📘 1. Quality of Financial Reports
✅ What It Means:
The quality of financial reports refers to how accurately and transparently a company’s financial statements reflect its actual economic performance and financial position.
🔍 Key Characteristics of High-Quality Financial Reporting:
| Attribute | Description |
|---|---|
| Accuracy | Numbers reflect reality, not manipulation. |
| Completeness | No key info is missing (off-balance sheet items, hidden risks). |
| Transparency | Assumptions, estimates, and judgments are disclosed. |
| Consistency | Same accounting methods applied over time. |
| Compliance | Follows applicable accounting standards (IFRS/GAAP). |
🧠 High-quality financial reports = a clear window into a company’s real financial health.
💰 2. Earnings Quality
✅ What It Means:
Earnings quality refers to how sustainable, repeatable, and reliable a company’s reported net income is.
In simple terms:
“Are these profits real, and will they likely continue?”
🧮 High Earnings Quality:
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Generated from core, ongoing operations (e.g., product sales)
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Supported by strong cash flow
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Not heavily reliant on accounting tricks or one-time gains
🚨 Low Earnings Quality:
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Inflated by:
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Aggressive revenue recognition
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Unusual or one-time items (e.g., asset sales, tax benefits)
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Earnings management via accruals or smoothing
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Poor alignment between net income and cash flow from operations
🔗 Relationship Between the Two
| Concept | Focus | Question it Answers |
|---|---|---|
| Financial Reporting Quality | Reporting practices | “Is this information trustworthy?” |
| Earnings Quality | Sustainability of profits | “Are these profits real and repeatable?” |
A company might follow the rules (high reporting quality) but still manage earnings within those rules (low earnings quality).
✅ Analyst Tip:
To assess these qualities, look at:
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Cash Flow vs. Net Income
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Non-recurring items (watch for spikes)
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Accounting choices (e.g., depreciation methods, provisions)
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Footnote disclosures
