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Investor Update

Thursday, July 9, 2026

Extreme Accounting Numbers Deserve a Closer Look

By Charles Rotblut, CFA

Earnings persistency is one of the stock characteristics that our A+ Investor Quality Grade takes into consideration. Specifically, the Quality Grade looks at how reliant a company is on accruals to boost its earnings. This reliance matters because it indicates whether a company has a greater risk of writing down earnings in the future.

Accrual accounting recognizes transactions when their economic benefits become probable. This practice makes corporate earnings easier to forecast since they aren't dependent on how quickly or slowly customers pay their invoices. It would be very difficult to forecast earnings for a specific period if corporations used cash accounting.

Risks arise when current earnings are more attributable to accruals than to cash flow. When earnings exceed operating cash flow, they are less likely to persist in the future—a factor known as the “accrual anomaly.” This is because the changes in current accruals are primarily attributable to changes in accounts receivable (money owed by customers) and inventories. These two balance sheet items are subjective and require management projections about what will likely occur in the future. 

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