Quality of Earnings: What It Is and Why It Matters
A practical explanation of Quality of Earnings (QoE) in M&A due diligence: what it covers, how it works and how to explain it in a Transaction Services interview.
Quality of Earnings is one of the most important concepts in Transaction Services — and one of the most poorly explained by candidates in interviews. Here's a clear, practical breakdown of what it actually means and how to talk about it convincingly.
The core question QoE answers
A buyer valuing a business at a 7x or 8x EBITDA multiple is making a simple bet: that the EBITDA figure in the accounts reflects the genuine, sustainable earning power of the business going forward. Quality of Earnings analysis asks: is that actually true?
The reported EBITDA may include one-off gains that won't recur. It may exclude costs that will appear once the business operates under new ownership. It may reflect accounting choices that flatter the near-term figures. QoE strips all of that back to reveal the underlying economic reality.
What QoE analysis actually covers
QoE is not just an EBITDA bridge — though that's its most visible output. A complete QoE analysis covers:
Revenue quality: Are revenues recurring? How concentrated is the customer base? Are there long-term contracts or purely transactional relationships? Has there been any aggressive revenue recognition?
Cost base normalisation: Which costs are genuinely one-off? Are there costs that should be in the P&L but were capitalised? What does the management pay themselves relative to market rates?
Run-rate adjustments: What is the full-year effect of changes that only partially hit the most recent accounts?
Pro-forma adjustments: What structural changes (acquisitions, new sites, contract wins) have happened that aren't yet fully reflected in the historical numbers?
The EBITDA bridge
The central output of a QoE exercise is the EBITDA bridge:
Reported EBITDA → ± Adjustments → Normalised EBITDA
Each adjustment must be:
- Clearly described.
- Quantified.
- Documented with source evidence.
- Categorised by type (one-off, run-rate, pro-forma).
Why the hierarchy of adjustments matters
Not all adjustments carry the same weight. A one-off supported by an invoice is nearly impossible to dispute. A pro-forma adjustment resting on unverified management assumptions is much more contestable. A strong FDD professional — and a strong interview candidate — understands this hierarchy and can articulate it.
What recruiters are really asking
When a recruiter asks "what is Quality of Earnings?", they're not looking for a definition. They're looking for the bridge. They want to hear: "I start with reported EBITDA, identify non-recurring items, apply run-rate adjustments for partial-year changes, and layer pro-formas on top — each level is progressively less certain and more open to challenge."
The case studies in this programme are built around real QoE exercises, with complete data sets for you to work through exactly as you would in a live transaction.