Recently, an attempt was made to assess earnings quality by connecting the dots between pre-tax income (accounting income) and taxable income, the argument being it would be unusual for a company to report high net earnings while showing little or no tax liability. There are three main advantages to using taxable income as a benchmark. First, taxable income is less subject to falsification than cash flow from operations, which is directly affected by transfers of receivables, accelerated accounts receivable collection, and delays in the settlement of payables. In addition, the taxable income figure reflects management's optimism because it is lower than accounting income. Management hesitates to artificially inflate taxable income, unlike earnings and cash flow. Finally, the measurement of taxable income is not as flexible as for accounting income. As a result, taxable income is less likely to be manipulated by management and an unusual gap between accounting and taxable income may indicate financial statement manipulation or aggressive tax behaviour.

Benchmarks
Earnings
Qualitative evaluation