Quick answer: A sell-side quality of earnings report is a financial analysis the owner commissions from an accounting firm before approaching buyers. The firm rebuilds adjusted EBITDA from the ledger, tests revenue cut-off, sets out monthly working capital, lists debt-like items and reconciles cash to the bank. Owners commission it once the books are closed and cleaned up, and before the confidential information memorandum is final, so that the numbers buyers receive are the numbers they will later confirm.
Key points
- The report belongs to the seller. The owner reads the findings first, decides what to fix, explain or drop, and controls how much of it each buyer receives.
- Timing is the value. Findings reached before launch can be corrected or explained, while the same findings reached after the letter of intent can arrive as a price reduction.
- Buyers usually still run their own review. A sell-side report narrows what their accountants find and gives the owner a documented reply, but it rarely replaces their work.
- The CIM, the add-back schedule and the data room should use the report’s figures and definitions, because a gap between documents is the first thing a buyer cites to lower the price.
A report the seller owns and a buyer’s accountants would recognize
A sell-side quality of earnings report applies the tests a buyer’s accountants would run, but the owner commissions it, reads the findings first and decides what to do with them. The decision rule is simple. Commission one when the price will rest on an earnings figure that contains judgment: add-backs, a recent change in margin, revenue recognized over time, inventory, or books kept on a cash basis. The more of those a business has, the more the exercise teaches. A company with closed, accrual-basis monthly books and few adjustments may need only part of the scope below.
The guide to quality of earnings reports describes the buyer’s version of this work. The seller’s version differs in who controls the scope, who sees the draft and what the owner can still change before a buyer asks. It is not an audit and gives no opinion on the financial statements. It starts from them and asks what profit a new owner could expect to earn.
What the report covers
A sell-side scope follows the structure of a buyer’s report, so that nothing in it surprises the buyer’s accountants.
| Workstream | What the reviewer does | What the owner can act on |
|---|---|---|
| Adjusted EBITDA bridge | Traces each add-back and deduction to invoices, payroll records and contracts, and compares each item across periods | A schedule defended line by line, and weak add-backs dropped before a buyer removes them |
| Revenue quality and cut-off | Tests sales recorded near period end, later credit memos, deferred revenue and unbilled work, then splits revenue by customer and type | Corrections to the books, and revenue definitions the CIM can use consistently |
| Margin by customer and product | Rebuilds gross margin below the totals and checks that costs sit in the right period | A view of which accounts earn the profit, and early warning on concentration |
| Operating expenses | Looks for accruals never booked and costs a buyer would have to add, such as a replacement manager | Missing costs recorded or priced into expectations |
| Net working capital | Builds monthly balances, separates seasonal swings and one-time items, tests receivable aging and inventory reserves | Evidence for the working capital target |
| Debt and debt-like items | Lists obligations outside loan agreements, such as accrued bonuses, customer deposits and unpaid taxes | Items to settle or define before the letter of intent |
| Cash reconciliation | Compares bank deposits and disbursements with recorded revenue and expenses | Confirmation that revenue became cash, and explanations for timing gaps |
| Capital spending | Separates maintenance from growth spending and flags equipment run past its useful life | An early read on catch-up costs a buyer might deduct |
Three of these workstreams have their own guides. The cash reconciliation is the proof of cash, the obligations list is covered in debt and debt-like items, and the target for working capital is explained in the net working capital peg guide.
Scope is a choice, and the areas to include are the ones where the books are weakest. A scope designed to avoid them gives the owner comfort and gives buyers no reason to trust the report, because their accountants will test those areas anyway.
When to commission it, and in what order
Timing is a sequencing problem. The reviewer needs closed monthly books, so the work starts once the latest period is closed and the obvious clean-up is done. A reviewer asked to test unreconciled accounts spends the engagement finding bookkeeping errors instead of testing earnings. The report should be finished before the CIM is, because the CIM’s adjusted EBITDA, revenue by customer and working capital figures should come from the report and not from a separate spreadsheet. The guide to CIM contents shows where those figures appear.
- Clean up and close. Reconcile bank accounts, record missing accruals and settle accounting policies. The checklist for cleaning up financial statements covers the work.
- Scope and engage. Fix the periods, workstreams and deliverables, and decide whether buyers will be given access.
- Fieldwork. The firm requests ledgers, bank statements, payroll registers and contracts, and interviews the finance lead. One person at the company handles every request.
- Draft findings. The owner, the M&A advisor and the firm go through the draft together, and the owner decides which findings to fix, explain or drop.
- Final report and alignment. The CIM, the management presentation and the add-back schedule adopt the report’s figures and definitions.
- Update. If the process runs past another period end, the firm brings the report forward to the latest closed month.
Starting too early produces a report that is stale by launch. Starting too late holds up the launch, because first-round bids are built on the numbers the report fixes.
Who should perform it
The choice of firm affects how much weight buyers give the result.
- Distance from the books. A firm that did not prepare the financial statements has no reason to defend them, and buyers know it. The company’s regular CPA understands the records and can supply them, but the review carries more weight when the author of the books is not also its tester.
- Transaction experience. The reviewer should have done financial diligence for buyers and lenders on companies of similar size and industry, because the value lies in anticipating what the buyer’s accountants will test.
- Recognition. Buyers’ lenders and investment committees often give more weight to a firm whose work they have seen before.
- Reliance terms. A report is commonly written for the seller, and a buyer is given access on stated terms instead of a right to rely on it as its own. What the engagement letter says about who may read and who may rely on the report is a question for the owner’s attorney and the firm before work begins.
The M&A advisor sets the scope with the owner, reads the draft as a buyer would and plans how the findings are presented. The accounting firm remains the author of what it found. A report whose findings were softened to flatter the owner gives buyers no reason to rely on it.
How the owner uses the report
The report has three audiences, and each should receive a different amount of it.
In the CIM and first-round materials
The CIM states adjusted EBITDA, and every figure in it should reconcile to the report. Buyers compare the CIM with what diligence later produces, and any gap between the two becomes the opening argument for a lower price. The guide to retrades after the LOI describes how that argument is made. The CIM can describe the adjustments and say that an independent firm reviewed the figures, while the full report waits for buyers who are serious.
In the data room
Release the report in stages. A summary of adjusted EBITDA and working capital can support first-round bids. The complete report, with margin by customer and findings that name individuals, belongs in the data room for short-listed buyers, behind its access controls. Buyers who receive it should be told what it covers and what it leaves out, so that no one reads silence as a clean result.
With the buyer’s accountants
The buyer’s accountants usually start from the report and re-test the items that drive price. A good result is a short list of open points in place of a fresh build of the numbers. Where the buyer’s figure differs from the report, the owner already holds a documented reply, and the guide to managing the diligence process shows how to run those exchanges.
Illustrative example: The same findings before launch and after the letter of intent
An owner’s draft schedule shows reported EBITDA of $2,000,000 and add-backs of $600,000, for adjusted EBITDA of $2,600,000. A sell-side review tests each item.
| Item | Owner’s schedule | Reviewer’s result |
|---|---|---|
| Reported EBITDA | $2,000,000 | $2,000,000 |
| Owner pay above a market replacement | $300,000 | $250,000 |
| Personal expenses traced to card statements | $100,000 | $100,000 |
| Legal settlement with a signed agreement | $80,000 | $80,000 |
| Recruiting fees described as one-time but incurred every year | $120,000 | $0 |
| Bonuses earned in the year but booked in the next | $0 | ($90,000) |
| Sales recorded before the goods shipped | $0 | ($60,000) |
| Adjusted EBITDA | $2,600,000 | $2,280,000 |
The gap is $320,000. At a multiple of 6.0x, it is $1,920,000 of price. If bidders price the owner’s $2,600,000 and a buyer’s accountants reach $2,280,000 after exclusivity begins, the owner negotiates that gap with one buyer. If the owner finds it first, the bonus accrual can be booked monthly, the recruiting fees can be dropped or explained, and every bidder prices the same figure. The numbers are invented to show the mechanics and are not benchmarks.
How it differs from a buyer’s report
| Sell-side report | Buyer’s report | |
|---|---|---|
| Commissioned and paid by | The seller | The buyer |
| First reader | The owner and the M&A advisor | The buyer’s deal team, investment committee and lender |
| Scope set by | The seller, to anticipate what buyers will test | The buyer, around its own concerns and financing |
| Findings used to | Correct the books, support the add-backs and set price expectations | Lower the price, change terms or size an escrow |
| Reliance | Written for the seller and shared with buyers on stated terms | Written for the buyer and often shared with its lender |
Buyers read a seller’s report knowing who paid for it. They treat it as organized evidence, not as proof, and they run their own tests where their price depends on the answer. What the seller gains is a head start: the problems have been found and the support assembled, so the buyer’s accountants spend their time confirming figures instead of discovering them. Whether a lender accepts the seller’s report in place of its own is the lender’s decision.
When the findings come back lower
The report can come in under the owner’s own schedule. That is the reason to commission it before launch, and the owner has four responses.
- Fix the process. A missing accrual or a cut-off error can be corrected going forward, for example by booking bonuses monthly. A fix improves later periods and does not rewrite earlier ones, and buyers price the periods as they were reported.
- Explain the item. A genuine one-time item stands when the support is attached to it: the agreement, the invoices, the dates.
- Drop the item. An add-back the owner cannot support costs credibility on every other add-back if the buyer is the one to remove it.
- Reset the range. If reviewed earnings are lower, the defensible price range is lower. Learning that before bids arrive is cheaper than learning it after exclusivity.
The report has limits. It does not replace the buyer’s own work, it does not cover the legal, tax, employment and environmental reviews described in the guide to due diligence in a business sale, and it ages with every month that passes. The findings most likely to come back, with ways to pre-empt each, are laid out in quality of earnings findings that reduce price. Because a report and its drafts create a record, the owner should ask an attorney how drafts and management responses will be handled before the engagement starts.
Frequently asked questions
When should a seller commission a quality of earnings report?
After the books for the latest period are closed and the obvious clean-up is done, and before the confidential information memorandum is finalized. Starting earlier produces a report that goes stale before launch. Starting later delays the launch or leaves buyers bidding on figures the owner has not tested.
Who pays for a sell-side quality of earnings report?
The seller commissions it and pays the accounting firm directly, usually before any buyer is involved. A buyer’s own report is paid for by the buyer. Cost depends on the size and complexity of the business, the condition of the books and the scope chosen, so ask the firm what is included and what would trigger additional work.
Can the company’s regular CPA prepare the report?
Sometimes, but buyers tend to give more weight to a review by a firm that did not prepare the books. One workable arrangement is for the regular CPA to supply records and context while an outside firm with transaction experience writes the report.
Will buyers rely on a seller’s quality of earnings report?
Buyers read it, and many start their own review from it, but they usually do not treat it as final. They re-test the items that drive price: add-backs, revenue cut-off, working capital and debt-like items. A buyer’s lender decides whether it accepts a seller’s report in place of its own.
What if the report finds lower earnings than the owner expected?
That is the case for commissioning it first. The owner can fix process problems, support one-time items with documents, drop add-backs that will not survive or reset price expectations before any buyer sees a number. The same findings reached after the letter of intent arrive when the owner has less leverage.
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Related guides
- Quality of Earnings Report: What It Is and What Buyers Test: A quality of earnings report tests whether a company’s reported profit is real and repeatable. See what buyers examine, how it affects price and how sellers prepare.
- Quality of Earnings Findings That Reduce Price and How to Pre-Empt Them: The quality of earnings findings that most often lower a sale price, such as rejected add-backs and cut-off errors, with how each appears and how to pre-empt it.
- Retrades in M&A: Why Buyers Cut the Price After the LOI and How a Seller Responds: A retrade is a buyer’s price cut after the letter of intent. Learn the fair and tactical triggers, how to prepare, a response playbook and when to walk away.
- Proof of Cash: How Buyers Test Revenue and Expenses Against the Bank: A proof of cash reconciles bank deposits and disbursements to reported revenue and expenses. See how buyers run it, what the gaps reveal and how a seller prepares.
- What Goes in a Confidential Information Memorandum (CIM): Section by Section: What is in a CIM: each section of a confidential information memorandum, from the executive summary to normalized financials, and what to hold back until later.
- Managing the Diligence Process as a Seller: Request Lists, Q&A and Response Discipline: How a seller runs due diligence: one point of contact, a request tracker, staged disclosure, a Q&A log and response discipline while the business keeps performing.
This guide is general education. It is not a valuation opinion, appraisal, investment advice, or legal or tax advice. How these guides are made.