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
Illinois Tool Works Inc., 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 | 16,077) | 15,612) | 15,068) | 14,870) | 16,780) | |
| Less: Cash and equivalents | 1,527) | 2,564) | 1,981) | 1,504) | 3,094) | |
| Operating assets | 14,550) | 13,048) | 13,087) | 13,366) | 13,686) | |
| Operating Liabilities | ||||||
| Total liabilities | 12,451) | 12,430) | 12,038) | 11,612) | 12,191) | |
| Less: Short-term debt | 778) | 350) | 4) | 1,351) | 850) | |
| Less: Long-term debt | 6,909) | 7,772) | 7,754) | 6,029) | 7,478) | |
| Operating liabilities | 4,764) | 4,308) | 4,280) | 4,232) | 3,863) | |
| Net operating assets1 | 9,786) | 8,740) | 8,807) | 9,134) | 9,823) | |
| Balance-sheet-based aggregate accruals2 | 1,046) | (67) | (327) | (689) | —) | |
| Financial Ratio | ||||||
| Balance-sheet-based accruals ratio3 | 11.29% | -0.76% | -3.65% | -7.27% | — | |
| 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
= 14,550 – 4,764 = 9,786
2 2021 Calculation
Balance-sheet-based aggregate accruals = Net operating assets2021 – Net operating assets2020
= 9,786 – 8,740 = 1,046
3 2021 Calculation
Balance-sheet-based accruals ratio = 100 × Balance-sheet-based aggregate accruals ÷ Avg. net operating assets
= 100 × 1,046 ÷ [(9,786 + 8,740) ÷ 2] = 11.29%
4 Click competitor name to see calculations.
An analysis of the balance-sheet-based accruals from 2018 to 2021 reveals a significant transition in the company's financial reporting quality. The period is characterized by a consistent movement from negative aggregate accruals toward a positive position, indicating a fundamental shift in the relationship between reported accounting earnings and cash flows.
- Net Operating Assets Trend
- Net operating assets exhibited relative stability between 2018 and 2020, decreasing slightly from 9,134 million to 8,740 million. A notable increase occurred in 2021, where assets rose to 9,786 million, representing the highest value within the four-year period.
- Aggregate Accruals Movement
- Balance-sheet-based aggregate accruals showed a steady upward trajectory. Beginning at -689 million in 2018, the figures moved to -327 million in 2019 and -67 million in 2020, before shifting to a positive 1,046 million in 2021. This transition suggests that while cash flows exceeded reported earnings in the initial years, accounting earnings exceeded cash flows by the end of the period.
- Accruals Ratio Analysis
- The balance-sheet-based accruals ratio mirrors the progression of aggregate accruals, rising from -7.27% in 2018 to 11.29% in 2021. The negative ratios recorded from 2018 through 2020 are typically associated with high earnings quality, as accruals were offsetting cash flows. The reversal to a positive 11.29% in 2021 indicates a pivot toward higher accrual-based reporting, which increases the gap between reported profits and actual cash generation relative to the net operating asset base.
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Cash-Flow-Statement-Based Accruals Ratio
Illinois Tool Works Inc., 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 | 2,694) | 2,109) | 2,521) | 2,563) | 1,687) | |
| Less: Net cash provided by operating activities | 2,557) | 2,807) | 2,995) | 2,811) | 2,402) | |
| Less: Net cash used for investing activities | (984) | (214) | (183) | (325) | (251) | |
| Cash-flow-statement-based aggregate accruals | 1,121) | (484) | (291) | 77) | (464) | |
| Financial Ratio | ||||||
| Cash-flow-statement-based accruals ratio1 | 12.10% | -5.52% | -3.24% | 0.81% | — | |
| 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 × 1,121 ÷ [(9,786 + 8,740) ÷ 2] = 12.10%
2 Click competitor name to see calculations.
The analysis of accruals from 2018 to 2021 reveals a significant shift in the relationship between reported accounting earnings and actual cash flows. The trend transitions from a near-neutral position to a period of negative accruals, culminating in a sharp increase in positive accruals by the end of the period.
- Net Operating Assets Trend
- Net operating assets remained relatively stable between 2018 and 2020, experiencing a slight decline from 9,134 million US dollars to 8,740 million US dollars. However, a notable increase occurred in 2021, with assets rising to 9,786 million US dollars, representing a growth of approximately 12% over the previous year.
- Cash-Flow-Statement-Based Aggregate Accruals
- Aggregate accruals exhibited substantial volatility. After starting at 77 million US dollars in 2018, accruals turned negative in 2019 (-291 million US dollars) and further declined in 2020 to -484 million US dollars. This trend reversed sharply in 2021, with aggregate accruals surging to 1,121 million US dollars.
- Accruals Ratio and Earnings Quality
- The cash-flow-statement-based accruals ratio mirrors the volatility of aggregate accruals. The ratio moved from 0.81% in 2018 to -3.24% in 2019 and -5.52% in 2020. Negative accruals during this period typically indicate conservative accounting or cash flows that exceed reported earnings. In 2021, the ratio shifted dramatically to 12.10%, the highest level in the observed period. This sudden increase suggests that a larger portion of the reported earnings in 2021 was comprised of non-cash accruals relative to the size of the operating asset base.
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