Quality of earnings: what buyers test in an industrial SME
Before signing, buyers commission a QoE review to reconcile reported EBITDA with the earnings they are willing to underwrite. Since valuations are set as a multiple of adjusted EBITDA, every euro the review removes — or defends — moves the price several times over.
A quality of earnings (QoE) review answers one question: how much of this company's EBITDA is real, repeatable and transferable? It tests revenue quality, normalizes earnings through adjustments, and examines working capital and cash conversion. What survives the review becomes the number the deal is priced on.
What does a QoE review actually examine?
A QoE is narrower and deeper than an audit. An audit asks whether the accounts are correct; a QoE asks whether the earnings are sustainable. As M&A advisors at IMAP note, buyers use it to test revenue and expense recognition, evaluate working capital and cash conversion, and surface risks that change price, financing or deal terms. For an industrial company, the review typically covers revenue recognition, customer concentration, gross margin by product line, payroll, add-backs, accruals and out-of-period items.
Which adjustments move EBITDA the most?
| Adjustment | Typical direction | Industrial SME example |
|---|---|---|
| Owner compensation | Up or down | Family salaries above/below market rate |
| One-off revenue | Down | A single large contract cycle inflating a strong year |
| Non-recurring costs | Up | Litigation, flood damage, ERP migration |
| Related-party pricing | Either | Rent paid to a family-owned building |
| Deferred maintenance | Down | Machinery overhauls postponed before the sale |
| Energy & input normalization | Either | Locking in the benefit of self-generated solar power |
The pattern buyers look for in manufacturing is concentration risk dressed as growth: a strong year driven by two or three large orders presents the same EBITDA as a diversified book — with a very different risk profile. A tannery whose volume spreads across footwear, leather goods and newer verticals such as hospitality or padel defends its multiple better than one dependent on a single category, which is why diversified platforms read as more resilient acquisition targets.
How does the QoE shape price and deal structure?
Three ways. First, the multiple applies to adjusted EBITDA, so the negotiation over add-backs is the negotiation over price. Second, working capital findings set the peg that determines closing adjustments — in seasonal industries like leather, where hide purchases and collection cycles swing the balance sheet, this is often worth more than the add-back debate. Third, unresolved doubts migrate into structure: earn-outs, escrows and warranties are the price of unanswered questions. A seller who cannot evidence recurring revenue will be offered contingent payment instead of cash.
How does a well-run seller prepare for it?
By running the exam before the examiner arrives. Monthly management accounts that tie to the annual statements, a documented add-back schedule, customer profitability by line, and export revenue traceable by market — the same discipline covered in our guide to vendor due diligence for industrial SMEs (Spanish).
Certifications do quiet work here too: an LWG Gold audit trail, energy data from a solar plant, or traceability records give a reviewer third-party evidence instead of management assertions. In cross-border deals, where the buyer cannot rely on local context, that documentation gap is often the difference between a clean close and a re-trade — and what survives the QoE becomes the baseline for the first 100 days after closing.
Frequently asked questions
Is a QoE report the same as an audit?
No. An audit verifies that accounts comply with accounting standards; a QoE assesses whether reported earnings are sustainable and transferable. Many audited companies see material EBITDA adjustments in a QoE.
Who pays for the quality of earnings review?
Usually the buyer commissions and pays for it during due diligence. Sellers increasingly commission their own sell-side QoE beforehand to control the narrative and pre-empt surprises.
How long does it take for an industrial SME?
Typically four to eight weeks, depending on the quality of monthly reporting. Companies with reconciled management accounts shorten it; those with year-end-only visibility lengthen it.
What is the most common negative adjustment in manufacturing?
Non-repeatable revenue — earnings driven by an unusual contract cycle — followed by deferred maintenance on machinery, which converts into a price reduction or an escrow.
The open board. Where do industrial partnerships start? Often with a conversation between operators. The TL San Martín Business Board — category Partners & factories — is an open, free B2B space where manufacturers, brands and investors in the leather and footwear sector connect directly.
TL San Martín — a third-generation tannery in Elda, Spain, tanning since 1995, LWG Gold certified, solar-powered and building AI-assisted sourcing tools — maintains open conversations with partners and investors who share its industrial vision. Confidential contact: jorge@tlsanmartin.com.