Before you buy that next hot stock, consider how its cash flow compares to its profit claims.
Here's a vexing question for investors: Is Under Armour swimming in profits or struggling to get by? Different sections of its financial statements provide very different answers. The fast-growing athletic-apparel maker reported net income of $68.5 million last year and another $12 million in the first quarter of 2011. Its net profit margin doubled to 3.9%.
Under Armour's cash flow statement tells a different story, however. Cash from operations was –$85 million in the first quarter as it piled on $33 million in inventory and increased accounts receivable by another $57 million.
Accountants call earnings unaccompanied by increases in cash flow "accruals," and they've long been flagged as a sign of potential trouble. Under Armour says it's adding inventory and receivables to "better anticipate consumer demand," and that may indeed prove a sage strategy. But today's valuable inventory could be tomorrow's worthless Beanie Babies. And receivables could turn into writeoffs instead of cash.
At the extreme, mounting accruals can point to earnings manipulation and outright fraud. That's because managers have a much easier time faking reported earnings than actual cash in the bank. Exhibit One is Enron, which booked profits from multiyear gas and electricity contracts the day they were signed instead of as they paid off.
"Every good manipulation flows through accruals," says Russell Lundholm, who now teaches accounting at the University of British Columbia. "That's why we start shopping there."
Accruals first gained widespread attention in the mid-1990s, when Richard G. Sloan, then a colleague of Lundholm's at the University of Michigan, showed that high-accrual firms tend to turn in worse stock market returns than companies whose cash flow exceeds their paper earnings. A profit could be made by shorting the high-accrual stocks and buying the low-accrual ones. There was one problem with the existing research: It measured accruals as a percentage of assets, following common academic practice. It took one of Lundholm's students, a Ph.D. candidate named Nader Hafzalla, to point out the obvious: If noncash earnings are suspect they should be measured against total earnings, not assets.
Lundholm was skeptical at first, but his student proved the theory after spending all night crunching stock market statistics. What's more, the stocks found with the new method had very little overlap with those found with the old one. It was a new way of finding both cheap and overvalued stocks.
In a 2011 paper in the Accounting Review Lundholm and coauthor Matt Van Winkle (Hafzalla died in 2006) showed how firms in the top 10% in terms of negative accruals turned in annual returns 5.5 percentage points in excess of the market from 1998 to 2008. Those with high accruals--earnings without cash--trailed the market by 6.1 points a year. Buying the first group and shorting the second would have resulted in an 11.6% annual gain.
Lundholm's accrual formula takes net income minus cash from operations and divides the result by net income. Lundholm uses trailing 12-month figures to account for seasonal swings in cash flow and earnings.
Firms with the highest accruals tend to have zero to slightly negative earnings but huge negative balances in cash from operations. In other words, they're struggling to report a profit as cash rapidly drains from their bank accounts.
For such a simple accounting measure, accruals pick up some of management's fondest tricks. Managers might be tempted to keep production lines going in the face of flagging demand, for example, because the cost of those extra widgets doesn't hit the earnings until they're sold. But the cash spent on raw materials shows up next quarter in the cash flow statement.
Accounts receivable also reflect "sales" that might become writeoffs when the buyer doesn't pay. That's one of the things that brought down grillmaker Sunbeam, whose chief executive, Albert "Chainsaw Al" Dunlap, booked orders from dealers who hadn't actually paid for or taken delivery of its grills .
Negative accruals are harder to understand. Say a company has poor earnings now but executives think next year will be better. They might have an incentive to write down assets and reduce the useful life of machinery so that when the recovery comes earnings look even better and last longer as profit margins begin their usual cyclical contraction.
Southwest Airlines might be one example. Last year it reduced the expected residual value of its planes from 15% to 10% of book value. The move added to the $628 million in depreciation on its $16 billion fleet of airplanes and reduced reported net income to $451 million, or only 28% of Southwest's $1.6 billion in cash from operations.
If an economic recovery increases demand for Southwest's used 737s, management could decide to reverse the move.
Lundholm reckons that the current spate of asset writedowns and slimmed-down cost structures are setting the stage for earnings increases ahead.
Screening for accruals may work well for hedge funds, which can use computerized trading to assemble portfolios with hundreds of stocks on the long and short sides.
But Lundholm says individuals can use the same technique on as few as five or ten stocks.
To find the best candidates, he says, look for companies that not only rack up extreme positive or negative accruals but also had earnings surprises going the other way.
A company with high accruals that still can't make earnings estimates is struggling to keep up appearances. A company that writes off everything but the kitchen sink yet still beats estimates is clearly on the upswing.
Wow, I need to improve my corporate finance knowledge. It sounds likely that the accruals is the secret weapon for accounting manipulation. Can any of you explain it to us in a simple way that why accruals is so important?? Thanks a lot
yeah , I have the same idea that this artical is thought-provoking and the cash doesn't lies. there is no time give a good reply to the topic. I have a meeting these days.
I give my best wishes to every member and everything goes on well with you.
不炒股也看了,还中英双版的....谢谢Southwest Airlines might be one example. Last year it reduced the expected residual value of its planes from 15% to 10% of book value. The move added to the $628 million in depreciation on its $16 billion fleet of airplanes and reduced reported net income to $451 million, or only 28% of Southwest's $1.6 billion in cash from operations.
A company with high accruals that still can't make earnings estimates is struggling to keep up appearances. A company that writes off everything but the kitchen sink yet still beats estimates is clearly on the upswing.
How about a big cash out flow from investment with a normal cash in flow from operation? The company's cash flow statement will be very different from those of years before. At this time, I believe you will not say the company is not good because it has a negative cash flow. Three statements show us the different aspects. Income statement shows the history, cash flow statement shows the present, while balance sheet shows the future. If you are a short-term or momentum investor, cash flow statement is enough, perhaps.
71，71
Good article !
A profit could be made by shorting the high accrual stocks and buying the low accrual ones .
To find the best candidates , look for companies as that not only rack up extreme positive or negative accruals , but also had earnings surprises going the other way .
balance sheet show the future? I think the big three of the fin statement all release the history from different view. M&L and cashflow have a strongly connection which impact or form the Balance sheet.
yup , this a professional artical about coperate financial issues . the key word is accruals. according to this artical , we can draw the following conclusions : (1)the accruals is a scret weapon used by company to gloss over the financial statements . (2)high-accrual firms tend to turn in worse stock market returns , (3)arbitrage can be achieved in high and low accruals between accruals .as a non-financial and accounting majors student , whereas i can understand the surface phenomena ，i still can not comprehend the real intrinsic link between corporate profits and accruals., why we can profits between high and low accruals between accruals , how the arbitrage is maded .
vex [veks]
vt.使烦恼
vexing ['veksiŋ]
adj. 讨厌的
Under Armour
短袖防晒排汗衣
get by
通过；过得去，(勉强)过活
accruals [ə'kru:əlz]
n. 权责发生额，应计利润
sage [seidʒ]
n.圣人, 哲人
n.鼠尾草, 蒿属植物
adj.贤明的, 明智的
Beanie Babies
毛绒玩具豆宝宝
write-off ['raitˌɔ:f]
n. 销帐, 勾销, 帐面价值的削减
n. （英）报废的东西
outright [ˈautrait]
ad.坦率地；彻底地；立即 a.无疑的；彻底的
multiyear
adj. 需好几年的
turn in
交还，上交；上床睡觉
crunch [krʌntʃ]
v.发出碎裂声, 嘎吱嘎吱地咀嚼,嘎喳嘎喳地碾过
n.嘎吱声, 艰难局面, 关键时刻
v.<俚>处理（数据）
trail [treil]
vi.拖，下垂；失败 vt.跟踪 n.小路；踪迹
be tempted to
受诱惑去做,总想做
swing [swiŋ]
v.(使)摇摆；(使)旋转 n.摆动；秋千
flagging ['flægiŋ]
adj. 疲惫的, 萎靡的
show up
暴露，显露；来到，露面
sunbeam [ˈsʌnbi:m]
n.日光
bring down
使落下，打倒；降低，减少
take delivery of
接收, 提取
grill [gril]
v.烧烤；拷问 n.烤架；烧烤餐馆；烤肉；格板
cyclical ['saiklikl]
adj. 循环的, 周期的
fleet [fli:t]
n.舰队，船队，车队
reckon [ˈrekən]
vt.认为，估计；(on)指望；测算
a spate of
大量的
spate [speit]
n.大批，大量，(水)泛滥
slimmed-down
精简型
set the stage for
为…提供舞台；为…创造条件
on the long and short sides
多空双方
rack up
得分, 积累, 获胜, 彻底击败
rack [ræk]
n.挂架，搁架 vt.折磨；使紧张，使努力
kitchen sink
激进现实主义
厨房洗涤盆
upswing [ˈʌpˌswiŋ]
n.上升，增长
on the upswing
adv. 正在高涨
Those companies with high profit but low or even negative operating cash flows as what Under Armor shows are not so inspiring. Mounting accruals are sometimes signs of earning manipulation and outright fraud. Picking up stocks with low accruals has been demonstrated by outperforming annual gains. Some managements tend to cover the depressing outcome by accruals and sometimes the receivables turn into bad accounts. But there are occasions that companies use negative accruals in expect of setting the stage for earnings increases ahead.
Finding those companies whose profit numbers are concurrent with operating cash flows or those racking up extreme negative accruals will give you a rosy picture of stock gains.
It is imposible for average people to understand or master those obscure accounting technical terms easily. So asymmetric information has become a common issue in portfolio investment.
I think unearned revenue provides more information than accrued revenue.
High-speed growing in unearned revenue means that a company's products or services are fit for the market, then good profit statements are large probability events
复习和考过cpa的童鞋应该很好消化的 对于偶来说 看中文都不知所云，希望大家以后能找一些大众化的文章 尤其是关于当今世界经济的新闻稿 对于这些热点 大家应该都比较关注
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