Profit against cash: accruals and earnings quality
Super Micro Computer doubled its profit to 2.2 billion dollars while burning 6.8 billion of operating cash. Measure the accruals, find what's behind them, and judge what they say about the earnings.
FinanceReading the accounts like an analystAbout 11 min: 11 readingUpdated
General education, not financial advice.
- Measure accruals by the cash flow method and by Sloan's balance-sheet method
- Explain why earnings made mostly of accruals tend to persist less
- Judge whether high accruals come from growth, from risk or from accounting choices
Builds toward: Judge a company. Read a company's accounts, apply Graham's tests, and make a rough valuation.
Reading the accounts like an analyst: lesson 7 of 10
- Reading the accounts like an analyst
- The three statements and how they link 10 min
- Common-size statements and trends 9 min
- Profitability ratios: margins, ROA and ROE 9 min
- Efficiency ratios and the cash conversion cycle 9 min
- DuPont analysis: where ROE comes from 10 min
- Reading the cash flow statement like an analyst 9 min
- Profit against cash: accruals and earnings quality 11 min
- When is a sale a sale? Revenue timing and channel stuffing 10 min
- The expense side: capitalised costs, reserves and big baths 8 min
- The Beneish M-score: a screen for manipulation, and its limits 10 min
Pairs with Richard G. Sloan, "Do Stock Prices Fully Reflect Information in Accruals and Cash Flows about Future Earnings?", The Accounting Review 71(3), 1996, pp. 289–315; any financial statement analysis text (the chapter on earnings quality)
Mission
From: the head of a fund's investment committee Due: Monday's meeting, one page
Super Micro Computer's profit more than doubled last year, to 2.2 billion dollars, yet its operations used 6.8 billion of cash. Before we discuss it, I want an earnings-quality note: how large are the accruals, what's behind them, and how much weight should we put on that profit? Use the 10-K for the year to 30 June 2026 (filed 31 August 2026).
The documents (Super Micro Computer, Inc., Form 10-K for the year to 30 June 2026; millions of dollars):
| Income and cash flow | 2025 | 2026 |
|---|---|---|
| Net sales | 21,972 | 39,063 |
| Gross margin | 11.1% | 10.8% |
| Operating income | 1,253 | 2,770 |
| Net income | 1,049 | 2,230 |
| Operating cash flow | 1,660 | (6,810) |
| Financing cash flow | 2,024 | 9,479 |
| Balance sheet, 30 June | 2025 | 2026 |
|---|---|---|
| Cash | 5,170 | 7,521 |
| Receivables | 2,204 | 6,125 |
| Inventories | 4,680 | 12,896 |
| Total current assets | 12,302 | 27,726 |
| Accounts payable | 1,282 | 2,247 |
| Income taxes payable | 53 | 263 |
| Lines of credit and loans, current | 75 | 2,040 |
| Deferred revenue, current | 369 | 1,578 |
| Total current liabilities | 2,345 | 7,160 |
| Total assets | 14,018 | 29,945 |
Total assets on 30 June 2024: 9,826. Depreciation and amortisation in 2026: 53.7.
From the MD&A and notes:
- Cost of sales rose mainly with shipments of "GPU servers, HPC systems, and rack-scale solutions"; tariff expenses rose 228%, while inventory write-down adjustments fell 19% (to 188, from 232) "resulting from increased sales related to some of our aged inventory products"; the industry "experienced supply constraints for certain components, including memory and storage, as well as GPU and CPU availability".
- Gross margin fell "primarily due to our strategy to offer competitive pricing to gain market share, change in product and customer mix, and higher manufacturing related expenses".
- Financing in 2026 included 3,948 of net borrowing on lines of credit and term loans and 5,639 from equity offerings.
From the company's filings: in 2020 it reached a consent settlement with the SEC over its financial accounting and disclosures for fiscal 2014–2017, paying a 17.5 million dollar penalty (Form 8-K, 25 August 2020). In October 2024 its previous auditor resigned during the audit of the 2024 accounts, citing concerns that included governance, transparency and internal control (Form 8-K, 30 October 2024); the 2024 10-K was filed in February 2025, with a new auditor.
What it is
The toolkit for this job.
Accruals are the part of profit that isn't (yet) cash: sales booked but not collected, stock bought but not sold, costs not yet paid, minus non-cash costs such as depreciation.
Two ways to measure them:
- Cash flow method: accruals = net income − operating cash flow.
- Sloan's balance-sheet method (Sloan, 1996, equation 1): accruals = (ΔCA − ΔCash) − (ΔCL − ΔSTD − ΔTP) − Dep, where Δ means the change over the year in current assets (CA), cash, current liabilities (CL), debt in current liabilities (STD) and income taxes payable (TP), and Dep is depreciation and amortisation. Debt is taken out because it's financing, not operating.
Both are divided by average total assets so companies of different size can be compared: the accrual ratio.
What the research found. Sloan studied 40,679 firm-years of US companies from 1962 to 1991. Sloan found that how well current earnings persist into the future depends on the split between cash and accruals: the accrual part persists less. And share prices behaved as if investors "fixate" on total earnings, not reflecting the difference until it showed up in later earnings. Later studies found that balance-sheet accruals are measured with error, especially around acquisitions and disposals (Hribar and Collins, 2002), which is why the cash flow method is now more common. Researchers still debate how much of the price effect remains today.
High accruals have three kinds of cause:
- growth: a fast-growing company builds stock and receivables before it collects;
- risk: stock that may not sell at cost, customers who may not pay;
- accounting choices: revenue booked early, costs deferred, reserves released.
The ratio can't tell you which. The notes, the MD&A and the trend can.
Before you start
List your first three checks on Super Micro's figures, and what result from each would change your reading. Then compare them with the expert's.
Why it matters
Profit is the figure most investors look at first, and much executive pay is linked to it. But profit built on accruals is an estimate of future cash: if the stock sells and the customers pay, it turns into cash; if not, it turns into write-downs. A high accrual ratio is one of the simplest warning lights in the accounts. It isn't a verdict, and growth companies often have one, but it tells an analyst exactly where to look.
Worked example
An imaginary company, Fenwick (millions): net income 120; operating cash flow 40; average total assets 1,000.
- Accruals (cash flow method) = 120 − 40 = 80; accrual ratio = 80 ÷ 1,000 = 8%.
- Of every 3 of profit, 2 is accruals and only 1 arrived as cash.
If Fenwick's sales grew 5% while receivables grew 40%, the accruals point to collection, or to revenue booked early. If sales grew 60% with stock and receivables growing in line, they point to growth, and the question becomes whether the stock and the customers are sound.
Common mistake
Calling high accruals "manipulation". Most high-accrual companies are growing or investing in working capital. The accrual ratio is a reason to read the notes, not a finding. The opposite mistake is just as common: treating low or negative accruals as proof of quality without asking why cash ran ahead of profit (suppliers paying later, customers paying in advance).
Key terms
- accruals
- the part of earnings that isn't cash in the period: net income minus operating cash flow, or Sloan's balance-sheet measure
- accrual ratio
- accruals ÷ average total assets
- earnings persistence
- how far this year's earnings carry into future years
- earnings quality
- how well reported earnings reflect sustainable, cash-backed performance
- inventory write-down
- reducing stock to what it can be sold for, when that's below cost
Practise the key terms
Tap a card to turn it over. 5 cards.
| Front | Back |
|---|---|
| accruals | the part of earnings that isn't cash in the period: net income minus operating cash flow, or Sloan's balance-sheet measure |
| accrual ratio | accruals ÷ average total assets |
| earnings persistence | how far this year's earnings carry into future years |
| earnings quality | how well reported earnings reflect sustainable, cash-backed performance |
| inventory write-down | reducing stock to what it can be sold for, when that's below cost |
Task
Write the one-page earnings-quality note for the committee:
- the accrual ratio for 2025 and 2026 by the cash flow method, and for 2026 by Sloan's method;
- what is behind the 2026 accruals, with the figures;
- which of the three causes (growth, risk, accounting choices) the evidence supports, and what it can't rule out;
- how much weight to put on 2026 profit, and what would change your view.
Model answer
Show the model answer
Workings.
- Average total assets: 2025 (9,826 + 14,018) ÷ 2 = 11,922; 2026 (14,018 + 29,945) ÷ 2 = 21,982.
- Cash flow method: 2025 (1,049 − 1,660) ÷ 11,922 = −5.1%; 2026 (2,230 + 6,810) ÷ 21,982 = 9,040 ÷ 21,982 = 41.1%.
- Sloan's method, 2026: ΔCA 15,425 − ΔCash 2,352 = 13,073; ΔCL 4,815 − ΔSTD 1,965 − ΔTP 209 = 2,641; accruals = 13,073 − 2,641 − 54 = 10,378, or 47.2% of average assets.
- Behind them: inventories +8,216 (days of stock at year end about 135 against 87, on cost of sales of 34,836 and 19,542); receivables +3,922 (about 57 days of sales against 37); partly offset by payables +965 and deferred revenue +1,209.
Super Micro: a profit that hasn't turned into cash · Source: Form 10-K, year to 30 June 2026
The 2026 profit holds only if customers pay the 6.1 billion they owe and the 12.9 billion of stock is worth at least what it cost; until then it deserves less weight than the same profit backed by cash. Accruals were 41% of average assets (47% on Sloan's measure), against −5% a year earlier. Nearly all of it is working capital: inventories grew 8.2 billion to 12.9 billion (about 135 days of cost of sales, up from 87) and receivables 3.9 billion (57 days of sales, up from 37), partly offset by more deferred revenue (up 1.2 billion: amounts customers paid before delivery or service). The business funded the gap with 3.9 billion of borrowing and 5.6 billion from issuing common and convertible preferred shares.
Which cause? Growth explains much of it: sales rose 78% and the MD&A describes component shortages that make building ahead rational. But the evidence also shows risk: stock grew far faster than sales (176% against 78%), and gross margin is thin and falling (10.8%), leaving little room if prices drop; write-downs fell this year, which is the figure to watch next. Nothing in the figures shows an accounting choice such as early revenue, but the previous auditor's stated concerns when it resigned in 2024 (governance, transparency and internal control) are a reason to hold the evidence to a higher standard, not a finding in themselves.
What would change my view: operating cash turning strongly positive as the stock ships, with inventory days falling back towards 90; receivable days steady as sales grow; no rise in write-downs. The opposite (more stock, slower collection, larger write-downs) would mean the 2026 profit was overstated by events.
How the expert gets there. Their first three checks: (1) the size of the accruals on both measures, against last year; (2) which balance-sheet lines carry them, in days not just money; (3) whether the notes and history point to growth, risk or choices. They give credit where the evidence supports it (growth, deferred revenue) and say plainly what it can't rule out.
What a reviewer would flag:
- "Accruals of 41% mean fraud": the figures don't show that, and saying so is unfounded.
- Ignoring the auditor history, or leaning on it as proof.
- Forgetting that 5.6 billion of share issues and 3.9 billion of borrowing paid for the cash burn.
- Using Sloan's method without taking current debt out of current liabilities.
Practice
Transfer: a second server maker. Dell Technologies sells many of the same AI servers. In the year to 30 January 2026 (Form 10-K filed 16 March 2026) its revenue grew 19% to 113.5 billion, net income was 5.9 billion and operating cash flow 11.2 billion: accruals of about −6% of average assets. A colleague says: "Dell's earnings quality is clearly far better than Super Micro's." Open Dell's balance sheet and cash flow statement. In three sentences: do you agree, and what would change your mind?
A model answer
Better, but for a reason that can reverse. Dell built stock and receivables too (inventories up 3.7 billion to 10.4 billion, receivables up 7.3 billion to 17.6 billion), but a larger rise in payables more than covered it: accounts payable rose 12.8 billion to 33.6 billion, taking payable days from about 102 to 135 days of cost of sales (longer terms or purchase timing near the year end; Dell also discloses 2.0 billion of supplier finance obligations). So its negative accruals come largely from payables, which can turn round if growth slows or suppliers tighten terms. What would change my mind: payable days holding steady while receivables and stock are collected and sold, or payables falling back without operating cash dropping below profit.
How the expert gets there: negative accruals get the same question as positive ones: which line did it?
What a reviewer would flag: reading a negative accrual ratio as automatically good; missing the supplier finance disclosure.
The other view
Some researchers argue that the accrual effect in share prices has weakened or disappeared since Sloan's paper became widely known (for example Green, Hand and Soliman, 2011), and others that part of it reflects growth and risk rather than investors misreading accounts. The measurement point stands either way: accruals tell you how much of a profit still has to turn into cash.
In short
- Accruals are the part of profit that isn't cash yet: net income − operating cash flow.
- Divide by average total assets to get the accrual ratio.
- Sloan (1996): earnings made of accruals persist less, and prices didn't fully reflect it.
- High accruals can mean growth, risk or accounting choices: the notes decide which.
- Negative accruals need the same question: which line produced the cash?
Check yourself
Answer in your head first, then open the answer. Nothing is saved.
Net income 300, operating cash flow 120, average total assets 2,000. What is the accrual ratio?
Show answer
(300 − 120) ÷ 2,000 = 9%.
Why does Sloan's balance-sheet measure take short-term debt out of the change in current liabilities?
Show answer
Because borrowing is a financing transaction, not part of operating profit; leaving it in would make new short-term loans look like operating cash.
A company's accruals are high because inventory tripled. What evidence would point to growth rather than risk?
Show answer
Sales growing in line with the stock, stable or falling inventory days after a lag, steady write-downs, and orders or deferred revenue backing the build.
Further reading
- Richard G. Sloan, "Do Stock Prices Fully Reflect Information in Accruals and Cash Flows about Future Earnings?", The Accounting Review 71(3), 1996, pp. 289–315.
- Paul Hribar and Daniel W. Collins, "Errors in Estimating Accruals: Implications for Empirical Research", Journal of Accounting Research 40(1), 2002, pp. 105–134.
- Jeremiah Green, John R. M. Hand and Mark T. Soliman, "Going, Going, Gone? The Apparent Demise of the Accruals Anomaly", Management Science 57(5), 2011, pp. 797–816.
- Super Micro Computer, Inc., Form 10-K for the year ended 30 June 2026, and Form 8-K filed 30 October 2024 (SEC EDGAR); Dell Technologies Inc., Form 10-K for the year ended 30 January 2026.
- On this site: Reading the cash flow statement like an analyst.
Finished? Mark it done to fill in your leaf on the Finance map.