One subtraction. Forty years of evidence. The line below earnings.

Accruals are the bridge between what the income statement says you earned and what the cash flow statement says you collected. Big bridge means the gap is being financed by the customer, the warehouse, or the auditor. Sloan put a number on it in 1996.

The subtraction . Sloan 1996

Accruals = Net Profit - Cash From Operations

Working capital is where most of the gap lives. Higher receivables means revenue booked but not collected. Higher inventory means cost capitalised but not sold. Lower payables means the company stopped using supplier credit. Cash conversion ratio is the same idea flipped . CFO divided by PAT . a clean number to track quarter on quarter.

CFO over PAT . three quarter median

Zone

What it usually means

Sloan abnormal return

0.80 and above Healthy . cash matches profit

Healthy

Earnings show up in the bank. Working capital cycle stable.

Top decile outperforms

0.50 to 0.80 Watch . cycle drifting

Watch

Receivables or inventory growing faster than sales for two quarters.

Middle deciles

Below 0.50 for three quarters Concern . profit on paper

Concern

Profit on the slide. Cash on the customer's terms. Most aggressive accruals deciles.

Bottom decile underperforms

Sloan 1996 long short Low accrual minus high accrual decile

Result

US 1962 to 1991 NYSE plus AMEX. Replicated in Asness Frazzini Pedersen 2019 globally.

~10.4 pp per year

Working capital cycle days DSO plus DIO minus DPO

Flow

Days receivable plus days inventory minus days payable. A blow out is the first signal.

Read trend not level

A CFO over PAT of 0.80 plus is a clean job. Below 0.50 for three quarters running is the earliest signal that the headline is being financed somewhere off the income statement. The market mostly notices the year after Sloan said it should have noticed.

Cohort zones illustrative. CFO and PAT defined as per Ind AS 7 and Ind AS 1 / Schedule III. Sloan 1996 . The Accounting Review 71(3) 289 to 315. Asness Frazzini Pedersen 2019 . Review of Accounting Studies . Quality Minus Junk. Past performance . backtest only . not a guarantee.