Does Your Business Run on Process or on People?
October 13, 2026Most owners manage their finances with two goals. For taxes, they want to show less income. For a sale, they want to show the full earning power of the business.
Those goals produce two different sets of numbers for the same company. The difference is normal. What matters is whether you can explain it before a buyer asks.
A buyer who finds the gap without an explanation will make assumptions. Those assumptions rarely favor the seller.
Not whether it would survive. Whether it would run well. Whether decisions would get made the right way, problems would get solved at the right level, and performance would stay consistent without someone at the top holding it together.
Most owners know the honest answer before they finish hearing the question.
Why Your Tax Return Understates Earnings
A tax return is built to reduce taxable income. It is not built to show what a business would earn for a new owner.
Several legitimate choices lower reported income. Accelerated depreciation is one. Owner pay that differs from a market salary is another. Personal expenses paid by the business also reduce profit on paper. The timing of income and expenses can shift results from one year to the next.
Each choice can make sense for tax purposes. Together, they can leave a bottom line that looks much weaker than the actual performance of the business.
What a Quality of Earnings Report Does
A quality of earnings report, often called a QoE, is an independent financial analysis. It restates earnings to show what the business produces on an ongoing basis.
The analysis starts with reported income and makes adjustments, often called add-backs. The result is usually shown as adjusted EBITDA(Earnings Before Interest, Taxes, Depreciation, and Amortization).
Buyers generally value businesses of the size we work with as a multiple of adjusted EBITDA. That makes the adjusted figure the starting input for price.
Common Adjustments
Some examples of common adjustments.
- Owner compensation reset to the cost of hiring a replacement
- Personal expenses that run through the business
- One-time costs, such as a legal settlement
- Differences in accounting methods, such as cash versus accrual
Adjustments can also reduce earnings. If an owner underpaid a key manager, a QoE would raise that cost to market level. The goal is accuracy, not the highest possible number.
Why Documentation Decides How Much Counts
An adjustment only helps if a buyer accepts it. Buyers accept what they can verify.
Take owner compensation. An owner may believe the role is worth less than what they were paid. The buyer will ask what it would cost to hire a replacement. A job description, a market salary comparison, and payroll records answer that question.
Personal expenses work the same way. A buyer will want invoices, card statements, and the accounting entries that show what was personal. An explanation without records is a claim, not an add-back.
One-time costs get the closest look. A buyer will ask whether the cost really happened once. If similar costs appear in several years, the buyer may treat them as a normal part of operating the business.
Every adjustment a buyer rejects lowers adjusted EBITDA. Because that figure is multiplied to reach a price, a small disagreement over an add-back can become a large disagreement over value.
How Buyers Use a QoE
Buyers often commission a QoE during due diligence. Their accountants review the financials line by line and build their own adjusted earnings figure. That figure becomes the basis for valuation.
If the buyer’s number is lower than yours, the difference is negotiated. This often happens late in the process, after the buyer has invested time and expects to close. A price change at that stage can slow the deal or end it.
The Case for Getting There First
A seller can commission a QoE before going to market. This is sometimes called a sell-side QoE.
It offers three practical benefits. You know your adjusted earnings figure before any buyer does. Each add-back has documentation behind it. Due diligence can move faster because the financial foundation already exists.
A buyer will usually still run its own review. The difference is that the review starts from a documented baseline. Questions get answered with records instead of explanations.
A sell-side QoE is not necessary for every sale. Cost, timing, and fit depend on the size and complexity of the business. An advisor can help you decide.
Questions to Ask About Your Own Financials
Even without a full QoE, you can review your numbers as a buyer would.
- How far apart are your adjusted EBITDA and your reported net income?
- Can you document every significant add-back?
- Would a buyer classify any revenue or expense item differently than you
A seller that knows their financials and has answers ready before the questions is in a better position.
Request a Confidential Consultation to review how your financials will look to a buyer’s accounting team.
Steven Pappas, M&A MI
Partner, Managing Director
Touchstone Advisors
860-669-2246
spappas@touchstoneadvisors.com
