Rising net income is not always a good sign. If cash does not follow, earnings may be "manufactured" through accounting choices rather than earned in the market. Accounting accruals let you measure this risk — and avoid it.
May 2026
9 min read
Advanced level
What is an accrual?
Accrual accounting records revenue when it is earned (sale completed) and expenses when they are incurred — not when the cash changes hands. The gap between accounting profit and actual cash flow is called accruals.
Simplified formula: Accruals = Net income − Operating cash flow
High positive accruals mean that net income is well above the cash actually generated. This is a sign that accounting estimates (revenue recognition, provisions, depreciation) are artificially inflating reported earnings.
Sloan's study (1996): Richard Sloan showed that companies with high accruals significantly underperform the market over the following 12 months. This seminal academic work gave rise to the "earnings quality" factor used by many quantitative funds.
Accruals ratio calculator
Earnings quality calculator
1,700 k€
Accruals
3.4%
Accruals ratio
62.2%
Net income → cash conversion
Acceptable earnings quality — moderate accruals.
Concrete warning signs
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Net income rising, FCF falling: the most direct signal. If cash does not confirm profit, earnings are probably of poor quality.
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Trade receivables growing faster than revenue: the company is recognising revenue not yet collected. There is a risk of future provisions if these receivables become uncollectible.
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Inflated inventories: overproducing to absorb fixed costs and improve the short-term accounting margin. Unsold inventory will have to be written down.
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Change in accounting policy: a longer depreciation period, a change in revenue-recognition policy. Look for the justification in the notes to the accounts.
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Unusually low provisions: provisions for doubtful debts, warranties or restructuring that are abnormally low compared with prior years and sector practice.
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Widening gap between "adjusted" earnings and IFRS/local-GAAP earnings: adjustments are legitimate occasionally, but when systematic they can mask a less flattering reality.
The Beneish model — 8 manipulation signals
The Beneish M-Score (1999) is an academic tool that combines 8 ratios to compute a probability of accounting manipulation. The 8 variables:
DSRI
Days Sales Receivables Index
Abnormal growth in trade receivables vs revenue — a sign of premature revenue recognition.
GMI
Gross Margin Index
Deterioration in gross margin — pressure on competitiveness.
AQI
Asset Quality Index
Growth in non-amortisable intangible assets — capitalisation of expenses.
SGI
Sales Growth Index
Strong revenue growth — fast-growing companies have more accounting latitude.
DEPI
Depreciation Index
Slowing pace of depreciation — a lengthening of asset useful lives.
SGAI
SG&A Expense Index
Disproportionate rise in general and selling expenses.
LVGI
Leverage Index
Rising financial leverage — pressure to keep up appearances.
TATA
Total Accruals to Assets
Overall level of accruals — a direct measure of earnings quality.
An M-Score above −1.78 indicates a high risk of manipulation. This model is one screening tool among others — not a final verdict. It should trigger an in-depth analysis, not an automatic decision to sell.
Applying it to small caps: on Euronext Growth, the data needed to compute the full M-Score is sometimes incomplete. Focus on the most accessible signals: the accruals ratio, the net income / FCF divergence, and growth in trade receivables.
Earnings quality built into the ML model
Screener Small Caps analyses net income → FCF conversion among its features to detect poor-quality earnings across the Euronext Growth universe.
The gap between accounting profit and actual cash flow. Accrual accounting recognises revenue and expenses when they are earned or incurred, not when cash is received. Accruals are the part of earnings not yet converted into cash.
Accruals ratio = (Net income − Operating cash flow) / Average total assets. A ratio > 5-8% is a warning sign. Negative = a positive signal (cash exceeds accounting earnings).
They indicate that earnings rest on accounting estimates rather than on real cash. Sloan's study (1996) demonstrates that companies with high accruals significantly underperform the market the following year.
Net income rising / FCF falling, trade receivables growing faster than revenue, inflated inventories, an unexplained change in accounting policy, abnormally low provisions, a widening gap between "adjusted" and statutory earnings.
Specific risk factors: less formalised internal controls, a founder-CEO with strong influence over accounting choices, pressure to report positive results. There is no absolute rule, but vigilance is more necessary than for large caps audited by the Big Four and followed by many analysts.