What is a Quality of Earnings Report?
A quality of earnings (QoE) report is an accountant's review that tests whether a company's reported earnings are accurate, sustainable and properly adjusted. It starts from reported EBITDA and works through each item that a buyer or lender would treat differently: one-time costs, owner expenses, accounting errors and revenue or costs recorded in the wrong period. The result is an adjusted EBITDA, which often becomes the figure the price is built on.
How a QoE Works for an Ecommerce Brand
For a product brand, most adjustments come from inventory and timing. Reviewers test whether cost of goods includes the full landed cost of each unit, whether aged or obsolete stock has been written down, whether marketplace fees, refunds and chargebacks land in the same month as the sales they relate to, and whether the sales behind each payout were recorded gross, with fees shown separately. They also tie inventory on the balance sheet to warehouse and fulfillment center counts.
Adjustments run both ways. A one-time legal cost or a family member's salary the buyer will not carry is added back. An inventory write-down that was never booked, or a returns allowance for December sales that come back in January, is taken off.
What a Buyer, Lender or Seller Looks At
A buyer reads the QoE to confirm the earnings it is paying a multiple of, and to set the working capital target for closing. A lender reads it to size debt against reliable cash flow. A seller who commissions one before going to market sees the buyer's likely adjustments first and can fix the books or explain the items before they become price reductions. Books kept on an accrual basis and closed every month usually shorten the review and can reduce the adjustments.
Further Reading
How to Prepare and Sell Your Ecommerce Business
Formula
Adjusted EBITDA = Reported EBITDA + Add-Backs − Deductions
Price Effect = Change in EBITDA × Valuation Multiple
Example
A brand reports $2.4M of EBITDA and has an offer at 5x, or $12M. The buyer's QoE review makes three adjustments:
- One-time legal settlement, added back: + $150,000
- Aged inventory never written down: − $200,000
- Returns allowance never booked, net of last year's: − $120,000
- Net change: $150,000 − $200,000 − $120,000 = − $170,000
Adjusted EBITDA: $2.4M − $170,000 = $2.23M. At the same 5x multiple, the price falls by $170,000 × 5 = $850,000, from $12M to $11.15M.
General education only, not legal, tax or investment advice; how a term applies to your brand depends on your own documents and advisers.