Earnings Quality – MCQ

Practice Question

Intro to Financial Accounting
Reporting and Interpreting Financial Information
Earnings Quality Assessment
MCQs

If a company has a lower quality of earnings ratio compared to its competitors, what does it imply?

  1. The company is generating more consistent earnings.
  2. The company relies more on accruals than cash flow, indicating lower reliability.
  3. The company is more profitable than its competitors.
  4. The company has higher cash reserves.
Answer +
Correct Answer: B
Explanation +

A lower quality of earnings ratio means the company's reported earnings rely more heavily on non-cash accounting entries (accruals), rather than actual cash inflows. This reduces the reliability and sustainability of the reported income.

Investors may view this as a red flag, as cash-based earnings are typically considered more stable and transparent. Competitors with higher ratios likely have more earnings supported by cash flow.