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
Stryker Corp., 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 | 34,631) | 34,330) | 30,167) | 27,229) | 22,197) | |
| Less: Cash and cash equivalents | 2,944) | 2,943) | 4,337) | 3,616) | 2,542) | |
| Less: Marketable securities | 75) | 81) | 88) | 83) | 251) | |
| Operating assets | 31,612) | 31,306) | 25,742) | 23,530) | 19,404) | |
| Operating Liabilities | ||||||
| Total liabilities | 19,754) | 21,246) | 17,360) | 15,499) | 12,217) | |
| Less: Current maturities of debt | 7) | 761) | 859) | 1,373) | 632) | |
| Less: Long-term debt, excluding current maturities | 12,472) | 13,230) | 10,231) | 8,486) | 6,590) | |
| Operating liabilities | 7,275) | 7,255) | 6,270) | 5,640) | 4,995) | |
| Net operating assets1 | 24,337) | 24,051) | 19,472) | 17,890) | 14,409) | |
| Balance-sheet-based aggregate accruals2 | 286) | 4,579) | 1,582) | 3,481) | —) | |
| Financial Ratio | ||||||
| Balance-sheet-based accruals ratio3 | 1.18% | 21.04% | 8.47% | 21.55% | — | |
| Benchmarks | ||||||
| Balance-Sheet-Based Accruals Ratio, Competitors4 | ||||||
| Abbott Laboratories | — | — | — | — | — | |
| Elevance Health Inc. | — | — | — | — | — | |
| Intuitive Surgical Inc. | — | — | — | — | — | |
| Medtronic PLC | — | — | — | — | — | |
| UnitedHealth Group Inc. | — | — | — | — | — | |
| Balance-Sheet-Based Accruals Ratio, Sector | ||||||
| Health Care Equipment & Services | 200.00% | — | — | — | — | |
| Balance-Sheet-Based Accruals Ratio, Industry | ||||||
| Health Care | 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
= 31,612 – 7,275 = 24,337
2 2021 Calculation
Balance-sheet-based aggregate accruals = Net operating assets2021 – Net operating assets2020
= 24,337 – 24,051 = 286
3 2021 Calculation
Balance-sheet-based accruals ratio = 100 × Balance-sheet-based aggregate accruals ÷ Avg. net operating assets
= 100 × 286 ÷ [(24,337 + 24,051) ÷ 2] = 1.18%
4 Click competitor name to see calculations.
The analysis of the financial reporting quality between 2018 and 2021 reveals a consistent expansion in net operating assets contrasted by significant volatility in aggregate accruals. Net operating assets increased from 17,890 million US dollars in 2018 to 24,337 million US dollars in 2021, indicating a steady growth in the company's operational investment base, with the most pronounced increase occurring between 2019 and 2020.
- Aggregate Accruals Volatility
- Balance-sheet-based aggregate accruals demonstrated a non-linear trend, characterized by sharp fluctuations. After declining from 3,481 million US dollars in 2018 to 1,582 million US dollars in 2019, accruals surged to a peak of 4,579 million US dollars in 2020, before falling precipitously to 286 million US dollars by the end of 2021.
- Accruals Ratio Analysis
- The balance-sheet-based accruals ratio followed a similar volatile pattern, reflecting the relationship between aggregate accruals and net operating assets. The ratio stood at 21.55% in 2018, decreased to 8.47% in 2019, and returned to a high of 21.04% in 2020. However, a significant contraction occurred in 2021, with the ratio dropping to 1.18%.
- Earnings Quality Implications
- The marked decrease in the accruals ratio to 1.18% in 2021 suggests a substantial alignment between reported earnings and cash flows for that period. Because lower accruals ratios typically correlate with higher earnings quality, the shift from the 21.04% peak in 2020 to the 2021 low indicates a reduction in the non-cash components of the company's operating assets relative to its total operating base.
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Cash-Flow-Statement-Based Accruals Ratio
Stryker Corp., 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 earnings | 1,994) | 1,599) | 2,083) | 3,553) | 1,020) | |
| Less: Net cash provided by operating activities | 3,263) | 3,277) | 2,191) | 2,610) | 1,559) | |
| Less: Net cash used in investing activities | (859) | (4,701) | (1,455) | (2,857) | (1,613) | |
| Cash-flow-statement-based aggregate accruals | (410) | 3,023) | 1,347) | 3,800) | 1,074) | |
| Financial Ratio | ||||||
| Cash-flow-statement-based accruals ratio1 | -1.69% | 13.89% | 7.21% | 23.53% | — | |
| Benchmarks | ||||||
| Cash-Flow-Statement-Based Accruals Ratio, Competitors2 | ||||||
| Abbott Laboratories | — | — | — | — | — | |
| Elevance Health Inc. | — | — | — | — | — | |
| Intuitive Surgical Inc. | — | — | — | — | — | |
| Medtronic PLC | — | — | — | — | — | |
| UnitedHealth Group Inc. | — | — | — | — | — | |
| Cash-Flow-Statement-Based Accruals Ratio, Sector | ||||||
| Health Care Equipment & Services | 11.34% | — | — | — | — | |
| Cash-Flow-Statement-Based Accruals Ratio, Industry | ||||||
| Health Care | 14.62% | — | — | — | — | |
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 × -410 ÷ [(24,337 + 24,051) ÷ 2] = -1.69%
2 Click competitor name to see calculations.
Between 2018 and 2021, the financial reporting quality indicators exhibited significant volatility, characterized by a steady expansion of the operational asset base contrasted with fluctuating accrual levels.
- Net Operating Assets Trend
- A consistent upward trajectory is observed in net operating assets, which grew from 17,890 million US dollars in 2018 to 24,337 million US dollars by the end of 2021. The most pronounced increase occurred between 2019 and 2020, where assets rose by approximately 23%, suggesting a significant expansion in the operational scale of the business.
- Aggregate Accruals Volatility
- Cash-flow-statement-based aggregate accruals demonstrated substantial instability over the four-year period. After a peak of 3,800 million US dollars in 2018, accruals declined sharply to 1,347 million US dollars in 2019, before rising again to 3,023 million US dollars in 2020. By December 31, 2021, this figure transitioned to a negative value of -410 million US dollars, indicating a fundamental shift in the relationship between reported earnings and actual cash flows.
- Accruals Ratio Interpretation
- The cash-flow-statement-based accruals ratio mirrored the volatility of the aggregate accruals. The ratio started at a high of 23.53% in 2018, indicating a significant gap between accrual-based earnings and cash flow. While it dipped to 7.21% in 2019 and recovered to 13.89% in 2020, the ratio ultimately reached -1.69% in 2021. The transition to a negative ratio in 2021 suggests that cash flows from operations exceeded net income for that period, which generally points to higher earnings quality and lower reliance on non-cash accounting estimates.
Overall, the convergence of increasing net operating assets and a declining accruals ratio indicates an improvement in the quality of financial reporting by the end of the analyzed period, culminating in a state where cash generation outpaced accrual-based accounting profit.
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