Quality of Earnings Ratio
The quality of earnings ratio is cash flow from operations divided by net income. At or above 1.0, the business collects its reported profit in cash, which is what buyers and lenders want to see. Well below 1.0, profit is accumulating in receivables or inventory rather than the bank, and the earnings deserve skepticism. It's a one-line screen analysts run before deciding how hard to dig into the underlying accounting.
Example: a brand reports $400,000 of net income while its cash flow statement shows $150,000 from operations, a ratio of 0.38. That doesn't prove anything is wrong, but it demands an explanation. For ecommerce the innocent answer is often inventory: a growing seller plows profit into stock, and the cash shows up when the stock sells through. The bad answers include channel-stuffed revenue, under-accrued refunds, or COGS that's simply understated.
Sustained low ratios are what turn a routine quality of earnings review adversarial, because the reviewer now has a reason to rebuild everything. Sellers with clean accrual books and a coherent inventory story can explain a 0.6 in one meeting; sellers with deposit-based books cannot. The ratio only exists if your books produce a real cash flow statement monthly, which is part of what a proper monthly close delivers.
Where this shows up in our work
This isn’t textbook material for us; it’s the day-to-day of keeping seller books right. See how we handle it in practice:
Monthly Ecommerce Bookkeeping→Related terms