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
Cummins Inc., balance sheet computation of aggregate accruals
US$ in millions
| Dec 31, 2023 | Dec 31, 2022 | Dec 31, 2021 | Dec 31, 2020 | Dec 31, 2019 | ||
|---|---|---|---|---|---|---|
| Operating Assets | ||||||
| Total assets | 32,005) | 30,299) | 23,710) | 22,624) | 19,737) | |
| Less: Cash and cash equivalents | 2,179) | 2,101) | 2,592) | 3,401) | 1,129) | |
| Less: Marketable securities | 562) | 472) | 595) | 461) | 341) | |
| Operating assets | 29,264) | 27,726) | 20,523) | 18,762) | 18,267) | |
| Operating Liabilities | ||||||
| Total liabilities | 22,101) | 20,074) | 14,309) | 13,635) | 11,272) | |
| Less: Loans payable | 280) | 210) | 208) | 169) | 100) | |
| Less: Commercial paper | 1,496) | 2,574) | 313) | 323) | 660) | |
| Less: Current maturities of long-term debt | 118) | 573) | 59) | 62) | 31) | |
| Less: Long-term debt | 4,802) | 4,498) | 3,579) | 3,610) | 1,576) | |
| Operating liabilities | 15,405) | 12,219) | 10,150) | 9,471) | 8,905) | |
| Net operating assets1 | 13,859) | 15,507) | 10,373) | 9,291) | 9,362) | |
| Balance-sheet-based aggregate accruals2 | (1,648) | 5,134) | 1,082) | (71) | —) | |
| Financial Ratio | ||||||
| Balance-sheet-based accruals ratio3 | -11.22% | 39.68% | 11.00% | -0.76% | — | |
| Benchmarks | ||||||
| Balance-Sheet-Based Accruals Ratio, Competitors4 | ||||||
| Boeing Co. | -22.39% | -12.09% | — | — | — | |
| Caterpillar Inc. | 9.40% | 1.82% | — | — | — | |
| Eaton Corp. plc | 2.18% | 2.87% | — | — | — | |
| GE Aerospace | -50.58% | -7.82% | — | — | — | |
| Honeywell International Inc. | 7.21% | -1.99% | — | — | — | |
| Lockheed Martin Corp. | 2.60% | 15.67% | — | — | — | |
| RTX Corp. | -1.23% | 1.57% | — | — | — | |
| Balance-Sheet-Based Accruals Ratio, Sector | ||||||
| Capital Goods | -5.90% | -0.33% | 200.00% | — | — | |
| Balance-Sheet-Based Accruals Ratio, Industry | ||||||
| Industrials | -0.83% | 0.67% | 200.00% | — | — | |
Based on: 10-K (reporting date: 2023-12-31), 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).
1 2023 Calculation
Net operating assets = Operating assets – Operating liabilities
= 29,264 – 15,405 = 13,859
2 2023 Calculation
Balance-sheet-based aggregate accruals = Net operating assets2023 – Net operating assets2022
= 13,859 – 15,507 = -1,648
3 2023 Calculation
Balance-sheet-based accruals ratio = 100 × Balance-sheet-based aggregate accruals ÷ Avg. net operating assets
= 100 × -1,648 ÷ [(13,859 + 15,507) ÷ 2] = -11.22%
4 Click competitor name to see calculations.
The financial data reveals significant volatility in the balance-sheet-based accruals and the corresponding accruals ratio between 2020 and 2023. While net operating assets experienced a general expansion and subsequent slight contraction, the aggregate accruals exhibited a sharp peak in 2022 followed by a substantial reversal in 2023.
- Net Operating Assets Trend
- Net operating assets grew steadily from US$ 9,291 million in 2020 to US$ 10,373 million in 2021, reaching a peak of US$ 15,507 million in 2022. A moderate decrease followed in 2023, with the balance settling at US$ 13,859 million.
- Balance-Sheet-Based Aggregate Accruals
- Aggregate accruals shifted from a near-zero negative position of US$ -71 million in 2020 to a positive US$ 1,082 million in 2021. A sharp increase occurred in 2022, where accruals reached US$ 5,134 million, before reversing sharply to a negative US$ 1,648 million by the end of 2023.
- Balance-Sheet-Based Accruals Ratio
- The accruals ratio demonstrates a highly non-linear trajectory. Starting at -0.76% in 2020, the ratio climbed to 11.00% in 2021 and peaked at 39.68% in 2022. This peak suggests a period where reported earnings were significantly higher than cash flows from operations. However, the ratio dropped to -11.22% in 2023, indicating that cash flows exceeded reported earnings during the final period of analysis.
The progression from a high positive accruals ratio in 2022 to a negative ratio in 2023 indicates a significant correction in financial reporting quality or a substantial shift in working capital dynamics. The volatility observed suggests that the 2022 earnings were heavily driven by non-cash accruals, which were subsequently reversed or offset by cash realizations in 2023.
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Cash-Flow-Statement-Based Accruals Ratio
Cummins Inc., cash flow statement computation of aggregate accruals
US$ in millions
| Dec 31, 2023 | Dec 31, 2022 | Dec 31, 2021 | Dec 31, 2020 | Dec 31, 2019 | ||
|---|---|---|---|---|---|---|
| Net income attributable to Cummins Inc. | 735) | 2,151) | 2,131) | 1,789) | 2,260) | |
| Less: Net cash provided by operating activities | 3,966) | 1,962) | 2,256) | 2,722) | 3,181) | |
| Less: Net cash used in investing activities | (1,643) | (4,172) | (873) | (719) | (1,150) | |
| Cash-flow-statement-based aggregate accruals | (1,588) | 4,361) | 748) | (214) | 229) | |
| Financial Ratio | ||||||
| Cash-flow-statement-based accruals ratio1 | -10.82% | 33.70% | 7.61% | -2.29% | — | |
| Benchmarks | ||||||
| Cash-Flow-Statement-Based Accruals Ratio, Competitors2 | ||||||
| Boeing Co. | -26.69% | -50.32% | — | — | — | |
| Caterpillar Inc. | 6.90% | 3.26% | — | — | — | |
| Eaton Corp. plc | 8.52% | 4.55% | — | — | — | |
| GE Aerospace | -8.42% | -15.92% | — | — | — | |
| Honeywell International Inc. | 5.80% | -0.79% | — | — | — | |
| Lockheed Martin Corp. | 3.08% | -1.36% | — | — | — | |
| RTX Corp. | -1.66% | 0.87% | — | — | — | |
| Cash-Flow-Statement-Based Accruals Ratio, Sector | ||||||
| Capital Goods | -0.94% | -5.98% | -27.73% | — | — | |
| Cash-Flow-Statement-Based Accruals Ratio, Industry | ||||||
| Industrials | 1.66% | -2.30% | -17.51% | — | — | |
Based on: 10-K (reporting date: 2023-12-31), 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).
1 2023 Calculation
Cash-flow-statement-based accruals ratio = 100 × Cash-flow-statement-based aggregate accruals ÷ Avg. net operating assets
= 100 × -1,588 ÷ [(13,859 + 15,507) ÷ 2] = -10.82%
2 Click competitor name to see calculations.
The analysis of cash-flow-statement-based accruals reveals significant volatility in financial reporting quality between 2020 and 2023, characterized by a sharp peak in 2022 followed by a substantial reversal in 2023.
- Net Operating Assets Trend
- Net operating assets experienced a period of expansion, rising from 9,291 million US$ in 2020 to a peak of 15,507 million US$ in 2022. A subsequent contraction occurred in 2023, with the balance decreasing to 13,859 million US$.
- Aggregate Accruals Analysis
- Cash-flow-statement-based aggregate accruals demonstrated extreme fluctuations. After starting at -214 million US$ in 2020, they climbed to 748 million US$ in 2021 and spiked to 4,361 million US$ in 2022. This trend reversed sharply in 2023, with accruals falling to -1,588 million US$, signaling a shift where cash flow significantly exceeded accrual-based earnings.
- Accruals Ratio Interpretation
- The accruals ratio mirrored the volatility of the aggregate accruals, moving from -2.29% in 2020 to a high of 33.70% in 2022. This peak indicates a period of lower earnings quality, as a substantial portion of the reported earnings was not supported by cash flows. The subsequent decline to -10.82% in 2023 represents a correction, suggesting that the earnings quality improved as the gap between accruals and cash flows closed and inverted.
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