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Quality of Earnings Report Review
Send the QoE report and the financials, and get the findings that move price, plus a priced register of everything the report never tested.
River reads a quality of earnings report the way a reviewer defending it would: scope pages first, then every figure inside them. In the worked example, a 43-page report on Ashmoor Fluid Power put adjusted EBITDA at $9,150,000 against management's $9,930,000. Its own findings were worth $5,460,000 of price at the 7.0 times the deal used. The scope carve-outs on pages 6 and 7 held $8,349,125, over half again as much, and nobody had read them.
Every guide to reading a QoE walks you through the same sections: the EBITDA bridge, revenue quality, concentration, the working capital peg, debt-like items. Those sections are worth reading and the good ones name scope limitations as a red flag. None of them turns scope into a number. Ashmoor's report performed revenue procedures on 25 customers, which was 62.0 per cent of revenue, and stated a figure to the dollar on a base where $32,800,000 of sales was never agreed to anything.
Written for the deal team the week the report lands, for the lender sizing debt off the same figure, and for the seller who commissioned it and wants to know what a buyer will find. Add-backs are a separate argument and the add-back review runs it. What the report tested came out of the room the data room review indexes, and the figure that survives is what belongs in the investment memo.
The scope section is two pages, and it governs the other forty-one
A QoE report reads like assurance and is not assurance. In an audit, a scope limitation is a named condition. A firm can give a clean opinion only if it applied every procedure it considered necessary. Where it could not, PCAOB standards require it to qualify or disclaim, and to say why. A QoE carries no opinion, so a scope limitation changes nothing on its face. The carve-outs sit in a procedures paragraph, the headline figure stays precise to the dollar, and the precision reads as coverage it never claimed.
Ashmoor's report excluded the Canadian entity because management represented it as immaterial. It was $11,900,000 of revenue, 13.8 per cent, contributing about $1,011,500 of EBITDA on its own reported margin. Carry a quarter of that as at risk and it is $252,875, or $1,770,125 of price. Inventory got no existence or valuation work at all, and at $14,200,000 it was the largest asset on the sheet: assets with procedures came to 35.6 per cent of the total. A 3 per cent overstatement is $426,000, and unlike an earnings gap it is not multiplied.
Then the calendar. Ashmoor's window closed 31 March and the deal signed 31 July, so the trailing twelve months a buyer owned on day one overlapped the tested period by eight months. Four months, a third of it, had no procedures of any kind. Regulators put a shelf life on this: Reg S-X requires most registrants to refresh statements in a filing once they are 135 days old. Ashmoor's were 122 days old at signing and headed past that line, which is why the register carries a roll-forward row.
How it works
Send the report
The PDF or the databook, however it arrived. The procedures and scope pages matter most.
Add what you have
Statements, monthlies and anything the report did not see, so the untested base can be sized.
Read both registers
The report's findings on one side, the priced scope gaps on the other, each with its base.
Decide what to extend
Ask what a further procedure would cost against the exposure it closes, or rerun at a later close.
What you get
- Three coverage ratios computed from the scope pages: revenue tested, assets tested, months in scope
- A register of every carve-out with the base inside it and a stated sensitivity, never an invented error
- Each gap classified as an earnings gap or a balance sheet gap, because only one is multiplied
- The report's own findings priced, so its visible work can be compared with its unread boundary
- The roll-forward gap between the measurement cut-off and your expected close, in months and dollars
- The gaps that cannot be priced, carried with the specific document that would close each one
- A short list of scope extensions worth buying, ranked by exposure per dollar of fee
Common questions
Is a QoE report an audit?
No, and the difference is the whole point of reading its scope pages. An audit that cannot apply a procedure it considers necessary has to qualify or disclaim its opinion in the report itself. A QoE has no opinion to qualify, so a procedure it skipped leaves the headline figure looking exactly as precise as one it tested end to end.
How do you price something that was never examined?
By sizing the base and naming a sensitivity rather than inventing an error. Ashmoor's untested US revenue was $20,900,000, so the register asks what 200 basis points of margin on that slice is worth: $418,000 of EBITDA, $2,926,000 at 7.0 times. You can disagree with the sensitivity. You cannot disagree with the base.
Why does the classification between earnings and balance sheet matter?
Because they hit price differently and the register would be wrong to add them. An earnings gap runs through the multiple, so $305,000 becomes $2,135,000 at 7.0 times. An inventory overstatement is a one-time hit that comes off price dollar for dollar. Ashmoor's $783,000 of balance sheet exposure would look like $5,481,000 if you multiplied it.
What is the roll-forward gap?
The share of the trailing twelve months you will own at close that post-dates the report's measurement cut-off. Ashmoor's report ended 31 March against a 31 July signing, so four of twelve months, a third of the period being priced, carried no procedures. Nobody reprices for it because nobody counts it.
Should we just commission more scope?
Sometimes, and the register is what makes that a real decision. Extending revenue procedures below the top 25 customers or getting a stock count is usually a small fee against a large number, while a full tax nexus study is not. Rank the gaps by exposure per dollar of additional fee and buy from the top.
Does this work on a sell-side QoE we paid for?
Yes, and it is the cheaper time to do it. A buyer's accountants will read your scope pages the same way, and a carve-out you accepted for cost reasons becomes a negotiating position later. Knowing which of your own exclusions carries the largest exposure tells you where a small extension of scope pays for itself.
What if the report will not release its databook?
Then the coverage ratios come off the procedures narrative alone, which is usually enough, because the narrative names the cohort even when it hides the share. A report saying revenue procedures covered the top 25 customers has told you the cohort. Your own customer file supplies the denominator the report left out.
Quality of Earnings Report Review
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