During private equity (PE) due diligence, investors often require the target company to provide a "Quality of Earnings" (QoE) report or conduct corresponding analysis. This requirement often confuses the company's management or financial team: What exactly is a Quality of Earnings report? Is there a standard format or common template? Based on typical questions in practice, this article provides professional answers and operational guidance.

I. Definition and Purpose of a Quality of Earnings Report

A Quality of Earnings report is not a statutory audit report, but rather a special analysis document prepared by financial advisors (usually from accounting firms or professional consulting agencies). Its core purpose is to assess the "quality" of net profit in the target company's historical financial statements—that is, whether earnings are generated from recurring, sustainable business operations, rather than relying on one-time gains, changes in accounting estimates, or non-cash items. PE institutions use this report to judge the target company's true profitability, providing a basis for valuation pricing, transaction structure design, and post-investment management.

II. Is There a Standard Template?

Regarding the question of "whether there is a standard format or template," the answer in practice is:There is no unified template mandated by regulatory bodies or industry associations. However, after years of practice, a relatively stable analytical framework and report structure have formed within the industry, and most professional institutions will adjust based on this framework combined with specific projects. Therefore, rather than searching for a "standard form," it is better to understand its core logic and essential modules.

(I) Common Report Structure

A typical Quality of Earnings report usually includes the following sections:

  • Executive Summary: Summarizes key findings, adjustments, and their impact on EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization).
  • Revenue Quality Analysis: Reviews revenue recognition policies, customer concentration, contract terms, returns, and discounts.
  • Cost and Expense Quality Analysis: Evaluates cost structure, non-recurring expenses, related-party transactions, capitalization policies, etc.
  • Working Capital Analysis: Analyzes accounts receivable, inventory, accounts payable turnover days, and seasonal fluctuations.
  • Cash Flow and Earnings Matching: Compares net profit with operating cash flow to identify accrual differences.
  • Adjusted EBITDA: Lists adjustments to reported period profit (such as non-recurring gains or losses, management salary adjustments, restructuring expenses, etc.) and provides adjusted metrics.

(II) Preparation Key Points

When preparing, note the following:

  • Clearly define the analysis period (usually the last 2-3 fiscal years and the most recent interim period);
  • Rely on audited or management-provided financial statements, but independently perform analytical procedures;
  • All adjustments must include detailed explanations and calculation bases to maintain traceability;
  • Report conclusions should distinguish between "factual findings" and "professional judgment," avoiding overcommitment.

III. Practical Recommendations

If a PE institution makes such a request, it is recommended that the company first clarify its specific expectations—whether it requires the internal financial team to provide preliminary analysis or hire external advisors to issue an independent report. Typically, PE trusts reports prepared by third-party institutions more because of their stronger independence and professionalism. If the company prepares internally, it can refer to the above framework, but should maintain objectivity and neutrality, avoiding selective disclosure.

Note: A Quality of Earnings report is not an audit opinion and does not provide assurance on the overall fairness of the financial statements. Its value lies in revealing the "substance" of earnings, helping investors identify potential risks and areas for adjustment.

IV. Conclusion

In summary, there is no legally mandated standard template for a Quality of Earnings report, but there is an industry-recognized analytical logic and content framework. Companies or financial advisors should flexibly design the report structure based on the transaction background, industry characteristics, and specific PE requirements, ensuring transparent information, accurate data, and reasonable adjustments. Ultimately, a high-quality QoE report should clearly answer the three core questions: "Is earnings sustainable, is cash conversion healthy, and what non-recurring factors exist?"