Analyzing Earnings Quality - the Accruals Ratio
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- A company's accrual earnings has two components: cash earnings and aggregate accruals
Accrual Basis Earnings = Cash Earnings + Aggregate Accruals
Aggregate Accruals = Accrual Basis Earnings - Cash Earnings
- When aggregate accruals are the dominant component of a company's earnings, mean reversion tends to occur more quickly and so earnings with a high accrual component can be considered lower quality.
- Accruals Ratio - the accruals ratio is a simple measure for analyzing earnings quality. There are two approaches: the balance sheet approach and the cash flow statement approach.
- Two approaches to the Accruals Ratio:
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