Cash flows: can stakeholders tell where your money is going?
Many financial statement users make the statement of cash flows a key part of their analysis when evaluating a company’s performance for investing and lending decisions. Operating cash flows is an area of significant focus because it is seen as the cash version of net income.
We spoke to investors and analysts to find out what they are looking to learn from a company’s statement of cash flows. And while needs vary, there are a few points where stakeholders agree.
Does earnings growth drive cash growth?
When earnings grow but cash flow doesn’t, stakeholders will wonder why. This will lead to additional scrutiny of the income statement as well as non-GAAP measures that show profitability.
Is free cash flow positive?
Free cash flow (operating cash flows less cash paid for capital expenditures) is a key metric used by investors and analysts to assess a company’s ability to repay debt and pay dividends. When free cash flow is positive, it indicates the company is generating more cash than is used to run and grow the business.
How does cash flow compare to peers?
When assessing a company, investors and analysts want to understand how it compares to its peers. Operating cash flow strips out the impact of estimates and accounting policy elections that may impact earnings, but don’t change cash, making comparisons easier.
What you need to know
- Stakeholders focus on the statement of cash flows to better understand a company’s profitability.
- Enhancing cash flow transparency will help users better understand a company’s financial health and future prospects.
- Improved financial reporting processes will contribute to the accuracy of the cash flow statement.
Improving cash flow reporting
There are some simple ways to make sure your stakeholders are getting what they need from your statement of cash flows.
Enhance cash flow information
We have heard from investors and analysts that they are looking for more cash flow transparency. Improved disclosure beyond what’s presented in the statement of cash flows can help companies achieve this goal.
Enhance disclosures of non-cash items Companies need to ensure that their reporting processes appropriately identify non-cash items and provide transparent disclosure. |
Highlight significant and unusual transactions The impact of significant and unusual transactions may not be clear to users when the indirect method is used. To provide additional clarity and improve usefulness, preparers should disclose where and how these transactions are reflected in the statement of cash flows. |
Improve MD&A discussion of cash flows Companies should describe the primary drivers of liquidity in MD&A so that a user can evaluate expected sources and needs for cash. For example, if there was a significant increase in inventory spending, it would be helpful to explain why and provide enough information so that the user knows if that level of spending will be sustained. |
Expand on interim disclosures A discussion of the drivers of cash flows on an interim basis can also be helpful in some cases. This could mean expanding the details of cash flows from operating activities (similar to how its presented in annual presentations), rather than electing the abbreviated interim presentation permitted under SEC regulations. |
Focus on the reporting process
Inappropriate classification of cash flows and the treatment of non-cash items continue to be a frequent source of financial statement restatements. A contributing factor may be that the preparation of the statement of cash flows is often completed later in the reporting process. The preparation of the cash flow statement is an integral part of the financial reporting process, and should be subject to the same review controls as other financial statements.
Practices that will contribute to the timeliness and accuracy of the cash flow statement include:
- Preparing the statement of cash flows earlier in the reporting process to ensure time for a thorough review.
- Determining the cash flow classification of significant transactions (including any non-cash elements) concurrent with the determination of the overall accounting treatment, through the joint efforts of the financial reporting team and the structuring team.
- Monitoring changes in cash management programs, such as structured payables programs or receivables factoring, to ensure they are accurately reflected in the cash flow statement.
Final thoughts
Given the level of stakeholder focus, companies should prioritize the preparation and review of the cash flow statement. Financial statements should provide transparent disclosure about how significant transactions are reflected in the cash flow statement as well as the primary drivers and material factors impacting the company’s liquidity. These steps will ensure users get a full picture of the company’s cash flow story and may benefit the company in the form of greater access to capital markets and a lower cost of capital.
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