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
3M Co., balance sheet computation of aggregate accruals
US$ in millions
| Dec 31, 2021 | Dec 31, 2020 | Dec 31, 2019 | Dec 31, 2018 | Dec 31, 2017 | ||
|---|---|---|---|---|---|---|
| Operating Assets | ||||||
| Total assets | 47,072) | 47,344) | 44,659) | 36,500) | 37,987) | |
| Less: Cash and cash equivalents | 4,564) | 4,634) | 2,353) | 2,853) | 3,053) | |
| Less: Marketable securities, current | 201) | 404) | 98) | 380) | 1,076) | |
| Operating assets | 42,307) | 42,306) | 42,208) | 33,267) | 33,858) | |
| Operating Liabilities | ||||||
| Total liabilities | 31,955) | 34,413) | 34,533) | 26,652) | 26,365) | |
| Less: Short-term borrowings and current portion of long-term debt | 1,307) | 806) | 2,795) | 1,211) | 1,853) | |
| Less: Current obligations of finance leases | 7) | 22) | 21) | 17) | 13) | |
| Less: Long-term debt, excluding current portion | 16,056) | 17,989) | 17,518) | 13,411) | 12,096) | |
| Less: Finance leases, net of current obligations | 93) | 93) | 111) | 75) | 60) | |
| Operating liabilities | 14,492) | 15,503) | 14,088) | 11,938) | 12,343) | |
| Net operating assets1 | 27,815) | 26,803) | 28,120) | 21,329) | 21,515) | |
| Balance-sheet-based aggregate accruals2 | 1,012) | (1,317) | 6,791) | (186) | —) | |
| Financial Ratio | ||||||
| Balance-sheet-based accruals ratio3 | 3.71% | -4.80% | 27.47% | -0.87% | — | |
| Benchmarks | ||||||
| Balance-Sheet-Based Accruals Ratio, Competitors4 | ||||||
| Boeing Co. | — | — | — | — | — | |
| Caterpillar Inc. | — | — | — | — | — | |
| Eaton Corp. plc | — | — | — | — | — | |
| GE Aerospace | — | — | — | — | — | |
| Honeywell International Inc. | — | — | — | — | — | |
| Lockheed Martin Corp. | — | — | — | — | — | |
| RTX Corp. | — | — | — | — | — | |
| Balance-Sheet-Based Accruals Ratio, Sector | ||||||
| Capital Goods | 200.00% | — | — | — | — | |
| Balance-Sheet-Based Accruals Ratio, Industry | ||||||
| Industrials | 200.00% | — | — | — | — | |
Based on: 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), 10-K (reporting date: 2017-12-31).
1 2021 Calculation
Net operating assets = Operating assets – Operating liabilities
= 42,307 – 14,492 = 27,815
2 2021 Calculation
Balance-sheet-based aggregate accruals = Net operating assets2021 – Net operating assets2020
= 27,815 – 26,803 = 1,012
3 2021 Calculation
Balance-sheet-based accruals ratio = 100 × Balance-sheet-based aggregate accruals ÷ Avg. net operating assets
= 100 × 1,012 ÷ [(27,815 + 26,803) ÷ 2] = 3.71%
4 Click competitor name to see calculations.
The analysis of balance-sheet-based accruals reveals significant volatility in financial reporting quality between 2018 and 2021, characterized by a notable divergence in 2019.
- Net Operating Assets Trend
- Net operating assets experienced a sharp increase from US$ 21,329 million in 2018 to US$ 28,120 million in 2019. Following this peak, the balance remained relatively stable, fluctuating slightly to US$ 26,803 million in 2020 and US$ 27,815 million in 2021.
- Aggregate Accruals Volatility
- Balance-sheet-based aggregate accruals exhibited extreme variance over the observed period. A modest negative value of US$ -186 million in 2018 transitioned to a substantial positive value of US$ 6,791 million in 2019. This was followed by a reversal to US$ -1,317 million in 2020 and a return to positive territory at US$ 1,012 million in 2021.
- Accruals Ratio Analysis
- The accruals ratio underscores a significant anomaly in 2019, where the ratio peaked at 27.47%. This indicates a substantial gap between reported accounting earnings and cash flow for that fiscal year. Conversely, the ratios for 2018 (-0.87%), 2020 (-4.80%), and 2021 (3.71%) remained relatively low, suggesting a closer alignment between accrual-based earnings and cash-based reality during those periods.
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Cash-Flow-Statement-Based Accruals Ratio
3M Co., cash flow statement computation of aggregate accruals
US$ in millions
| Dec 31, 2021 | Dec 31, 2020 | Dec 31, 2019 | Dec 31, 2018 | Dec 31, 2017 | ||
|---|---|---|---|---|---|---|
| Net income attributable to 3M | 5,921) | 5,384) | 4,570) | 5,349) | 4,858) | |
| Less: Net cash provided by operating activities | 7,454) | 8,113) | 7,070) | 6,439) | 6,240) | |
| Less: Net cash (used in) provided by investing activities | (1,317) | (580) | (6,444) | 222) | (3,086) | |
| Cash-flow-statement-based aggregate accruals | (216) | (2,149) | 3,944) | (1,312) | 1,704) | |
| Financial Ratio | ||||||
| Cash-flow-statement-based accruals ratio1 | -0.79% | -7.83% | 15.95% | -6.12% | — | |
| Benchmarks | ||||||
| Cash-Flow-Statement-Based Accruals Ratio, Competitors2 | ||||||
| Boeing Co. | — | — | — | — | — | |
| Caterpillar Inc. | — | — | — | — | — | |
| Eaton Corp. plc | — | — | — | — | — | |
| GE Aerospace | — | — | — | — | — | |
| Honeywell International Inc. | — | — | — | — | — | |
| Lockheed Martin Corp. | — | — | — | — | — | |
| RTX Corp. | — | — | — | — | — | |
| Cash-Flow-Statement-Based Accruals Ratio, Sector | ||||||
| Capital Goods | -27.73% | — | — | — | — | |
| Cash-Flow-Statement-Based Accruals Ratio, Industry | ||||||
| Industrials | -17.51% | — | — | — | — | |
Based on: 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), 10-K (reporting date: 2017-12-31).
1 2021 Calculation
Cash-flow-statement-based accruals ratio = 100 × Cash-flow-statement-based aggregate accruals ÷ Avg. net operating assets
= 100 × -216 ÷ [(27,815 + 26,803) ÷ 2] = -0.79%
2 Click competitor name to see calculations.
The analysis of financial reporting quality between 2018 and 2021 reveals significant volatility in the relationship between earnings and cash flows. The accruals ratio exhibits a fluctuating pattern, shifting from negative values to a substantial peak in 2019 before returning to near-zero and negative territory in subsequent periods.
- Net Operating Assets Trend
- Net operating assets grew from 21,329 million US dollars in 2018 to 28,120 million US dollars in 2019. Following this increase, the balance stabilized, recording 26,803 million US dollars in 2020 and 27,815 million US dollars in 2021, indicating a consistent asset base for the latter three years of the period.
- Cash-Flow-Statement-Based Accruals
- Aggregate accruals demonstrated sharp oscillations. A negative accrual of -1,312 million US dollars in 2018 was followed by a significant reversal to 3,944 million US dollars in 2019. This was followed by a return to negative figures, reaching -2,149 million US dollars in 2020 and -216 million US dollars in 2021.
- Accruals Ratio and Earnings Quality
- The accruals ratio moved from -6.12% in 2018 to a peak of 15.95% in 2019, representing a period where earnings significantly exceeded cash flows. This trend reversed in 2020, with the ratio dropping to -7.83%, suggesting that cash flows surpassed accrual-based earnings. By 2021, the ratio converged toward zero at -0.79%, indicating a high degree of alignment between reported earnings and cash flow generation.
The transition from a high positive accruals ratio in 2019 back to negative and near-neutral values in 2020 and 2021 suggests a normalization of financial reporting quality. The prevalence of negative ratios in three of the four analyzed years indicates that cash flows generally exceeded accrual-based earnings, which is typically associated with higher earnings quality.
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