Should you judge a company’s performance by its earnings or cash flow? Cash flows are highly volatile and seasonal, while earnings are far smoother. That’s why accrual accounting – recording transactions when they occur, regardless of when money changes hands – can produce a clearer picture of financial performance.

However, some recent studies have concluded that the timing role of accruals has largely disappeared. In new research published in the Journal of Accounting and Economics, INSEAD Assistant Professor of Accounting and Control Martin Kapons and David Veenman from the University of Amsterdam suggest that this conclusion isn’t warranted when looking at quarterly data.

Why it matters

Despite a recent proposal by the United States Securities and Exchange Commission to eliminate mandatory quarterly reporting, it remains standard practice in the US. Quarterly cash flows can be highly seasonal – retailers may experience a sharp dip in the quarter before the holiday season as they build inventory, followed by a spike in the next quarter thanks to peak-season sales.

Seasonal cash flows can therefore be poor indicators of future performance. Accruals act as a stabiliser by producing an earnings figure that is less volatile, which can make them more useful for investors, analysts and management to analyse firm performance.

The study

The researchers analysed financial statements from US-listed firms between 1989 and 2024, supplemented with similar data from international firms. Using primarily regression models, they examined the timing role of accruals and investigated why its effect has seemed to decline when looking at annual financial statements.

The takeaway

The researchers found that accruals enable earnings to better capture performance by playing a critical role in smoothing quarterly cash flow swings. This effect is not observable in annual measurements.

The findings also reveal that seasonal cash flow volatility has declined substantially in the US over recent decades. The reason? Structural shifts in how firms do business – including greater international diversification, a shrinking and less seasonal retail sector and the rise of zero-inventory business models. Notably, this trend did not extend to international markets.

In short, the role of accruals has evolved rather than disappeared. Even as cash flows have become less lumpy, accruals still matter for a more accurate reading and interpretation of performance. The findings also speak to the ongoing debate on reporting frequency. Annual data obscures economically meaningful variation in working capital dynamics that’s plainly visible in quarterly data – something worth keeping in mind as the policy discussion continues.