Quality of revenue

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Technical notes

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October 23, 2024

Financial Statements Quality Questionnaire

General Accounting Principles

Statement	Yes	No
Financial reports conform to GAAP, are decision-useful, sustainable, and provide adequate returns (e.g. higher than the cost of capital)
No new changes to the company’s accounting policies (e.g. unusual revenue and expense recognition)
The company timely fills required financial reports

Revenue Quality

Statement	Yes	No
Revenue is highly predictable (e.g., 90% or more clients return year over year)
The business generates high profitability (e.g., gross margins over 70%)
The revenue is diverse (no single client makes up more than 15% of revenue)
The company has growth potential (Revenue and net income are growing)

Financial Report Warning Signs

Statement	Yes	No
Earnings do not have a significant accrual component
Company does not consistently report earnings that exactly meet or only narrowly beat benchmarks
Company does not recognize revenue prematurely or defer expenses or recognize fraudulent revenues
The company does not represent expenditures as assets rather than as expenses or misstate of the timing or amount of expenses
The reports have an unqualified audit opinion (the best type of audit opinion)
Goodwill is assessed for impairment and the company does not have a high allowance for doubtful accounts or loan loss reserves
The reports are conservative and do not have high related-party transactions or significant amounts of off-balance-sheet debt
The company does not have alarming differences between net income and operating cash flows and does not have many earnings from non-recurring, one-off activities
The company has recurring and persistent earnings, beats benchmarks, and has no after-the-fact confirmations of poor-quality earnings, such as enforcement actions and restatements

Choosing “Yes” makes gets one point. If all answers are “Yes” then revenue of quality is high.

References

References:

CFA Institute. (2024). CFA Program Curriculum Level I Box Set (pp. 3312-3316). Wiley. Kindle Edition.

CFA Institute. (2024). CFA Program Curriculum Level II Box Set (p. 2016-2172). Wiley. Kindle Edition.

Sawhney, M., Wolcott, R. C., & Arroniz, I. (2013, February). What high-quality revenue looks like. Harvard Business Review. Retrieved from https://hbr.org/2013/02/what-high-quality-revenue-look

Spool, A. (2023, January 26). The 4 ‘Abilities’ Of High-Quality Revenue. Forbes. Retrieved from https://www.forbes.com/councils/forbesfinancecouncil/2023/01/26/the-4-abilities-of-high-quality-revenue/

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