Quality of Earnings: Introduction for the FDD Analyst

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.