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
Parker-Hannifin Corp., balance sheet computation of aggregate accruals
US$ in thousands
| Jun 30, 2022 | Jun 30, 2021 | Jun 30, 2020 | Jun 30, 2019 | Jun 30, 2018 | Jun 30, 2017 | ||
|---|---|---|---|---|---|---|---|
| Operating Assets | |||||||
| Total assets | 25,943,943) | 20,341,200) | 19,738,189) | 17,576,690) | 15,320,087) | 15,489,904) | |
| Less: Cash and cash equivalents | 535,799) | 733,117) | 685,514) | 3,219,767) | 822,137) | 884,886) | |
| Less: Marketable securities and other investments | 27,862) | 39,116) | 70,805) | 150,931) | 32,995) | 39,318) | |
| Operating assets | 25,380,282) | 19,568,967) | 18,981,870) | 14,205,992) | 14,464,955) | 14,565,700) | |
| Operating Liabilities | |||||||
| Total liabilities | 17,084,023) | 11,927,530) | 13,609,660) | 11,608,538) | 9,454,594) | 10,222,558) | |
| Less: Notes payable and long-term debt payable within one year | 1,724,310) | 2,824) | 809,529) | 587,014) | 638,466) | 1,008,465) | |
| Less: Long-term debt, excluding payable within one year | 9,755,825) | 6,582,053) | 7,652,256) | 6,520,831) | 4,318,559) | 4,861,895) | |
| Operating liabilities | 5,603,888) | 5,342,653) | 5,147,875) | 4,500,693) | 4,497,569) | 4,352,198) | |
| Net operating assets1 | 19,776,394) | 14,226,314) | 13,833,995) | 9,705,299) | 9,967,386) | 10,213,502) | |
| Balance-sheet-based aggregate accruals2 | 5,550,080) | 392,319) | 4,128,696) | (262,087) | (246,116) | —) | |
| Financial Ratio | |||||||
| Balance-sheet-based accruals ratio3 | 32.64% | 2.80% | 35.08% | -2.66% | -2.44% | — | |
| Benchmarks | |||||||
| Balance-Sheet-Based Accruals Ratio, Competitors4 | |||||||
| Boeing Co. | -12.09% | — | — | — | — | — | |
| Caterpillar Inc. | 1.82% | — | — | — | — | — | |
| Eaton Corp. plc | 2.87% | — | — | — | — | — | |
| GE Aerospace | -7.82% | — | — | — | — | — | |
| Honeywell International Inc. | -1.99% | — | — | — | — | — | |
| Lockheed Martin Corp. | 15.67% | — | — | — | — | — | |
| RTX Corp. | 1.57% | — | — | — | — | — | |
| Balance-Sheet-Based Accruals Ratio, Sector | |||||||
| Capital Goods | -0.33% | 200.00% | — | — | — | — | |
| Balance-Sheet-Based Accruals Ratio, Industry | |||||||
| Industrials | 0.67% | 200.00% | — | — | — | — | |
Based on: 10-K (reporting date: 2022-06-30), 10-K (reporting date: 2021-06-30), 10-K (reporting date: 2020-06-30), 10-K (reporting date: 2019-06-30), 10-K (reporting date: 2018-06-30), 10-K (reporting date: 2017-06-30).
1 2022 Calculation
Net operating assets = Operating assets – Operating liabilities
= 25,380,282 – 5,603,888 = 19,776,394
2 2022 Calculation
Balance-sheet-based aggregate accruals = Net operating assets2022 – Net operating assets2021
= 19,776,394 – 14,226,314 = 5,550,080
3 2022 Calculation
Balance-sheet-based accruals ratio = 100 × Balance-sheet-based aggregate accruals ÷ Avg. net operating assets
= 100 × 5,550,080 ÷ [(19,776,394 + 14,226,314) ÷ 2] = 32.64%
4 Click competitor name to see calculations.
The financial data reveals a significant expansion in net operating assets accompanied by high volatility in aggregate accruals between June 30, 2018, and June 30, 2022. While the asset base grew consistently, the accruals ratio fluctuated sharply, indicating alternating periods of high earnings quality and periods where accrual-based earnings significantly diverged from cash flow.
- Net Operating Assets Trend
- A consistent upward trajectory is observed in net operating assets, which increased from 9.97 billion US dollars in 2018 to 19.78 billion US dollars by 2022. The most substantial growth occurred between 2019 and 2020, where assets rose by approximately 42%, followed by another significant surge between 2021 and 2022.
- Balance-sheet-based Aggregate Accruals
- Aggregate accruals exhibited extreme variance over the five-year period. From 2018 to 2019, accruals remained negative, reflecting a state where cash flows exceeded accrual-based earnings. This shifted abruptly in 2020 to a positive 4.13 billion US dollars, retreated to 392 million US dollars in 2021, and spiked again to 5.55 billion US dollars in 2022. These fluctuations suggest significant shifts in the timing of revenue and expense recognition relative to cash movements.
- Balance-sheet-based Accruals Ratio
- The accruals ratio mirrors the volatility of the aggregate accruals. In 2018 and 2019, the ratio remained slightly negative at -2.44% and -2.66%, respectively, which is typically associated with higher earnings quality. However, a sharp increase to 35.08% occurred in 2020, indicating a substantial accrual component relative to the asset base. After a correction to 2.80% in 2021, the ratio rose again to 32.64% in 2022, suggesting that a significant portion of the reported earnings in the final year is not supported by immediate cash flow.
The cyclical nature of the accruals ratio, shifting from negative to high positive percentages, suggests that the company's financial reporting quality has fluctuated. The recurrence of ratios exceeding 30% in 2020 and 2022 indicates periods of aggressive asset growth or significant non-cash earnings components that warrant closer examination of the underlying operational drivers.
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Cash-Flow-Statement-Based Accruals Ratio
Parker-Hannifin Corp., cash flow statement computation of aggregate accruals
US$ in thousands
| Jun 30, 2022 | Jun 30, 2021 | Jun 30, 2020 | Jun 30, 2019 | Jun 30, 2018 | Jun 30, 2017 | ||
|---|---|---|---|---|---|---|---|
| Net income attributable to common shareholders | 1,315,605) | 1,746,100) | 1,206,341) | 1,512,364) | 1,060,801) | 983,412) | |
| Less: Net cash provided by operating activities | 2,441,730) | 2,575,001) | 2,070,949) | 1,730,140) | 1,600,287) | 1,302,471) | |
| Less: Net cash (used in) provided by investing activities | (418,837) | (13) | (5,023,993) | (218,510) | 20,090) | (3,365,148) | |
| Cash-flow-statement-based aggregate accruals | (707,288) | (828,888) | 4,159,385) | 734) | (559,576) | 3,046,089) | |
| Financial Ratio | |||||||
| Cash-flow-statement-based accruals ratio1 | -4.16% | -5.91% | 35.34% | 0.01% | -5.55% | — | |
| Benchmarks | |||||||
| Cash-Flow-Statement-Based Accruals Ratio, Competitors2 | |||||||
| Boeing Co. | -50.32% | — | — | — | — | — | |
| Caterpillar Inc. | 3.26% | — | — | — | — | — | |
| Eaton Corp. plc | 4.55% | — | — | — | — | — | |
| GE Aerospace | -15.92% | — | — | — | — | — | |
| Honeywell International Inc. | -0.79% | — | — | — | — | — | |
| Lockheed Martin Corp. | -1.36% | — | — | — | — | — | |
| RTX Corp. | 0.87% | — | — | — | — | — | |
| Cash-Flow-Statement-Based Accruals Ratio, Sector | |||||||
| Capital Goods | -5.98% | -27.73% | — | — | — | — | |
| Cash-Flow-Statement-Based Accruals Ratio, Industry | |||||||
| Industrials | -2.30% | -17.51% | — | — | — | — | |
Based on: 10-K (reporting date: 2022-06-30), 10-K (reporting date: 2021-06-30), 10-K (reporting date: 2020-06-30), 10-K (reporting date: 2019-06-30), 10-K (reporting date: 2018-06-30), 10-K (reporting date: 2017-06-30).
1 2022 Calculation
Cash-flow-statement-based accruals ratio = 100 × Cash-flow-statement-based aggregate accruals ÷ Avg. net operating assets
= 100 × -707,288 ÷ [(19,776,394 + 14,226,314) ÷ 2] = -4.16%
2 Click competitor name to see calculations.
The financial reporting quality analysis reveals significant volatility in the cash-flow-statement-based accruals ratio between 2018 and 2022. While net operating assets showed a consistent upward trajectory, ending at US$ 19.78 billion in 2022, the aggregate accruals exhibited erratic swings, most notably during the 2020 fiscal year.
- Accruals Ratio Volatility
- A substantial anomaly is observed in June 2020, where the accruals ratio spiked to 35.34%. This indicates a period where accrual-based earnings significantly exceeded cash flows. In contrast, the ratio remained negative or near zero in all other observed periods, specifically -5.55% in 2018, 0.01% in 2019, -5.91% in 2021, and -4.16% in 2022.
- Net Operating Asset Expansion
- Net operating assets grew from US$ 9.97 billion in 2018 to US$ 19.78 billion by 2022. The most pronounced increases occurred in 2020 and 2022, suggesting significant expansions in the asset base that did not correlate linearly with the movements in aggregate accruals.
- Earnings Quality Implications
- The prevalence of negative accruals ratios in four out of the five years analyzed suggests that cash flows generally exceeded accrual earnings, which is typically indicative of higher earnings quality. The temporary surge in 2020 represents a marked departure from this trend, though the subsequent return to negative ratios in 2021 and 2022 suggests a normalization of the reporting quality profile.
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