Accrual Quality

Accrual accounting records revenue and expenses when they are earned or incurred, not when cash moves. This requires estimates, such as how much customers will pay, how long assets will last and what future costs will arise. High accrual quality means these estimates turn into cash as expected.

Analysts assess accrual quality by comparing profits with operating cash flow over time, looking at changes in working capital items such as receivables and inventory, and checking how often estimates are revised.

For example, if a company reports rising profits but its operating cash flow stays flat while receivables grow rapidly, its profits rely heavily on accruals. Customers may be slow to pay, or revenue may be recognised aggressively. This suggests lower accrual quality.

Research has found that companies with large accruals relative to their assets have, on average, tended to see weaker future earnings and share returns, although this is not true in every case. Accrual quality is a key part of assessing the overall quality of earnings.