Discuss the general factors that influence the quality of a company’s reported earnings

and its balance sheet.

When a person is considering the quality of a firm’s earnings, some key factors should be kept in mind.
First, the earning is high quality if it tends to be to be cash earnings and if a greater proportion of those
earnings is derived from regularly recurring transactions.
-One of the factors that influence the quality of a company’s reported earnings is the accounting method
used in recognizing revenue and expense- accrual basis of accounting or cash basis of accounting.
The cash basis of accounting recognizes revenues when cash is received and recognizes expenses when
cash is paid out. The accrual basis of accounting recognizes revenues when earned (a product is sold or a
service has been performed), regardless of when cash is received. Expenses are recognized as incurred,
whether or not cash has been paid out. The accounting method used by the company greatly affects the
quality of its reported earnings. Under accrual basis of accounting, revenue is recognized when it is
earned regardless of when cash is received, thus a company may report high earnings for a certain period
while having low cash available. In financial analysis, the earning is considered high quality if it tends to
be cash earnings. Another factor that affects the quality of earnings reported is the nature of the earnings-
whether it’s from regular recurring transactions or not. If a major part of company’s earnings is from gain
on sale of its building when its regular recurring transaction or ordinary trade or business is sale of
livestock, such decreases the quality of the reported earnings. A firm’s earnings can be viewed as high
quality if a greater proportion of those earnings is derived from regularly recurring transactions.

- Some factors affecting the quality of firms Balance Sheet are the quality of assets and the presence of
hidden liabilities. If the market value of the assets is greater or equal to its book value, this enhances the
quality of the Balance Sheet. If significant amount of assets in the company’s Balance Sheet has market
value lower than its book value, this reduces its quality. If the firm has significant amount of non-moving
inventory, although this contributes to a greater amount of asset, this reduces the quality of the Balance
Sheet until it is sold or used in the production because the presence of non-moving inventories may mean
that the item is not marketable. Hidden liabilities should also be considered in determining the quality of
Balance Sheet. These liabilities may take the form of obligations not appearing on the company’s balance
sheet or uninsured losses arising from pending lawsuits. The quality of the firms Balance Sheet decreases
in proportion to the increase in hidden liabilities.

In making financial analysis, the factors mentioned should be considered in order to come up with sound
financial decisions.