Quality of Earnings. QoE. It sounds like something only large corporations need to worry about. But in the context of a preschool sale — especially any transaction above $400,000 — a Quality of Earnings analysis is increasingly common. Understanding what it tests can mean the difference between a clean close and a surprise renegotiation at the worst possible moment.
What Is a Quality of Earnings Review?
A Quality of Earnings (QoE) review is an analysis conducted by the buyer’s accountants to verify that your reported earnings are real, recurring, and sustainable. Unlike a standard financial audit (which confirms your books are accurate), a QoE asks a harder question: are these earnings the kind a new owner can actually count on?
Buyers don’t want to pay a premium for revenue that came from a one-time grant, earnings that depended on your personal relationships, or cash flow that required unsustainable subsidies. A QoE review digs into the source and quality of every dollar — not just whether the numbers add up.
The Five Areas a QoE Review Tests
1. Revenue Quality and Stability
Reviewers look at whether revenue is recurring and contractual (monthly tuition from enrolled families) versus one-time or non-recurring (state grants, PPP funds, one-time program fees). They’ll test enrollment consistency month by month over 24–36 months. Sudden spikes or drops trigger questions.
2. Add-Back Legitimacy
Every add-back claimed to increase SDE gets scrutinized. Reviewers verify whether each add-back is genuinely discretionary or non-recurring, whether it’s documented, and whether the amount is reasonable. Inflated or poorly-documented add-backs are the most common QoE red flag in childcare transactions.
3. Expense Patterns and Anomalies
Are expenses consistent year over year? Did staffing costs drop dramatically in one year? Did supply costs spike unexpectedly? Unusual patterns require explanation. If you haven’t thought about them, you’ll be caught flat-footed in due diligence.
4. One-Time vs. Recurring Revenue Items
COVID-era grants (EIDL, PPP, Child Care Stabilization Funds) were significant revenue sources for many centers in 2020–2022. Buyers will explicitly strip these from any earnings analysis. A school whose SDE included $80,000 in grant income will look very different after QoE adjustment than one whose earnings came entirely from tuition.
5. Working Capital Adequacy
Reviewers assess whether the business has adequate working capital to sustain normal operations — especially in the months around the sale. Security deposits, pre-paid tuition, accounts receivable, and vendor payment cycles all factor in.
A Real-World QoE Impact
A childcare center showed $210,000 in SDE on their tax return. During the buyer’s QoE analysis, accountants identified:
- $35,000 in Child Care Stabilization grant income included in SDE (non-recurring)
- $18,000 in owner add-backs that couldn’t be fully documented
- $12,000 in one-time equipment replacement that was recurring and shouldn’t have been excluded
The adjusted SDE: $145,000. At a 3x multiple, the seller’s expected $630,000 was revised to $435,000. The deal renegotiated but closed at $465,000 after months of additional back-and-forth — far below initial expectations, and far more painful than necessary.
How to Prepare for QoE Scrutiny
- Separate all grant income from tuition income in your P&L. Know exactly how much revenue came from government programs.
- Document every add-back with source documentation — bank statements, receipts, payroll records. Undocumented add-backs are the most common QoE vulnerability.
- Normalize your expenses across years and be ready to explain unusual patterns with facts, not just assertions.
- Have your CPA prepare a normalized earnings statement using the same methodology a QoE reviewer would use — so you already know your defensible SDE figure before a buyer starts asking.
What This Means for You
The sellers who come through QoE reviews with their price intact are the ones who have already done the work — who know their numbers, have documented their add-backs, and can explain every material trend in their financials. The sellers who lose money in QoE are the ones who are surprised by the process. Don’t be surprised. Get your earnings story straight before a buyer starts asking questions.
