Accruals
How large the gap between book profit and actual cash is relative to assets — a quality metric for whether profit has been inflated.
In plain terms
The profit a company books (net income) and the cash that actually came into its account (operating cash flow) can differ. That difference is called "accruals."
The accruals ratio looks at how large that difference is relative to the company's assets. The larger the difference, the more "book profit was recognized ahead of cash."
What it tells you
It is a metric for the quality of earnings. Small accruals (profit equals cash) means healthy earnings; large accruals raises suspicion that profit has been inflated.
It comes from accounting research (Sloan, 1996) showing that companies whose book profit ran well ahead of cash tend to have disappointing earnings afterward.
Formula
accruals ratio = (net income − operating cash flow) ÷ total assets
What high or low means
Generally, 10% of total assets or below is read as fine, larger than that as worth watching.
It is a rule of thumb that when the gap between book profit and cash exceeds 10% of assets, you question the quality of earnings once more.
Large accruals can have normal reasons too. A fast-growing company sees receivables and inventory rise together, so accruals naturally grow. So you cannot conclude from one year's number alone.
Read the trend rather than one year, and look at it together with other cash metrics like FCF conversion to see the real quality of earnings.
It is hard to apply to overseas (IFRS) companies on different accounting standards, so it is used mainly for US-GAAP companies.
In 2001 the large US company Enron looked like a blue-chip firm posting enormous book profits. But much of that profit was not actual cash — it was "book numbers" inflated by accounting devices.
When the reality came out, Enron went bankrupt almost overnight, and Arthur Andersen, one of the world's five largest accounting firms auditing it, lost client trust and collapsed alongside it. It showed why a metric like accruals — checking "whether book profit is backed by cash" — matters: even when the numbers look good, if cash does not follow, you should be suspicious.
Metrics to read alongside
See it in real stocks
Search US stocks on Stocklore to see Accruals and other financial metrics alongside the sector average.
This explanation is for information and reference only and is not a recommendation to buy or sell any security. Investment decisions and their consequences are your own.