QUALITY OF EARNINGS RATIO

Description: It can be extremely difficult for an outsider, such as a stock analyst, bank officer, or investor, to determine if the earnings reported by a company are based on a foundation of solid operational earnings or if the company is taking advantage of a broad array of accounting tricks that are allowable under generally accepted accounting principles (GAAP) to artificially bolster its earnings. A simple ratio for determining the quality of reported earnings is the quality of earnings ratio. This measurement essentially compares the reported earnings level to the reported cash flow from operations. If the numbers are close, then the reported earnings number probably fairly reflects actual results.

Formula: Subtract cash from operations from net earnings, and divide the result by average total assets. The formula is: