What is a Quality of Earnings analysis?
A Quality of Earnings (QoE) analysis is a targeted financial review that goes beyond reported or audited financial statements to assess the sustainability, predictability and cash‑generating nature of earnings. Rather than focusing solely on historical accuracy, the objective is to determine the level of sustainable earnings that a buyer could expect on a stand-alone basis following the transaction.
Importantly, a QoE analysis is not tied to a single performance metric. Its purpose is to assess the quality of earnings as an economic concept, irrespective of how that performance is ultimately measured or expressed.
In practice, a QoE analysis typically focuses on:
- Earnings that are recurring and operational in nature, excluding results driven by timing effects, one‑off contracts or exceptional transactions
- Adjustments for non‑operating, non‑recurring or owner‑related items, to isolate earnings that are expected to continue on a standalone basis
- Accounting judgments or anomalies that may distort reported performance, where legitimate accounting choices materially affect comparability or sustainability
- The extent to which earnings are supported by operating cash flows, including the impact of working capital movements and accrual‑based effects
The outcome of a QoE analysis is therefore not merely an adjusted EBITDA figure, but a clearer understanding of how reliable the earnings base really is and how exposed it is to operational, accounting or cash‑flow‑related risks.
In this article, adjusted EBITDA is used as the primary reference point because it remains the most widely applied metric in middle‑market M&A and valuation discussions. However, depending on the industry and business model, other measures such as EBIT, EBITDAR or sector‑specific operating profit metrics may be equally relevant. The principles of QoE analysis apply in the same way, regardless of the metric ultimately used as the valuation anchor.
Quality of Earnings versus audits
QoE analyses and statutory audits often review similar financial information, but they serve fundamentally different purposes.
An audit is designed to provide assurance that financial statements comply with the applicable accounting framework – whether local standards such as the Swiss Code of Obligations or Swiss GAAP FER or international standards such as IFRS or US GAAP. It is primarily retrospective and compliance‑driven.
A QoE analysis, by contrast, is transaction‑focused. It looks at historical performance through an economic lens, with selective forward‑looking normalisations where appropriate. Rather than issuing an audit opinion, it produces an adjusted view of earnings sustainability, which is commonly used as an input for valuation, negotiations and deal structuring.
From reported to adjusted EBITDA
Adjusted EBITDA is often the most visible output of a QoE analysis, but it should not be confused with its purpose. In a transaction context, EBITDA is not adjusted to improve the story; it is adjusted to reflect what a buyer is actually acquiring.
Reported EBITDA is, by definition, an accounting construct. It reflects historical performance measured under a given accounting framework and is influenced by judgments, timing effects, ownership structure and non‑recurring events. A QoE analysis does not seek to “correct” that number for compliance purposes – that remains the role of an audit – but to normalise it for economic sustainability.
Adjusted EBITDA is therefore a necessary reference point in M&A, but it is not, on its own, a guarantee of sustainable cash generation or long‑term value creation.
In practice, adjustments made in a QoE analysis typically fall into one of three categories:
- Management‑identified adjustments, reflecting items management considers non‑recurring or non‑operational, such as one‑off professional fees or discretionary owner‑related expenses
- Due diligence adjustments, identified independently during the diligence process, including accounting normalisations, consistency issues or findings that affect the reliability of reported earnings
- Pro forma adjustments, which reflect changes expected to affect the business going forward and are, by nature, more judgment‑driven and execution‑dependent
While all three categories may be relevant, they do not carry the same level of certainty. Historical, well‑documented normalisations are typically viewed very differently from forward‑looking assumptions that depend on successful execution or behavioural changes.
For this reason, experienced deal teams focus not only on the headline adjusted EBITDA figure, but also on the credibility, transparency and logic of the adjustment bridge. Given the level of judgment involved, reasonable professionals may legitimately reach different conclusions, making transparency and defensibility more important than the pursuit of a single “correct” number.
The quality of the analysis is reflected less in the number itself than in how clearly it distinguishes
- recurring and exceptional items;
- evidence‑based adjustments and judgment calls; and
- historical facts and forward‑looking assumptions.
The sections that follow address the analytical pillars that determine whether that adjusted figure is economically meaningful and sustainable.
The core pillars of a QoE analysis and adjusted EBITDA
While adjusted EBITDA is often the most visible output of a QoE analysis, the credibility of that figure depends on a broader, more structured assessment. In practice, a comprehensive QoE analysis is built around a set of core analytical pillars, which together determine whether earnings are sustainable, repeatable and economically meaningful.
Revenue quality and sustainability
Revenue is the starting point for any assessment of earnings quality. A QoE analysis examines not only the level of revenue reported, but also its nature, drivers and durability.
Key considerations typically include:
- The extent to which revenue is recurring versus one-off
- The contractual or discretionary nature of customer relationships
- Customer concentration and visibility in terms of future demand
- Revenue recognition policies, including timing, cut-off and judgment-based estimates
The objective is to assess whether reported revenues reflect a repeatable operating model or whether they are influenced by timing effects, exceptional transactions or short-term commercial decisions that are unlikely to persist post-transaction.
In practice, revenue quality is often the primary determinant of earnings durability, as weaknesses in the top line cannot be fully mitigated by cost normalisation or accounting adjustments further down the analysis.
Cost base and margin quality
A second pillar of QoE focuses on the quality of the cost base underlying reported margins. This analysis seeks to distinguish between structural profitability and results driven by temporary or non-recurring effects.
Typical areas of review include:
- Fixed versus variable cost dynamics and operating leverage
- Exceptional or non-recurring expenses embedded in the profit and loss statement
- Evidence of cost deferrals, underinvestment or temporary savings
- Personnel costs and compensation levels relative to market norms
The aim is not to normalise the business to an ideal cost structure, but to determine whether the reported margin profile is representative of ongoing operations under normal conditions.
Non-recurring and non-operational items
Identifying and assessing non-recurring and non-operational items is a central component of QoE and a key driver of adjusted EBITDA.
These items may include:
- One-off restructuring, legal or advisory costs
- Gains or losses on disposals or settlements
- Expenses that are specific to the current ownership or transaction context
While the exclusion of genuinely non-recurring items is generally accepted, this area often involves judgment, particularly where costs recur irregularly or are expected to reappear in a different form. A robust QoE analysis, therefore, focuses not only on identification but also on the likelihood and economic substance of these items going forward.
Cash conversion, working capital and liquidity
Earnings quality cannot be assessed in isolation from cash. A core pillar of QoE is therefore the analysis of how reported earnings convert into operating cash flows and the role played by working capital.
This typically includes:
- A reconciliation between EBITDA and operating cash flow
- Analysis of receivables, inventory and payables trends
- Identification of seasonality, cut-off practices and unusual movements
- Assessment of working capital financing mechanisms, such as factoring
Working capital is particularly important in transactions structured on a cash-free, debt-free basis, where the definition of a normalised working capital level directly affects value transfer at closing. This aspect is especially relevant in Swiss mid-market transactions, where working capital mechanisms are frequently a focal point of negotiation and a source of execution risk. Weak or volatile cash conversion does not invalidate earnings, but it does have a material effect on their risk profile and economic quality.
Proof of cash and consistency checks
In some cases, a QoE analysis also includes a proof of cash, which serves as a consistency check between reported earnings, cash flows and balance sheet movements.
The purpose of this exercise is not to audit cash balances, but to confirm that
- reported revenues and expenses are supported by actual cash movements;
- changes in working capital reconcile with cash flow trends; and
- there are no unexplained differences between accounting records and bank activity.
Where performed, proof of cash enhances confidence in the integrity of the underlying data and provides additional reassurance that reported earnings are anchored in economic reality.
Taken together, these pillars provide the analytical foundation of a QoE analysis. They explain why certain adjustments are made, how risks are identified and whether adjusted EBITDA represents a sustainable earnings base. Without this broader context, adjusted EBITDA risks becoming a mechanical output. With it, the figure becomes a defensible, decision-relevant measure of earnings quality suitable for valuation, negotiations and deal structuring.
Why QoE matters in a transaction
A well‑executed QoE analysis helps to
- establish a credible, maintainable earnings baseline;
- identify non‑recurring items and timing effects early;
- support valuation and deal-structuring discussions;
- align internal stakeholders and investment committees; and
- reduce the risk of post‑closing surprises.
In markets where capital is more selective and risk tolerance is lower, the absence of this clarity often results in valuation renegotiations, delayed closings or post‑transaction disputes.
Conclusion
Quality of Earnings is not about maximising EBITDA. It is about understanding what portion of earnings is durable, repeatable and supported by cash generation. A strong QoE analysis is transparent, evidence‑based and explicit about judgement.
For business owners, it provides clarity on how performance is likely to be assessed by buyers. For investors and acquirers, it is a key tool for pricing in risk and allocating value. In that sense, QoE should be viewed not as an optional diligence workstream, but as a core component of effective M&A execution.
How Grant Thornton can help
At Grant Thornton Switzerland/Liechtenstein, we support buyers with focused, commercially driven QoE analyses that go beyond financial validation. Our team helps identify deal-critical issues early, validate earnings and working capital and provide clear, actionable insights to support valuation, deal structuring and negotiation.
With in-depth transaction experience and sector expertise, we deliver the clarity and confidence buyers need to make informed investment decisions in a competitive market.
What sets Grant Thornton Switzerland/Liechtenstein apart is our ability to deliver this service efficiently, with a single point of contact and swift responses. Moreover, through our global network, we can tap into subject matter experts from various markets whenever needed, ensuring that clients benefit from world-class expertise and seamless support throughout their transaction.
