A quality of earnings review isn't a number — it's a process
"Quality of earnings" doesn't refer to a calculation the way EBITDA or gross margin does. It refers to a diligence process — usually run by a third-party accounting firm on behalf of a buyer — that tests whether the adjusted EBITDA a seller is presenting actually holds up under scrutiny. It's the step between "here's our number" and "here's what we're actually willing to pay for that number."
What it typically checks
Revenue recognition. Whether revenue is being counted at the right time — jobs booked but not yet completed, deposits treated as revenue too early, or agreement revenue recognized in ways that don't match when the service is actually delivered.
Customer concentration. How much of total revenue depends on one or two accounts or contracts that could reasonably walk away. High concentration is a real risk a buyer prices in, whether or not it shows up anywhere in the headline financials.
Add-back documentation. Whether every add-back in the adjusted EBITDA — owner salary normalization, one-time expenses, discretionary perks — is real, actually one-time, and backed by paperwork, rather than asserted because it makes the number look better.
Working capital normalization. Whether the business needs an unusual amount of cash on hand to operate day to day, which affects what a buyer actually needs to fund at close on top of the purchase price itself.
Why sellers get surprised by this
Most owners who've never sold a business have never had their own numbers put through this process, which means the first time it happens is usually during an actual deal — under time pressure, with real money on the line. An adjusted EBITDA number that's been quoted casually for years, informally, sometimes doesn't survive contact with a real quality-of-earnings review, because the add-backs behind it were never documented as they happened. They were reconstructed under deadline instead, which is a much weaker position to negotiate from.
The practical fix is boring and cheap relative to the alternative: keep the paperwork for every add-back as it happens — the invoice, the explanation, the date — rather than trying to rebuild the case for it two years later when a buyer's accountant is asking hard questions on a clock.
Running this before you're forced to
A quality-of-earnings-style review doesn't have to wait until there's a buyer at the table. Running the same discipline on your own numbers — a real look at revenue recognition, customer concentration, add-back documentation, and working capital — before you need it produces the same benefit diligence produces for a buyer: you actually know what your numbers will hold up to, instead of finding out under pressure.
The Numbers Primer covers the underlying vocabulary this all builds on. The ServiceTitan Operating Audit covers the operational side of the same question — is what's driving the reported numbers actually sound — and ongoing coaching is there if the answer is "not yet, and here's what to fix."
This is IronMargin operational education, not legal, accounting, tax, or employment-law advice. See the disclaimer.
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