Profit is an opinion. Cash is a fact. Some of the biggest wealth destroyers on Indian exchanges reported years of strong growth right up to the quarter they collapsed. The early warning was rarely in the headline. It sat in the receivables line, in the cash flow statement, and in the auditor's notes that nobody read.
Earnings quality analysis is the habit of checking whether reported profit is turning into cash, and whether reported revenue is the kind that repeats. It takes 20 minutes per company once you know where to look. Here is the order I walk through the numbers.
- RevenueReceivable days, receivables against sales, customer concentration, related party sales.
- CashCash from operations against profit, over three years.
- AccrualsInventory build, other income, exceptional items.
- AuditorOpinion, Key Audit Matters, CARO remarks, auditor changes.
- DecideAny flag you cannot explain is a reason to skip.
Revenue quality: is the growth real?
Not all revenue is equal. High quality revenue is collected in cash, repeats every year, comes from many customers and grows on its own. Low quality revenue is pushed into distribution channels at quarter end, comes from one large order, depends on two customers, or is booked before the work is done.
| Grade | What it looks like |
|---|---|
| High quality | Low and stable receivable days, recurring or contracted revenue, no customer above about 10% of sales, organic growth, steady gross margin |
| Watch carefully | Receivables growing faster than sales, one large order in the year, 2 or 3 customers dominating, growth from acquisitions, gross margin under pressure while sales rise |
| Red flag | Growth far ahead of every peer, negative operating cash flow with reported profit, revenue from related parties, sales reversed in the next quarter, revenue heavily bunched in the last month of the year |
Since 1 April 2018, listed Indian companies on Ind AS book revenue under Ind AS 115, a five step model: identify the contract, identify each promise in it, set the price, split the price across the promises, and book revenue when each promise is met. The standard is sound. The judgement inside it is where quality varies. Long contracts booked on percentage of completion, bundled products, and variable pricing all need estimates, and estimates can be leaned on.
MCA, Indian Accounting Standards (Ind AS 115, Ind AS 116)The DSO test
Rough Indian ranges: above 90 days for a consumer business or above 120 days for a business to business company deserves a closer look. The level matters less than the direction. DSO rising year after year while revenue grows is the classic sign of channel stuffing or aggressive booking.
The balance sheet now makes this easier. Since the Schedule III amendment that applies from 1 April 2021, companies disclose an ageing table for trade receivables: how much is under 6 months old, 6 months to a year, 1 to 2 years, 2 to 3 years and older, with disputed amounts shown separately. Read that table every year. Money that has sat unpaid for over a year is often money that will not come.
MCA, Schedule III amendment notified 24 Mar 2021Earnings quality: does profit become cash?
The most basic test is cash flow from operations (CFO) against profit after tax (PAT). In a healthy business CFO roughly equals or exceeds PAT over a run of years, because depreciation is a non cash charge and working capital should not grow faster than the business. One weak year can be timing. Three weak years is a pattern.
This is one of the oldest and most studied ideas in accounting research. Richard Sloan showed in 1996 that companies with high accruals tended to see earnings fall back and their stocks underperform, while companies with low accruals did better. The market was reading the profit line and ignoring how much of it was cash. That lesson has held up in many markets since. Messod Beneish later built the M score, which combines receivables growth, margin changes, accruals and other ratios into a single probability of earnings manipulation. You do not need the formula to use the idea: profit that runs ahead of cash for years is a warning.
Over five years Company X reported ₹800 crore of cumulative profit but only ₹250 crore of cumulative operating cash flow. Company Y reported ₹680 crore of profit and ₹745 crore of operating cash flow.
Illustrative companies, ₹ crore. Not real data.
Worked example: two companies, same headline
Two illustrative companies, round numbers, not real businesses. Both report revenue of ₹2,000 crore this year. Both look like good growth stories.
| Illustrative, ₹ crore | Company X | Company Y |
|---|---|---|
| Revenue, last year to this year | 1,600 to 2,000 (+25%) | 1,739 to 2,000 (+15%) |
| Trade receivables, last year to this year | 300 to 550 (+83%) | 220 to 250 (+14%) |
| DSO | 68 days to 100 days | 46 days to 46 days |
| PAT | 200 | 180 |
| CFO | 40 | 200 |
| CFO ÷ PAT | 0.20 | 1.11 |
| Accrual ratio, average assets ₹1,700 crore | 9.4% | −1.2% |
Company X grew faster and earned more. It also collected almost none of that extra profit. Receivables grew 3.3 times as fast as sales and DSO jumped by 32 days. Of ₹200 crore profit, ₹160 crore is still an IOU. Company Y grew slower, earned less, and turned every rupee of profit into cash. If the market pays the same multiple for both, it is paying for X's paper profit. That is the gap earnings quality analysis is built to find.
Key earnings quality metrics
| Signal | Comfortable | Yellow flag | Red flag |
|---|---|---|---|
| CFO ÷ PAT, 3 year total | Above 0.8 | 0.5 to 0.8 | Below 0.5 for 2 years or more |
| Receivables growth vs revenue growth | Same or slower | Up to 1.5 times | More than 1.5 times |
| DSO change in a year | Stable or falling | Up 5 to 10 days | Up more than 10 days |
| Accrual ratio | Below 5% | 5% to 10% | Above 10% |
| Inventory days | Within 5 days of last year | Up 5 to 15 days | Up more than 15 days with flat sales |
| Related party revenue | Below 5% of sales | 5% to 15% | Above 20% |
| Other income and exceptional gains | Small share of PAT | 10% to 25% of PAT | Above 25% of PAT, repeating |
These are my working thresholds, not regulatory ones. Sector context changes them. A capital goods maker with long projects will always carry higher receivables than a consumer company paid in cash. Compare a company with its own history and its closest peers first.
Two more lines to read on the profit and loss statement. Other income: interest, dividends, gains on investments. Fine in small amounts, worrying when it props up a falling operating profit. And exceptional items: one off gains that seem to appear every year are not one off. Strip both out and see what the core business earned.
Watch for a lease effect too. Since Ind AS 116 applied from 1 April 2019, most lease rent is shown as depreciation and interest rather than as an operating expense. EBITDA rose for retailers, airlines and anyone with many rented sites without a rupee of extra cash. When you compare EBITDA margins across years that straddle 2019, adjust for it.
- Ind AS 115 for revenue
Five step model for booking revenue from contracts.
- Key Audit Matters in listed company audits
Auditors name the areas of highest audit risk (SA 701).
- Ind AS 116 for leases
Rent moves below EBITDA as depreciation and interest.
- Schedule III ageing tables
Receivables and payables shown by age, disputed amounts separate.
- CARO 2020 auditor remarks
Auditors report on loans to related parties, defaults and more.
MCA notifications for Ind AS and Schedule III; ICAI for SA 701 and CARO 2020.
The Indian promoter concentration risk
Promoters held 50% of the market value of NSE listed companies at the end of March 2026, according to NSE's India Ownership Tracker. In the Nifty 50 the figure was 40.8%. Concentrated ownership aligns the promoter with the business, and it also creates specific earnings quality risks that minority shareholders need to check.
- Related party transactions at non market prices. Purchases from a promoter owned supplier, rent to a promoter family property, royalty to a promoter holding company, loans to group entities. Each can move profit out of the listed company.
- Value extracted through pay rather than dividends. Salary, commission and consulting fees reach the promoter family. Dividends reach every shareholder.
- Pledged shares. When promoters borrow against their shares, a falling price can trigger margin calls and forced selling. Promoters must disclose each pledge within 7 working days under the SEBI takeover regulations, and since a SEBI circular of 7 Aug 2019 they must also give reasons once the encumbered shares reach 50% of their holding or 20% of the company's share capital. The quarterly shareholding pattern on NSE and BSE shows the pledged percentage.
Promoter share of NSE listed market value
NSE Ownership Tracker, Mar 2026
Promoter share in the Nifty 50
NSE Ownership Tracker, Mar 2026
Private Indian promoters, a 27 quarter low
NSE Ownership Tracker, Mar 2026
Module 9.5 goes deeper on governance. For earnings quality the point is simple: if a meaningful share of revenue or costs flows through promoter entities, the reported margin is partly a decision, not a market outcome.
Common mistakes
Myth: rising profit means the business is doing well. Profit can rise because customers are paying slower, inventory is being built, or a gain was booked. Check that cash from operations rose with it. If it did not, ask why before you believe the profit.
MythProfit is rising, so the business is doing well.
FactProfit can rise on slower collections, inventory build or one off gains. If cash from operations did not rise with it, the profit is partly an IOU.
- Judging one year. Working capital swings make single year CFO noisy. Use a 3 year total of CFO against a 3 year total of PAT.
- Using the company's own highlighted ratios. Investor presentations often show adjusted EBITDA and adjusted cash flow. Calculate CFO ÷ PAT yourself from the cash flow statement.
- Ignoring the receivables ageing table. A stable DSO can hide a growing pile of debts older than a year.
- Treating lenders like manufacturers. For banks and NBFCs, CFO is dominated by loan growth and means little. Use asset quality, credit costs and provisioning instead.
- Skipping the auditor's report. Key Audit Matters and the CARO annexure often name the exact line that needs checking. Module 9.6 shows how to read them.
The RupeeCase strategies are rule based momentum models on NSE index universes, so a stock enters on its price trend, not on its cash conversion. What earnings quality protects you from is the slow kind of blow up that price trends catch late. That is why every strategy page shows the universe, the rebalance rhythm and the exit rule up front: a name that falls out of the top ranks is sold at the next rebalance. Forensic screens like CFO ÷ PAT and DSO trend belong to the analysis and research module RupeeCase will open to qualified investors and institutions. Browse the rules on the strategies page and try the ratio tools in learn tools.
Questions readers ask
Is a CFO to PAT ratio above 1 always good?
Usually, but check why. A company can push CFO up for a year by delaying payments to suppliers, which shows as a jump in trade payables. Look at payable days next to receivable days. If CFO is high because suppliers are funding the business, that can reverse quickly.
Where do I find the receivables ageing table?
In the notes to the balance sheet in the annual report, under trade receivables. Since the Schedule III amendment that applies from 1 April 2021, it splits receivables by age and shows disputed amounts separately. Annual reports are filed with NSE and BSE and are free to download.
Does high other income mean something is wrong?
Not by itself. A cash rich company earns interest on its treasury and that is fine. The concern is when other income is a large and rising share of PAT while operating profit is flat or falling. Then the core business is weaker than the bottom line says.