Who this is for
- Owners of a US sole proprietorship, partnership, LLC or corporation selling to a buyer who wants a quality of earnings report
- Sellers whose books are on the cash method, mix in personal costs or do not tie to their tax returns
Not covered here
- What a report costs, and whether a buyer should order one
- Tax on the sale and how the price is split among the assets
- How each add-back is argued and how seller's discretionary earnings are figured
- Canadian businesses, and lender rules outside the SBA programs
What is a quality of earnings report for a small business, and who orders it?
A quality of earnings (QoE) report restates a business's profit to a normalized figure, meaning profit adjusted for one-time items and owner-specific costs, so a buyer can price it. It is not a government form. A buyer, or the buyer's lender, orders it, often once a letter of intent (the signed outline of price and terms before the final contract) is in place.
The SBA lender manual defines it as a financial due diligence report on the reliability, sustainability and accuracy of a business's earnings. It ties together the accountant-prepared statements, tax returns, internal statements and IRS transcript data (SBA lender manual, Appendix 15). For most SBA 7(a) acquisitions at a business price of $3 million or more, the lender must obtain one. An independent professional prepares it for the lender's benefit, and it must not be prepared by or for the seller.
What makes a case not simple: books on the cash method, personal costs run through the business, revenue that does not tie to the bank deposits or the tax return, and months that were never reconciled. Each becomes an adjustment or a gap, and each needs a document from you. If a letter of intent is signed and more than one applies, how many months to restate before the data room (the shared folder where the buyer's team reads your records) opens is worth a CPA's review (bookkeeping help).
What to gather: three years of returns and statements, monthly profit and loss statements, and bank and card statements for the same months. The data room list below has the rest.
When does a buyer or lender ask for a quality of earnings report?
This page covers one written price test, the SBA 7(a) rule. Any other request comes from the buyer or the bank, and it often follows the signed letter of intent.
| Deal | QoE required? | What the lender still checks |
|---|---|---|
| SBA 7(a), business price $3 million or more | Yes, the lender obtains it, unless an exception below applies | A business valuation, and your numbers against IRS transcripts (rules differ for some programs) |
| SBA 7(a), business price below that | Not required by SBA; the lender or buyer may still ask | The same checks (rules differ for some programs) |
| Bank loan outside SBA, or a buyer paying cash | The buyer or the bank decides | The lender's own credit tests |
The SBA test uses the contract price minus the appraised value of any owner-occupied commercial real estate in the deal, before buyer equity, seller debt or other financing. It applies when a new majority or largest owner takes over, or one business buys another. Owner buyouts, ESOP and cooperative deals, and the purchase of an owner-occupied special-purpose property are outside the requirement, and some buyouts by a recent employee count as acquisitions (SBA lender manual). The threshold is from version 8.1 of the manual, and SBA revises it from time to time, so ask the buyer's lender which version applies to the application and which category your deal falls in. How the lender decides is in the buyer's guide.
What does a buyer's team compare: my statements, tax returns and IRS transcripts?
A buyer's team lines up the same periods in each record and asks why any two differ. The cash proof, covered next, adds the bank statements.
A transcript is not a photocopy of your return. A partnership or corporation income tax return transcript shows most line items as filed, not the documents attached to the return or changes made after filing (IRS).
For an SBA loan the lender gets the transcripts itself, through the IRS's Income Verification Express Service with a Form 4506-C request, or through a Form 8821 that names the lender. SBA does not let the borrower (the buyer) or the borrower's own tax preparer file that Form 8821 (SBA lender manual, Chapter 5; IRS). The IRS sends your records to the lender only if you approve its request, in your IRS account or on the signed form, with an acceptable title if you act for a business (IRS). A signed form must reach the IRS within 120 days of the signature date, so sign when the lender is ready to submit it (Form 4506-C).
Pull your own transcripts first, for your own tie-out. A sole proprietor, or an individual who owns a single-member LLC that has not elected corporate treatment, reports the business on the owner's personal return (Publication 583; IRS), so the owner uses an IRS online account or requests them by mail (IRS), and the lender checks the Schedule C. A single-member LLC owned by a corporation or partnership is reported on that owner's return, so the transcript is the owner's. A partnership, a corporation, or an LLC taxed as either, uses a business tax account, Form 4506-T by mail, or the business tax line (IRS; Form 4506-T). For a business transcript, allow 2 to 3 weeks after e-filing and 6 to 8 weeks after mailing a paper return before you request one.
Three cases to settle early, all from the SBA manual's transcript rules (Chapter 5):
- The transcript says no record of a year you filed. The lender may proceed with proof of filing (an e-file acceptance or a paper return the IRS stamped as received) and proof that the tax was paid or refunded, matching the return. Keep both for every year.
- You amended a year. When no transcript of the amended return is available, the lender needs the signed amended return and evidence that it was filed.
- You are selling a division or segment. If transcripts and statements cannot identify it, the lender must use other third-party evidence, such as CPA-prepared or reviewed statements and sales tax payment records, so keep books that set the division apart.
What is a cash proof, and why do bank statements matter?
A cash proof rebuilds the money that came in and went out from the bank statements, then reconciles it to the income statement and the tax return for each period under review. SBA requires one inside every QoE, for the latest 12 months and the last two fiscal years. A business open under two years can get a smaller scope. SBA says its purpose is to find discrepancies in income and undisclosed expenses (SBA lender manual).
Bank statements come from outside your business, so the buyer's team tests the ledger against them. Revenue, deposits and the return often differ, and each gap needs a document that explains it:
| The gap | Common cause | Document that closes it |
|---|---|---|
| Deposits above booked revenue | Sales tax collected, loan proceeds, owner money, transfers between your own accounts | Sales tax return, loan statement, matching transfer entries |
| Booked revenue above deposits | Unpaid invoices at the period end, refunds, processor fees taken from payouts | Receivables list, refund log, processor statement |
| Booked revenue above the return | Accrual books with a cash-method return, refunds shown net on the return, or income the return left off (a tax question, see below) | A line-by-line bridge from book revenue to return revenue |
Cash sales are the hard case. The IRS says to deposit all daily receipts in the business account and keep documents that show gross receipts, such as cash register tapes, bank deposit slips, receipt books, invoices and credit card charge slips (Publication 583). Sales that never reached a deposit or the return are a tax question as well as a books question. A CPA can review them before the buyer's team reaches them.
What adjustments will a buyer make to my earnings?
The SBA manual says the report must identify and document every add-back and adjustment to the seller's reported earnings. It names five groups (SBA lender manual).
| Adjustment | What it can look like | What to have ready |
|---|---|---|
| One-time revenue or expenses | An equipment sale in income, an insurance payout, a one-time legal bill | The closing statement, invoice or letter behind it |
| Owner pay above or below market | An owner who takes no wages, a relative paid well above the going rate | Payroll records and what a replacement would cost |
| Related-party transactions | Rent paid to the owner's own building | The lease and a list of related parties |
| Deferred maintenance | Repairs put off, which lifts profit | Repair history and an equipment list |
| Cash versus accrual | A cash-method return counts income when received and costs when paid; accrual counts them when earned or incurred (Publication 538) | Receivables and payables at each month end |
If you own an S corporation and work in it, the IRS instructions say payments to an officer must be treated as wages to the extent they are reasonable compensation (Form 1120-S), so pay taken only as distributions is an IRS question as well as a buyer adjustment. If inventory is necessary to account for your income, the method your return may use for purchases and sales is limited, with an exception for small business taxpayers (Publication 538). A CPA can check both before the data room opens.
Personal costs run through the business are a familiar add-back in a small sale. How a buyer tests them is in add-backs and seller's discretionary earnings.
The report also looks at customer concentration, contract continuity and whether revenue and margins are likely to hold after the sale. The lender uses the report's earnings for debt service coverage, and if that does not support the valuation and the debt, the loan amount must be reduced (SBA lender manual). An unsupported adjustment can therefore shrink what the buyer's lender will lend.
What breaks most often in small business books?
Personal costs, cash-basis timing, unrecorded cash sales and missing months break most often. Each leaves a gap the buyer's team will ask about.
| What breaks | Fix before the data room opens |
|---|---|
| Personal costs in the business leave expenses with no business purpose and owner pay that is hard to size | Sort each item as business or personal, then treat the personal ones as personal expenses paid from the business account describes for your entity; the IRS says to use the business account for business only (Publication 583) |
| Cash-basis books make profit move with when customers pay | Rebuild receivables and payables at each month end. See switching from cash to accrual |
| Unrecorded cash sales leave a cash proof gap with no register tapes or receipt books behind it | Document what exists, and take the rest to a CPA |
| Missing months mean accounts never reconciled and statements missing | Reconcile each account to its statement every month; the IRS advises this for the business checking account (Publication 583). See catching up on overdue books |
How far back do I clean up my books, and how long does it take?
Clean up at least the latest 12 months and the last two fiscal years, month by month, and keep three years of returns and statements ready. The cash proof covers the first two. An SBA lender analyzes the three most recent year-ends plus the current interim statement (SBA lender manual, Appendix 15).
No rule sets how long cleanup takes; it grows with the number of unreconciled accounts and months. The waits that are fixed are for transcripts: 2 to 3 weeks after e-filing a business return and 6 to 8 weeks after mailing one. The buyer's request often comes soon after the letter of intent, so start before it. In this order:
- Pull your filed returns and your own IRS transcripts for the years under review.
- List every bank, card and payment-processor account open in those periods, and collect every statement.
- Reconcile each account to its statement, month by month, and close each month. See the month-end close checklist.
- Sort personal items and one-time items, with a document for each.
- Restate to accrual if the buyer wants accrual figures. That changes the books, not the method on your return; a change to the return's method generally needs IRS approval (Publication 538).
- Run the cash proof, then build the bridge from book profit to return profit for each year.
If my numbers do not match my tax returns, what do I do before the buyer's review?
Find every gap first and put a document behind it. A buyer's team compares your statements with your returns, and on 7(a) loans other than SBA Express and Export Express the lender must get the seller's IRS transcripts and reconcile discrepancies with the financial data before it first disburses the loan, so a gap is likely to be found (SBA lender manual, Chapter 5).
- Compare revenue and profit for each year across the statements, the return and the transcript.
- Name the cause of each difference. Timing between the cash and accrual methods is an ordinary cause (Publication 538). See books to the business tax return for others.
- Write the bridge from book profit to return profit, with a document for each line.
- Correct a books error with a dated correcting entry and keep the original record. Explain a timing difference in the bridge instead of changing the books for it.
A third kind is not a books problem. If the books show income the filed return left off, or the return deducted personal costs, the return itself may need correcting, and how that is done depends on the entity. A sole proprietor's case is in income left off past returns; a partnership's or corporation's is in correcting a filed business return, which also covers the owner returns that can change. Whether to correct a return, and what that means for the sale, depends on the facts and is worth a CPA's review before the data room opens.
Should I order my own quality of earnings report first, and will a lender accept it?
For an SBA loan at or above the threshold, a report you order does not meet the requirement. The manual says the report must not be prepared by or for the seller, and the lender may not rely on a report another party prepared unless one of its own approved vendors reviews it. The manual describes a report the buyer commissions, not the seller (SBA lender manual).
Outside SBA, no rule decides. A buyer or bank may read a seller's report, retest it, or order its own. Ask in writing whether it will use a seller-ordered report before you pay for one.
A lighter first step is a CPA tie-out of your own books: returns, statements and bank deposits for the same periods, with every gap listed and explained. It is not a QoE, and on its own it does not meet an SBA requirement, but it shows where the gaps are. What a report costs is on the cost page.
What goes in the data room folder for the books?
The folder holds the records that let the buyer's team rebuild your earnings without calling you.
| Item | What it shows |
|---|---|
| Tax returns for the last three years, all schedules, plus your IRS transcripts | What you reported |
| Read-only access or a full export of your accounting file, with a list of any accounts kept outside it | Lets the buyer's team trace any total to its entries |
| Annual and monthly profit and loss statements and balance sheets, the year-to-date statement and the same period a year earlier, and the general ledger | Earnings, trend and the detail behind them |
| Statements for every bank, card, payment-processor and marketplace account, with monthly reconciliations | The cash proof |
| Sales by customer, receivables list at each period end, key contracts | Customer concentration and cash versus accrual |
| Payroll reports and sales tax returns | Wages and sales reported to the agencies, to compare with the books |
| Owner and related-party schedule: owner pay, family on payroll, loans to or from owners, related-party leases | Owner pay and related-party adjustments |
| Add-back schedule with a document per item, the bridge from book profit to return profit, and the cash proof workpaper | Each adjustment and why the numbers differ |
| Equipment, loan and lease schedules, and inventory counts if you hold inventory | Assets and debts the price assumes |
Sales slips, invoices, receipts, deposit slips and account statements are what make each entry provable (Publication 583; IRS recordkeeping). The records for the sale itself are in selling your business.
Example
These examples are illustrative; all figures are in US dollars.
A landscaping company with a letter of intent
A landscaping company signs a letter of intent at $1,500,000. The books are on the cash method. A one-time $40,000 equipment sale sits in income, and $12,000 of family truck payments sit in expenses. The price is below the $3 million SBA test, so SBA does not require a report, but the buyer's accountants ask for a review anyway. They remove the $40,000 from recurring income, add back the $12,000 if the truck is personal and the payments are proven, and move December jobs billed but unpaid into December. If the return also deducted those truck payments, that is a return question too, not only an add-back, and the equipment sale needs its own line in the bridge. A seller who fixed these items first has the support ready when the questions arrive.
A restaurant group sold with SBA financing
A restaurant group sells to an outside buyer for $4,000,000 with an SBA 7(a) loan, a price for the business with no real estate in it. The lender must obtain a QoE. A report the seller paid for does not count, and a buyer-commissioned report counts only after the lender's vendor reviews it. The seller's job is records ready on day one: every location's bank and processor statements for the latest 12 months and the last two fiscal years, monthly reconciliations, three years of returns, and owners ready to sign the transcript consents.
A cash proof with two gaps
A seller's bank deposits for the year total $820,000, booked revenue is $800,000, and the tax return shows $780,000. Each gap is $20,000. The deposits gap is $12,000 of sales tax collected and an $8,000 loan deposit, and the seller attaches the sales tax return and the loan statement. The return gap is $20,000 of customer refunds that the return subtracts from revenue and the books record as an expense. The seller attaches the refund log and a note that profit is the same either way.
Different for you?
- A letter of intent is signed, or a buyer or lender has named a quality of earnings review, and your books are on cash, mix personal costs or do not tie to your returns: a CPA can work through with you how many months to restate and whether to close the books monthly before the data room opens. Whether the numbers support the price is the buyer's and the lender's call. See bookkeeping help.
- Your books are months or years behind: a buyer cannot test records that do not exist. See catching up on overdue books and get bookkeeping help.
- The books show income a filed return left off, or the return deducted personal costs: this is a tax question as well as a books question. See income left off past returns or correcting a filed business return. A CPA can review it before the data room opens: individual tax for a sole proprietor or an individual-owned single-member LLC, corporate tax for a partnership, a corporation or an LLC taxed as either (an LLC owned by another entity follows that owner), and bookkeeping help for the books side.
- Your books are on cash and the buyer wants accrual figures: see switching from cash to accrual.
- You ran personal costs through the business: see add-backs and seller's discretionary earnings and personal expenses paid from the business account.
- You want to know what a report costs: see quality of earnings report cost.
- You are asking about tax on the sale and how the price is split: see selling your business.
- You paid lawyers or accountants for deal work: see due diligence and deal costs.
- The owner, the buyer or the money is in more than one country: the records and the tax rules on both sides change the picture. See cross-border tax.
- You are the buyer: see do you need a quality of earnings report to buy a business and checking a seller's books before you buy.
Figures on this page
| Figure | Value | Source |
|---|---|---|
| Business purchase price at which an SBA 7(a) lender must obtain a quality of earnings report SOP 50 10 version 8.1 (effective October 1, 2026), Appendix 15, Para. C.1, Quality of Earnings. Initial acquisitions and business expansions. Measured before buyer equity, seller debt or other financing; the business purchase price excludes owner-occupied commercial real estate. Owner buyouts and ESOP or cooperative deals are exempt. | $3 million | SBA: SOP 50 10, Lender and Development Company Loan Programs (version 8.1) Checked |
| IRS receipt window for signed Form 4506-C The IRS must receive Form 4506-C within this period after the taxpayer signs it or the request is rejected. | 120 days | IRS: Form 4506-C, IVES Request for Transcript of Tax Return, page 2 Checked |
| Wait after e-filing before requesting a business tax transcript For a return filed electronically; "No record of return filed" may mean the return is not processed yet. | 2 to 3 weeks | IRS: Get a business tax transcript Checked |
| Wait after mailing a paper return before requesting a business tax transcript For a return filed on paper. | 6 to 8 weeks | IRS: Get a business tax transcript Checked |
Primary sources
- SBA: SOP 50 10, Lender and Development Company Loan Programs (version 8.1), Appendix 15 and Chapter 5
- IRS: Income Verification Express Service for taxpayers
- IRS: Form 4506-C, IVES Request for Transcript of Tax Return
- IRS: About Form 8821, Tax Information Authorization
- IRS: About Form 4506-T, Request for Transcript of Tax Return
- IRS: Get a business tax transcript
- IRS: Get your tax records and transcripts
- IRS: Publication 538, Accounting Periods and Methods
- IRS: Publication 583, Starting a Business and Keeping Records
- IRS: Recordkeeping
- IRS: Single member limited liability companies
- IRS: Instructions for Form 1120-S
About this guide
Published by Cloud Accounting under standing professional approval. This version has no separately recorded personal review. It explains general rules for the tax year shown. It is not advice for your situation.
Changes
- : First published.