Financial Reporting Quality: Aggregate Accruals
Earnings can be decomposed into cash and accrual components. The accrual component (aggregate accruals) has been found to have less persistence than the cash component, and therefore (1) earnings with higher accrual component are less persistent than earnings with smaller accrual component, all else equal; and (2) the cash component of earnings should receive a higher weighting evaluating company performance.
Balance-Sheet-Based Accruals Ratio
Align Technology Inc., balance sheet computation of aggregate accruals
US$ in thousands
| Dec 31, 2022 | Dec 31, 2021 | Dec 31, 2020 | Dec 31, 2019 | Dec 31, 2018 | ||
|---|---|---|---|---|---|---|
| Operating Assets | ||||||
| Total assets | 5,947,947) | 5,942,110) | 4,829,683) | 2,500,702) | 2,052,458) | |
| Less: Cash and cash equivalents | 942,050) | 1,099,370) | 960,843) | 550,425) | 636,899) | |
| Less: Marketable securities, short-term | 57,534) | 71,972) | —) | 318,202) | 98,460) | |
| Operating assets | 4,948,363) | 4,770,768) | 3,868,840) | 1,632,075) | 1,317,099) | |
| Operating Liabilities | ||||||
| Total liabilities | 2,346,589) | 2,319,396) | 1,595,818) | 1,154,533) | 799,567) | |
| Operating liabilities | 2,346,589) | 2,319,396) | 1,595,818) | 1,154,533) | 799,567) | |
| Net operating assets1 | 2,601,774) | 2,451,372) | 2,273,022) | 477,542) | 517,532) | |
| Balance-sheet-based aggregate accruals2 | 150,402) | 178,350) | 1,795,480) | (39,990) | —) | |
| Financial Ratio | ||||||
| Balance-sheet-based accruals ratio3 | 5.95% | 7.55% | 130.55% | -8.04% | — | |
| Benchmarks | ||||||
| Balance-Sheet-Based Accruals Ratio, Competitors4 | ||||||
| Abbott Laboratories | -0.73% | — | — | — | — | |
| Elevance Health Inc. | 0.32% | — | — | — | — | |
| Intuitive Surgical Inc. | -10.21% | — | — | — | — | |
| Medtronic PLC | -1.37% | — | — | — | — | |
| UnitedHealth Group Inc. | 17.32% | — | — | — | — | |
| Balance-Sheet-Based Accruals Ratio, Sector | ||||||
| Health Care Equipment & Services | 6.46% | 200.00% | — | — | — | |
| Balance-Sheet-Based Accruals Ratio, Industry | ||||||
| Health Care | 5.30% | 200.00% | — | — | — | |
Based on: 10-K (reporting date: 2022-12-31), 10-K (reporting date: 2021-12-31), 10-K (reporting date: 2020-12-31), 10-K (reporting date: 2019-12-31), 10-K (reporting date: 2018-12-31).
1 2022 Calculation
Net operating assets = Operating assets – Operating liabilities
= 4,948,363 – 2,346,589 = 2,601,774
2 2022 Calculation
Balance-sheet-based aggregate accruals = Net operating assets2022 – Net operating assets2021
= 2,601,774 – 2,451,372 = 150,402
3 2022 Calculation
Balance-sheet-based accruals ratio = 100 × Balance-sheet-based aggregate accruals ÷ Avg. net operating assets
= 100 × 150,402 ÷ [(2,601,774 + 2,451,372) ÷ 2] = 5.95%
4 Click competitor name to see calculations.
An analysis of the financial reporting quality indicates a period of significant volatility in aggregate accruals, followed by a trend toward stabilization. Net operating assets experienced substantial growth over the four-year period, increasing from 477,542 thousand US dollars in 2019 to 2,601,774 thousand US dollars by the end of 2022, with the most pronounced expansion occurring between 2019 and 2020.
- Balance-sheet-based Aggregate Accruals
- Accruals exhibited extreme fluctuation, transitioning from a negative value of 39,990 thousand US dollars in 2019 to a peak of 1,795,480 thousand US dollars in 2020. Following this surge, accruals declined sharply to 178,350 thousand US dollars in 2021 and further decreased to 150,402 thousand US dollars in 2022, suggesting a significant correction or shift in accounting dynamics after the 2020 spike.
- Balance-sheet-based Accruals Ratio
- The accruals ratio reflects this volatility, moving from -8.04% in 2019 to an exceptional high of 130.55% in 2020. This spike indicates a period where accruals grew disproportionately relative to net operating assets. However, a subsequent downward trend is observed, with the ratio normalizing to 7.55% in 2021 and 5.95% in 2022.
- Earnings Quality Implications
- The convergence of the accruals ratio toward lower, positive percentages from 2020 through 2022 suggests an improvement in the quality of reported earnings. The reduction in the ratio implies that a smaller portion of the balance sheet growth is attributable to non-cash accruals, aligning reported figures more closely with underlying operating assets.
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Cash-Flow-Statement-Based Accruals Ratio
Align Technology Inc., cash flow statement computation of aggregate accruals
US$ in thousands
| Dec 31, 2022 | Dec 31, 2021 | Dec 31, 2020 | Dec 31, 2019 | Dec 31, 2018 | ||
|---|---|---|---|---|---|---|
| Net income | 361,573) | 772,020) | 1,775,888) | 442,776) | 400,235) | |
| Less: Net cash provided by operating activities | 568,732) | 1,172,544) | 662,174) | 747,270) | 554,681) | |
| Less: Net cash (used in) provided by investing activities | (213,316) | (563,430) | (231,506) | (350,444) | 6,927) | |
| Cash-flow-statement-based aggregate accruals | 6,157) | 162,906) | 1,345,220) | 45,950) | (161,373) | |
| Financial Ratio | ||||||
| Cash-flow-statement-based accruals ratio1 | 0.24% | 6.90% | 97.81% | 9.24% | — | |
| Benchmarks | ||||||
| Cash-Flow-Statement-Based Accruals Ratio, Competitors2 | ||||||
| Abbott Laboratories | -2.08% | — | — | — | — | |
| Elevance Health Inc. | 8.35% | — | — | — | — | |
| Intuitive Surgical Inc. | -20.88% | — | — | — | — | |
| Medtronic PLC | -0.97% | — | — | — | — | |
| UnitedHealth Group Inc. | 21.73% | — | — | — | — | |
| Cash-Flow-Statement-Based Accruals Ratio, Sector | ||||||
| Health Care Equipment & Services | 8.70% | 11.34% | — | — | — | |
| Cash-Flow-Statement-Based Accruals Ratio, Industry | ||||||
| Health Care | 4.25% | 14.62% | — | — | — | |
Based on: 10-K (reporting date: 2022-12-31), 10-K (reporting date: 2021-12-31), 10-K (reporting date: 2020-12-31), 10-K (reporting date: 2019-12-31), 10-K (reporting date: 2018-12-31).
1 2022 Calculation
Cash-flow-statement-based accruals ratio = 100 × Cash-flow-statement-based aggregate accruals ÷ Avg. net operating assets
= 100 × 6,157 ÷ [(2,601,774 + 2,451,372) ÷ 2] = 0.24%
2 Click competitor name to see calculations.
The analysis of financial reporting quality reveals a period of significant volatility in accruals between 2019 and 2022, characterized by a substantial spike in 2020 followed by a rapid convergence of earnings and cash flows.
- Net Operating Assets Trend
- A significant expansion in net operating assets is observed, increasing from 477.5 million in 2019 to 2.6 billion by 2022. The most pronounced growth occurred between 2019 and 2020, where assets increased nearly fivefold, suggesting a major scaling of operations or a strategic shift in asset management during that period.
- Aggregate Accruals Volatility
- Cash-flow-statement-based aggregate accruals exhibited extreme fluctuation. After starting at 45.9 million in 2019, accruals surged to 1.3 billion in 2020. This peak was followed by a sharp contraction to 162.9 million in 2021 and a further decline to 6.2 million in 2022, indicating that the discrepancy between accounting earnings and cash flows was largely temporary.
- Accruals Ratio and Earnings Quality
- The cash-flow-statement-based accruals ratio mirrors the volatility of aggregate accruals, peaking at 97.81% in 2020. Such a high ratio typically suggests that a substantial portion of reported earnings was not supported by operating cash flows, which can be an indicator of lower earnings quality or aggressive accounting accruals. However, the subsequent decline to 6.90% in 2021 and nearly zero (0.24%) in 2022 demonstrates a strong correction. This downward trend indicates that current earnings are almost entirely backed by cash, signifying a marked improvement in the quality of financial reporting and a reduction in accrual-based earnings distortions.
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