When the Numbers Don’t Match: Reconciling Financials Under the New SBA QoE Requirement

Part 2 of Inside the New SBA QoE Requirement. Read Part 1: What Is a Cash Proof, and Why Is SBA Requiring One?

One of the more important provisions in SBA's new Quality of Earnings requirement has received less attention than Cash Proof: The QoE must reconcile the company's internal financial statements, accountant-prepared financial statements, tax returns, and IRS transcript data when arriving at normalized earnings.

For anyone who regularly works with privately held businesses, the reason for this requirement should be familiar. Those records often do not agree.

A company may report one level of revenue and earnings in QuickBooks, another in the year-end financial statements prepared by its CPA, and another on its federal tax return. In many cases, there is a perfectly reasonable explanation. The company may keep accrual-basis books but file a cash-basis tax return. The CPA may record year-end adjustments that were never posted back to the general ledger. Depreciation may differ between book and tax records. Revenue and expenses may move between periods because of cutoff adjustments.

The existence of a difference is not necessarily the problem. The problem is reaching a purchase price and debt structure based on earnings that nobody has reconciled back to the underlying records.

That is what the new SBA requirement is intended to address.

What SBA now requires

Effective October 1, 2026, SBA SOP 50 10 8.1 requires a Quality of Earnings report for certain Initial Acquisition and Business Expansion transactions when the Business Purchase Price is $3 million or more. Appendix 15 sets out the requirements for these Changes of Ownership transactions, including the Cash Proof discussed in Part 1 and the broader analysis of normalized earnings.

As part of that analysis, the QoE must reconcile the accountant-prepared financial statements, tax returns, internal financial statements, and IRS transcript data.

The purpose is not simply to determine whether those documents match. It is to understand the differences among them and determine how those differences affect the recurring earnings of the business.

That distinction matters because none of these sources is automatically the “right” one.

A tax return is not necessarily the best representation of economic earnings simply because it was filed with the IRS. Likewise, an internal P&L does not become reliable merely because it contains more detail. Each source was prepared for a different purpose and may reflect a different accounting basis, timing convention, or set of adjustments.

The QoE provider has to understand the bridge among them.

Why the financial records often differ

The most common source of differences is the accounting basis itself.

Many privately held businesses maintain accrual-basis financial statements but file tax returns on the cash basis. Under accrual accounting, revenue is generally recognized when earned and expenses when incurred. Under cash accounting, the timing is tied more closely to when cash is received or paid. A business with meaningful accounts receivable or accounts payable can therefore report different revenue, expenses, and net income under the two methods even though the underlying transactions are the same.

Year-end CPA adjustments are another common source of differences. A company may close each month using its internal books, then send those records to an outside accountant after year-end. The accountant may record depreciation, adjust inventory, accrue payroll or other liabilities, write off receivables, or correct prior entries. Those adjustments do not always get posted back into the company's accounting system.

There can also be differences in classification. A tax preparer may place an expense in a different category than the bookkeeper without changing total expenses or net income. Related-party transactions may be presented differently. A change in accountants, bookkeeping systems, or accounting policies may also create inconsistencies between periods.

None of these circumstances is unusual. What matters is whether the differences can be identified, quantified, and explained.

What a reconciliation should actually accomplish

Consider a business whose internal books report $10 million of revenue while the tax return reports $9.5 million.

The wrong approach is to assume that the $500k difference represents overstated revenue. It is equally wrong to assume that the tax return must be wrong because management says the internal books are more accurate.

The analyst needs to build the bridge.

Perhaps $350k of the difference consists of year-end accounts receivable because the company keeps accrual-basis books but files a cash-basis return. Another $100k may relate to a year-end cutoff adjustment recorded by the CPA, while the remaining $50k reflects a documented classification or entity-level difference.

If those items are supported, the $500k difference may be entirely explainable.

The objective is not to make every document show the same number. The objective is to understand why the numbers differ and determine which treatment best reflects the historical operations of the business for purposes of normalized earnings.

Some differences matter much more than others

A useful reconciliation should distinguish between differences that affect presentation and differences that affect earnings.

If a $75k expense was classified as Professional Fees in the general ledger and Outside Services on the tax return, there may be little economic consequence. The expense exists in both records and net income is unchanged.

Compare that with a recurring $75k expense that appears on the tax return but is absent from the internal P&L used to calculate the seller's adjusted EBITDA. That is a different issue because it may mean the earnings figure being used to market the business is overstated.

Revenue differences deserve the same treatment. A variance caused by supported cash-versus-accrual timing may be routine. Revenue included in the internal statements but associated with an affiliated company outside the transaction is not. Nor is revenue that cannot be connected to invoices, receivables, cash collections, tax filings, or another reasonable source.

The relevant question is whether resolving the difference changes the economics of the business being acquired.

The IRS transcript adds another level of verification

The inclusion of IRS transcript data is also significant.

A copy of a tax return in the data room is still a document supplied by the seller or its advisors. IRS transcript data provides an independent point of comparison with the information reported to the government.

Most of the time, those records should reconcile without much difficulty. When they do not, the discrepancy needs to be understood.

An amended return may explain the difference. There may be a processing issue. The seller may have provided an outdated copy of the return.

None of those circumstances automatically suggests wrongdoing, but an unexplained difference between the tax return being used in diligence and the tax information verified through the IRS deserves attention, particularly when it affects revenue or earnings.

How this fits with Cash Proof

Cash Proof and financial reconciliation test the same financial story from different directions.

Cash Proof asks whether the actual movement of cash through the business is consistent with its reported financial performance.

Financial reconciliation asks whether the different records describing that performance can be brought back to a consistent economic picture.

A business can pass one test and still have issues under the other. For example, bank activity might reasonably support $5 million of reported revenue, while the tax return reports only $4.5 million. Cash Proof may support the operating activity, but it does not explain the $500k tax-return difference. The reconciliation still has to answer that question.

Why this matters before discussing add-backs

In many small-business transactions, attention quickly moves from reported net income to adjusted EBITDA. Buyers and sellers debate owner compensation, personal expenses, one-time professional fees, unusual repairs, and other proposed add-backs.

Those adjustments matter, but they come after a more basic question: What historical earnings figure are we adjusting?

Suppose the seller presents $1.5 million of adjusted EBITDA based on the internal financial statements, but there is an unexplained $250k difference between those statements and the accountant-prepared records. Debating a $25k vehicle add-back before resolving the $250k difference misses the larger issue.

The starting point has to be supportable before the adjustments layered on top of it have much meaning.

This is one of the more useful aspects of SBA's new requirement. It pushes the analysis beyond a schedule of proposed add-backs and toward the reliability of the earnings being adjusted.

When reconciliation becomes a financing issue

These differences also have implications beyond the QoE report.

The earnings developed through the QoE become part of the lender's analysis of whether the business can service the proposed acquisition debt.

If a seller is marketing the business based on $1.5 million of adjusted earnings but the QoE supports only $1.25 million after the underlying records are reconciled, the difference may affect debt service coverage, the amount of debt the business can support, the buyer's required equity contribution, or ultimately the purchase price.

What initially looks like a bookkeeping issue can therefore become an underwriting issue.

That does not mean every reconciliation difference will reduce earnings. The process can also identify duplicated expenses, transactions that belong outside the business being acquired, or accounting treatments that understate operating performance.

The purpose is not to produce a lower earnings figure. It is to produce one that can be defended.

What buyers and sellers should do before the QoE begins

For sellers, the practical takeaway is straightforward: The financial records do not need to match perfectly, but material differences should be understood before the QoE provider finds them.

If an SBA-financed buyer is a realistic possibility, the seller and its accountant should compare annual revenue and net income across the internal financial statements, accountant-prepared statements, and filed tax returns. They should understand whether the books and tax returns use the same accounting basis, whether year-end CPA adjustments were posted back into the accounting system, and whether amended returns or changes in accounting practices affect comparability.

Buyers should perform the same high-level comparison early in diligence. A full reconciliation is not necessary before submitting an LOI, but a material difference in revenue or earnings deserves an explanation.

A statement such as “the accountant makes some adjustments at year-end” may be true, but it is not a reconciliation. The entries should be identifiable and supportable.

Most of these issues are manageable when they are discovered early. They become more disruptive when the first person to identify them is the QoE provider after the transaction is already in underwriting.

Financial records do not need to match. They need to reconcile.

Privately held businesses often have several legitimate versions of their financial history. Internal books serve management. Accountant-prepared statements incorporate year-end adjustments. Tax returns follow tax rules. IRS transcript data provides an independent verification point.

SBA's new QoE requirement recognizes that relying on any one of these sources in isolation can leave important questions unanswered.

The practical lesson is not that different numbers indicate a bad business. It is that material differences need to be understood before those earnings are used to finance an acquisition.

Part 1 of this series addressed whether the underlying cash activity supports the company's reported financial performance. Part 2 addresses the next question: Whether the financial records themselves can be reconciled into a consistent and supportable view of historical earnings.

Once that foundation is established, the next question is what should be adjusted to arrive at normalized earnings.

That will be Part 3.