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
Generac Holdings Inc., balance sheet computation of aggregate accruals
US$ in thousands
| Dec 31, 2021 | Dec 31, 2020 | Dec 31, 2019 | Dec 31, 2018 | Dec 31, 2017 | ||
|---|---|---|---|---|---|---|
| Operating Assets | ||||||
| Total assets | 4,877,780) | 3,235,423) | 2,665,669) | 2,426,314) | 2,019,964) | |
| Less: Cash and cash equivalents | 147,339) | 655,128) | 322,883) | 224,482) | 138,472) | |
| Operating assets | 4,730,441) | 2,580,295) | 2,342,786) | 2,201,832) | 1,881,492) | |
| Operating Liabilities | ||||||
| Total liabilities | 2,605,643) | 1,779,012) | 1,571,591) | 1,604,049) | 1,416,204) | |
| Less: Short-term borrowings | 72,035) | 39,282) | 58,714) | 45,583) | 20,602) | |
| Less: Current portion of long-term borrowings and finance lease obligations | 5,930) | 4,147) | 2,383) | 1,977) | 1,572) | |
| Less: Long-term borrowings and finance lease obligations, excluding current portion | 902,091) | 841,764) | 837,767) | 876,396) | 906,548) | |
| Operating liabilities | 1,625,587) | 893,819) | 672,727) | 680,093) | 487,482) | |
| Net operating assets1 | 3,104,854) | 1,686,476) | 1,670,059) | 1,521,739) | 1,394,010) | |
| Balance-sheet-based aggregate accruals2 | 1,418,378) | 16,417) | 148,320) | 127,729) | —) | |
| Financial Ratio | ||||||
| Balance-sheet-based accruals ratio3 | 59.21% | 0.98% | 9.29% | 8.76% | — | |
| 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
= 4,730,441 – 1,625,587 = 3,104,854
2 2021 Calculation
Balance-sheet-based aggregate accruals = Net operating assets2021 – Net operating assets2020
= 3,104,854 – 1,686,476 = 1,418,378
3 2021 Calculation
Balance-sheet-based accruals ratio = 100 × Balance-sheet-based aggregate accruals ÷ Avg. net operating assets
= 100 × 1,418,378 ÷ [(3,104,854 + 1,686,476) ÷ 2] = 59.21%
4 Click competitor name to see calculations.
An analysis of the balance-sheet-based accruals from 2018 to 2021 reveals a period of relative stability followed by a significant escalation in accruals during the final year of the period. The relationship between net operating assets and aggregate accruals indicates a substantial shift in the composition of the balance sheet and the implied quality of reported earnings.
- Net Operating Assets Trend
- Net operating assets remained relatively stable between 2018 and 2020, moving from US$ 1,521,739 thousand to US$ 1,686,476 thousand. However, a substantial increase occurred in 2021, with net operating assets rising to US$ 3,104,854 thousand, representing an increase of approximately 84% over the previous year.
- Aggregate Accruals Volatility
- Balance-sheet-based aggregate accruals exhibited significant volatility. After a slight increase from 2018 to 2019, accruals dropped sharply in 2020 to US$ 16,417 thousand. This was followed by an unprecedented surge in 2021, where aggregate accruals reached US$ 1,418,378 thousand, marking a drastic departure from the levels observed in the prior three years.
- Accruals Ratio and Earnings Quality
- The balance-sheet-based accruals ratio remained in the single digits from 2018 through 2020, reaching a low of 0.98% in 2020, which typically suggests that reported earnings were closely aligned with cash flows. In 2021, the ratio spiked to 59.21%. Such a pronounced increase in the accruals ratio indicates that a significantly larger portion of the company's assets is comprised of non-cash accruals, which may signal a decline in the quality of earnings or a massive buildup of non-cash working capital.
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Cash-Flow-Statement-Based Accruals Ratio
Generac Holdings Inc., cash flow statement computation of aggregate accruals
US$ in thousands
| Dec 31, 2021 | Dec 31, 2020 | Dec 31, 2019 | Dec 31, 2018 | Dec 31, 2017 | ||
|---|---|---|---|---|---|---|
| Net income attributable to Generac Holdings Inc. | 550,494) | 350,576) | 252,007) | 238,257) | 159,386) | |
| Less: Net cash provided by operating activities | 411,156) | 486,533) | 308,887) | 247,227) | 261,116) | |
| Less: Net cash used in investing activities | (817,287) | (124,095) | (170,078) | (108,894) | (31,922) | |
| Cash-flow-statement-based aggregate accruals | 956,625) | (11,862) | 113,198) | 99,924) | (69,808) | |
| Financial Ratio | ||||||
| Cash-flow-statement-based accruals ratio1 | 39.93% | -0.71% | 7.09% | 6.85% | — | |
| 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 × 956,625 ÷ [(3,104,854 + 1,686,476) ÷ 2] = 39.93%
2 Click competitor name to see calculations.
The financial reporting quality for Generac Holdings Inc. exhibits significant volatility between 2018 and 2021, characterized by a dramatic increase in accruals during the final year of the analyzed period.
- Net Operating Assets Evolution
- Net operating assets remained relatively stable from 2018 through 2020, increasing modestly from 1.52 billion to 1.69 billion. A substantial expansion occurred in 2021, with assets rising to 3.10 billion, representing an approximate 84% increase over the prior year.
- Accruals Ratio Stability and Reversal
- Between 2018 and 2019, the cash-flow-statement-based accruals ratio remained consistent, moving from 6.85% to 7.09%. In 2020, a reversal was observed as aggregate accruals became negative, resulting in a ratio of -0.71%. This negative value indicates a period where cash flows from operations exceeded accrual-based earnings.
- Analysis of the 2021 Surge
- A significant divergence is evident in 2021, as aggregate accruals spiked to 956.6 million. This caused the accruals ratio to jump to 39.93%. The magnitude of this increase suggests that a considerably larger portion of the company's reported earnings was derived from non-cash accruals relative to the operating asset base.
The transition from a negative ratio in 2020 to a high positive ratio in 2021 indicates a sharp shift in earnings composition. The elevated 2021 ratio suggests a potential decline in the cash-backed quality of reported financial performance compared to the preceding three years.
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