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
Colgate-Palmolive Co., balance sheet computation of aggregate accruals
US$ in millions
| Dec 31, 2022 | Dec 31, 2021 | Dec 31, 2020 | Dec 31, 2019 | Dec 31, 2018 | ||
|---|---|---|---|---|---|---|
| Operating Assets | ||||||
| Total assets | 15,731) | 15,040) | 15,920) | 15,034) | 12,161) | |
| Less: Cash and cash equivalents | 775) | 832) | 888) | 883) | 726) | |
| Operating assets | 14,956) | 14,208) | 15,032) | 14,151) | 11,435) | |
| Operating Liabilities | ||||||
| Total liabilities | 14,925) | 14,069) | 14,819) | 14,476) | 11,964) | |
| Less: Notes and loans payable | 11) | 39) | 258) | 260) | 12) | |
| Less: Current portion of long-term debt | 14) | 12) | 9) | 254) | —) | |
| Less: Long-term debt, excluding current portion | 8,741) | 7,194) | 7,334) | 7,333) | 6,354) | |
| Operating liabilities | 6,159) | 6,824) | 7,218) | 6,629) | 5,598) | |
| Net operating assets1 | 8,797) | 7,384) | 7,814) | 7,522) | 5,837) | |
| Balance-sheet-based aggregate accruals2 | 1,413) | (430) | 292) | 1,685) | —) | |
| Financial Ratio | ||||||
| Balance-sheet-based accruals ratio3 | 17.46% | -5.66% | 3.81% | 25.23% | — | |
| Benchmarks | ||||||
| Balance-Sheet-Based Accruals Ratio, Competitors4 | ||||||
| Procter & Gamble Co. | 3.98% | — | — | — | — | |
| Balance-Sheet-Based Accruals Ratio, Industry | ||||||
| Consumer Staples | 7.61% | 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
= 14,956 – 6,159 = 8,797
2 2022 Calculation
Balance-sheet-based aggregate accruals = Net operating assets2022 – Net operating assets2021
= 8,797 – 7,384 = 1,413
3 2022 Calculation
Balance-sheet-based accruals ratio = 100 × Balance-sheet-based aggregate accruals ÷ Avg. net operating assets
= 100 × 1,413 ÷ [(8,797 + 7,384) ÷ 2] = 17.46%
4 Click competitor name to see calculations.
An analysis of the balance-sheet-based accruals ratio reveals significant volatility in financial reporting quality metrics between 2019 and 2022. The period is characterized by a sharp contraction in aggregate accruals followed by a substantial reversal in the final year.
- Net Operating Assets Trend
- Net operating assets remained relatively stable between 2019 and 2021, fluctuating between 7,384 million and 7,814 million. A notable expansion occurred in 2022, with assets increasing to 8,797 million, representing a significant rise from the previous year's levels.
- Aggregate Accruals Volatility
- Balance-sheet-based aggregate accruals demonstrated extreme variance. After starting at 1,685 million in 2019, values declined sharply to 292 million in 2020 and transitioned into negative territory at -430 million in 2021. This trend reversed abruptly in 2022, with accruals climbing back to 1,413 million.
- Accruals Ratio Interpretation
- The accruals ratio followed a mirrored path to the aggregate accruals, dropping from 25.23% in 2019 to a low of -5.66% in 2021. The transition to a negative ratio in 2021 suggests a period where cash flows exceeded accrual-based earnings, typically indicative of higher earnings quality. However, the subsequent spike to 17.46% in 2022 indicates a renewed increase in the non-cash components of reported earnings relative to net operating assets.
The overall trajectory indicates that after a three-year period of decreasing accruals and improving cash-to-earnings alignment, the 2022 fiscal year saw a return to a higher reliance on accruals, coinciding with the expansion of net operating assets.
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Cash-Flow-Statement-Based Accruals Ratio
Colgate-Palmolive Co., cash flow statement computation of aggregate accruals
US$ in millions
| Dec 31, 2022 | Dec 31, 2021 | Dec 31, 2020 | Dec 31, 2019 | Dec 31, 2018 | ||
|---|---|---|---|---|---|---|
| Net income attributable to Colgate-Palmolive Company | 1,785) | 2,166) | 2,695) | 2,367) | 2,400) | |
| Less: Net cash provided by operations | 2,556) | 3,325) | 3,719) | 3,133) | 3,056) | |
| Less: Net cash used in investing activities | (1,601) | (592) | (779) | (2,099) | (1,170) | |
| Cash-flow-statement-based aggregate accruals | 830) | (567) | (245) | 1,333) | 514) | |
| Financial Ratio | ||||||
| Cash-flow-statement-based accruals ratio1 | 10.26% | -7.46% | -3.20% | 19.96% | — | |
| Benchmarks | ||||||
| Cash-Flow-Statement-Based Accruals Ratio, Competitors2 | ||||||
| Procter & Gamble Co. | 3.50% | — | — | — | — | |
| Cash-Flow-Statement-Based Accruals Ratio, Industry | ||||||
| Consumer Staples | 4.81% | -9.79% | — | — | — | |
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 × 830 ÷ [(8,797 + 7,384) ÷ 2] = 10.26%
2 Click competitor name to see calculations.
The analysis of financial reporting quality between 2019 and 2022 reveals significant volatility in the relationship between net income and operating cash flows, reflected in the fluctuations of aggregate accruals and the corresponding ratio relative to net operating assets.
- Net Operating Assets Trend
- Net operating assets demonstrated a general upward trajectory over the four-year period, increasing from US$ 7,522 million in 2019 to US$ 8,797 million in 2022. A brief contraction was observed in 2021, where assets declined to US$ 7,384 million, followed by a substantial increase of approximately 19.5% in 2022.
- Aggregate Accruals Performance
- Cash-flow-statement-based aggregate accruals exhibited high variability. A positive balance of US$ 1,333 million in 2019 shifted to negative values in 2020 (US$ -245 million) and 2021 (US$ -567 million), before returning to a positive US$ 830 million in 2022. The negative values in 2020 and 2021 indicate periods where cash flows from operations exceeded reported net income.
- Accruals Ratio and Earnings Quality
- The accruals ratio followed a similar pattern of volatility, starting at 19.96% in 2019 and descending to -3.20% in 2020 and -7.46% in 2021. The ratio then rebounded to 10.26% in 2022. The shift to negative ratios during 2020 and 2021 suggests a temporary increase in earnings quality, as a higher proportion of earnings were realized as cash. The return to a positive ratio in 2022 indicates that non-cash accruals once again contribute a significant portion of the net operating assets.
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