SBA lenders and buyers need to know whether a business’s reported earnings are supported by its financial records. An SBA Quality of Earnings (QoE) review can uncover issues that affect those earnings. These may include cash differences, unsupported add-backs, customer concentration, changing margins, and missing liabilities. This helps lenders and buyers make confident decisions based on supported earnings and a clearer view of the risks in the transaction. In many cases, the QoE analyst may find red flags that lead to an earnings adjustment or a review of additional records. In this guide, we break down 10 SBA Quality of Earnings red flags that lenders and buyers may find during financial due diligence. We explain how each finding can affect normalized earnings and the lender’s view of debt service. To learn more about QoE analysis, check out What is an SBA Quality of Earnings Report.
Peak Business Valuation works with SBA lenders, buyers, and sellers nationwide. We can provide expert SBA QoE findings relevant to your transaction. We also offer separate SBA business valuations when needed. If you have questions about SBA Quality of Earnings red flags, schedule a free consultation with Peak Business Valuation below.
Why Do SBA Quality of Earnings Red Flags Matter to Lenders?
SBA Quality of Earnings red flags matter because lenders need earnings that can support loan repayment. Qualifying Initial Acquisition and Business Expansion transactions require a separate QoE under SOP 50 10 8.1. The SOP applies to applications that have been issued an SBA loan number on or after October 1, 2026. The separate QoE requirement applies to transactions with a Business Purchase Price of $3 million or less, excluding owner-occupied commercial real estate. The transaction type and business price determine whether this requirement applies, not just the loan amount.
For transactions that require a separate QoE, the lender uses QoE earnings to assess debt service coverage. Lower earnings may mean less debt, more buyer equity, or revised terms. The analyst should also separate earnings adjustments from risks that cannot be measured. Because these findings can affect the earnings used in this analysis, it is important to identify and review them closely.
What are SBA Quality of Earnings Red Flags?
Below, we break down 10 SBA Quality of Earnings red flags that can affect reported earnings and require closer review during an SBA Quality of Earnings analysis.
1. Bank Deposits Do Not Reconcile to Reported Revenue
As part of a QoE analysis, an analyst uses an SBA Cash Proof procedure. It compares bank activity with reported revenue after accounting for valid differences. For example, transfers, loan proceeds, receivable collections, and merchant settlement timing can affect the comparison. A significant unexplained difference is a red flag because it may indicate that reported revenue is not fully supported by cash collections. However, the difference alone does not prove that sales were misstated. As such, the analyst may request more records, adjust earnings, or disclose a limitation based on the findings.
2. Proposed Add-Backs Lack Transaction-Level Support
SBA add-back verification tests proposed adjustments against supporting records to determine whether the expenses are valid and will continue after the transaction. The analyst may review dates, vendors, ledger entries, and invoices to support material items. An unsupported add-back is a red flag because it may overstate the earnings available to repay an SBA loan. A seller schedule alone is not enough to verify an add-back.
3. Owner Compensation Excludes Necessary Replacement Labor
Owner compensation can create an earnings risk when an adjustment removes pay for work that will still be needed after closing. The analyst considers the owner’s duties, replacement labor, and related payroll costs when determining the appropriate adjustment. Removing the full amount of owner compensation is a red flag because it may overstate the cash flow available to repay an SBA loan. Only compensation that exceeds the cost of replacing the owner’s work is an appropriate add-back.
4. One Customer Supplies a Large Share of Profit
Customer concentration can create repayment risk when a large share of earnings depends on one account. The analyst may review contracts, renewals, customer history, and gross profit by account. A customer that supplies a large share of profit is a red flag because losing that account could reduce the earnings available to repay an SBA loan.
5. Recent Growth Came From One-Time Work
Recent revenue growth may not reflect recurring business activity. An analyst may examine large projects, unusual orders, and other revenue that may not continue after closing. One-time work is a red flag when it makes trailing twelve-month earnings appear higher than the business can reasonably sustain. Only the earnings tied to work that will not recur need adjustment, so the analyst reviews the project’s contribution margin.
If you have questions about SBA Quality of Earnings red flags in a specific transaction, Peak Business Valuation is happy to help. Our financial analysts can review the records behind reported earnings and explain how each finding may affect normalized earnings. Schedule a free consultation below!
6. Gross Margins Change Without an Operating Explanation
Gross margin changes can result from prices, product mix, purchasing costs, labor efficiency, or accounting entries. An analyst compares monthly trends with invoices, job records, and other supporting records to determine what caused the change. A significant unexplained change is a red flag because it may affect the earnings available to repay an SBA loan.
7. Related-Party Expenses Are Below Market
Related-party expenses may not reflect the costs a buyer will incur after closing. The analyst may review rent, payroll, equipment leases, and management fees against market costs to determine whether an adjustment is needed. An expense that is below market is a red flag because reported earnings may not reflect the buyer’s actual ongoing costs.
8. Working Capital Deteriorates as EBITDA Rises
Working capital trends can show whether rising earnings are supported by the cash needed to operate the business. An analyst may examine accounts receivable, inventory, accounts payable, and other working capital accounts. Deteriorating working capital is a red flag because rising EBITDA may not translate into enough cash to support operations and repay an SBA loan. The lender may also consider the cash needed after closing.
9. Liabilities or Operating Costs Are Missing
Missing accruals, unpaid vendors, customer deposits, and warranty obligations can affect the financial picture of a business. The analyst may examine liability detail and subsequent payments to determine whether expenses were recorded in the proper period. Missing liabilities or operating costs are a red flag because they may understate the costs or obligations associated with the business. Depending on the item, the finding may affect EBITDA, create a closing obligation, or belong in working capital.
10. Financial Reports Disagree for the Same Period
Financial reports for the same period should be reconciled when they show different results. An analyst may compare tax returns, accountant statements, internal reports, and lender schedules to identify the reason for the differences. A material unexplained difference is a red flag because it may raise questions about the reliability of the reported financial results. Accounting methods and closing entries can create valid differences, so the analyst reconciles the amounts before treating a difference as an error. Peak’s SBA Quality of Earnings documents guide identifies records for the review.
Conclusion
An SBA Quality of Earnings analysis can point to issues in cash collections, adjustments, customer relationships, margins, and balance-sheet accounts. The lender needs to know which of these flags impact recurring earnings and which require disclosure or further support. The QoE report should identify the records reviewed and explain how unresolved differences affect the earnings available for underwriting.
Peak Business Valuation can support lenders by providing an SBA Quality of Earnings analysis to assess the underlying records. Schedule a free consultation with Peak Business Valuation today if you have any questions.
