
3. Cost Analysis
The cost side mirrors the revenue analysis:
- Fixed vs. variable cost structure
- Items that inflate reported profits (e.g. under-provision for bad debts)
- Management remuneration vs. market norms
- Any costs that have been capitalised rather than expensed
Key Skills Required for QoE Analysis
Becoming a strong QoE analyst requires:
- Attention to detail: You are reading management accounts, audit files and board packs simultaneously, looking for inconsistencies.
- Scepticism: Management will always present the most favourable version of events. Your job is to challenge it.
- Commercial awareness: You need to understand the business model to assess whether an adjustment is plausible.
- Excel proficiency: Multi-year P&L models, bridging schedules, and sensitivity analyses are built daily.
The Link Between QoE and Valuation
Every €1 of EBITDA adjustment multiplies through the valuation at the deal multiple. In a transaction at 9x EBITDA, a €200k QoE adjustment means €1.8m in deal value. This is why buyers' advisers work hard to challenge upward adjustments, and why sellers' advisers support them.
For a junior analyst, this is the most important context to keep in mind: you are not just crunching numbers. Every line of your QoE analysis has a direct financial consequence for the transaction.
Conclusion
QoE analysis is a discipline that combines financial rigour, business judgement and communication skills. For FDD analysts at Big 4 firms or boutiques, it is the daily language of the job.
The Transaction Services Interview Programme (€119.99, one-time) teaches you to perform QoE analysis from scratch with 8+ case studies and 150+ real EBITDA adjustments. Start learning today.