5(c). Cash Flow Statement
Need for the Direct Method of Presenting Operating Cash Flows [following 3 paragraphs]: We need a cash flow statement that is consistent in format and can be used for comparison with related line items on both the income statement and/or a cash flow projection. It is not enough to know why net income is different from net cash from operations. We also must know why revenues are different from the cash collected and why payments for goods are different from the cost of goods sold. For example, consider the broadcasting industry where barter arrangements are common. They result in noncash sales and noncash expenses. There is no adjustment necessary to produce agreement between income and cash flow from operations, but there may be significant adjustments to the gross amounts included therein. [RMA92, p. 3]
In addition, we use historic cash flow data to estimate our customers' future borrowing needs and repayment capacity. That involves projecting actual cash flows, collections and payments, not reconciliations between net income and net cash flow. The indirect format is almost useless for such purposes. [RMA92, p. 3]
We hope we have been successful in communicating to you the reasons that explain the strong desire of credit analysts for cash flows from operating activities to be presented in the direct format. Furthermore, we note that FAS 95 encourages use of the direct method (paragraph 27), although it permits use of the indirect method (paragraph 28). Therefore, we feel that the Special Committee should make equally detailed inquiries of financial statement preparers and their accountants as to the specific reason(s) for their unwillingness to provide cash flows data in a format that is advocated by the FASB as well as by RMA and a variety of other financial statement users. As a matter of fact, we would be interested in knowing whether any users interviewed by the Special Committee expressed a preference for the indirect method and, if so, why. [RMA92, p. 3]
Need for a One-Year Cash Flow Forecast [following 4 paragraphs]: Many of your questions regarding this subject can be answered with a simple statement. We make loans to enterprises that currently do not have sufficient cash to make business investments that are intended to generate more than sufficient cash in the future to repay the loan. It is our job, in making the loan, to assess the amounts, timing and uncertainties of those future cash flows. What document could be more relevant to and useful for that purpose than the enterprise's own projections of its cash flows, prepared under the supervision and with the advice of its independent accountants? [Also included in 12] [RMA92, p. 3]
To be more specific, we use the projected cash flow data to: (1) assess the viability of the operation, (2) project debt service capability, (3) anticipate additional borrowing needs, and (4) understand the borrowers' expectations. We do not use those projections without first testing them for reasonableness. That task that is diminished in importance and complexity when either or both of two factors are present. One is the involvement in the forecast of the borrower's independent accountant. The other is assumptions that are set forth in detail; the more detailed they are, the less reasonableness testing we have to do. Nevertheless, we as lenders tend to "haircut" the borrowers' expectations and to supplement them with our own worst case scenarios. But, we do use forecasts! [Also included in 12] [RMA92, p. 4]
You also ask why cash forecasts would be useful if there were more detailed income statement data and cash flows were presented in the direct format. The point is forecasts address the future. No amount of additional detailed reporting about the past, either on the income statement or on the cash flow statement, can replace projections of the future. Did we misunderstand you here? [Also included in 12] [RMA92, p. 4]
Finally, you should never ask a user how much detail is necessary. We are sure you already have heard from others that there is no end to user requests for detail. To be practical, however, an income statement, cash flow statement (direct method), and a cash flow forecast should all have the same level of detail. Our work is to compare them. If we could know why past revenues and expenses are different from past cash receipts and collections and why each of those is different from expected future receipts and collections, the quality of our analysis and lending activities would be aided immeasurably. [RMA92, p. 4]
__________
The APC [Accounting Policy Committee] believes that a complete set of financial statements must contain a statement of cash flows. The purpose of that statement is to inform financial statement readers of the behavior of enterprise cash cycles which can differ vastly in timing from operating and investment cycles. The cash flow statement should display gross changes in cash and cash equivalents, and they should be classified by operating activities, investing activities and financing activities. The APC believes that the direct method of displaying operating activity data provides information that is most useful in judging a company's liquidity, financial flexibility, and financial risk. Gross cash flows are superior to net flows as an indicator of a company's maximum borrowing needs and the source and availability of cash inflows for debt servicing. [Footnote reference omitted] [RMA90, p. 4]
Lenders also require information about significant investing and financing transactions that do not produce cash flows, but those data should be presented only in schedules that are clearly designated as supplementary to the cash flow statement. [RMA90, p. 4]
__________
The balance sheet receives far less attention than the income statement [by equity sell-side analysts], and the occurrences of balance sheet type words and phrases occur far less frequently [in analysts' reports]. Much of the attention to balance sheet items comes in the form of liquidity and cash flow analysis. For example, reports may assert balance sheet strength on the basis of a company's free cash flow. While several income statements are almost always presented, many reports contain only summary balance sheets. [Also included in 1(b), 1(c) and 5(b)] [PREVITS, p. 17]
[A]nalysts asserted that a cable television company had substantial off-balance-sheet assets in the form of residual payments to be received in the future. They calculated the value of the company using several methods, one being the present value of the anticipated cash flows from these residuals. One analyst stated that "balance sheet recognition of . . . hidden asset values . . . will occur in future years". Other examples include inventory and reserve valuations of extractive industry companies. For instance, in gold mining companies, a market value appraisal is included of the reserve values by ore type. [Also included in 1(b), 1(c), 4, and 5(b)] [PREVITS, p. 17]
Liabilities are usually addressed in a summary fashion, often in a simple analysis of the capitalization of the corporation. Extensive attention to liabilities usually only occurs for companies that are highly leveraged and typically in conjunction with a cash flows analysis. [Also included in 1(b), 1(c), and 5(b)] [PREVITS, p. 17]
Cash flow analysis [by equity sell-side] analysts displays considerable variety in format and content. Many reports present and/or discuss cash flow extensively. Cash flow information is sometimes presented by segment or operating unit. Some reports make no mention of cash flow at all. Cash flow type phrases occurred about 6,000 times in the full sample. [Separately, dividends are mentioned over 2,000 times.] [Also included in 1(b), 1(c), and 3(c)] [PREVITS, p. 18]
Although cash flow per share calculations are not permitted in audited filings under SEC rules nor by SFAS 95, cash flow per share and operating cash flow per share are almost always calculated by analysts when they provide any cash flow data. Analysts also calculate "fully diluted cash flow per share" and some provide "distributable cash flow per share", "excess cash flow per share", "discretionary cash flow per share", and "free cash flow per share." [Also included in 1(b) and 1(c)] [PREVITS, p. 18]
Some [equity sell-side] analysts compute a price to cash flow ratio, and present a comparison of this ratio with other companies in that industry. Others assess the relationship between cash flows and earnings. For example one report stated that the value of a company was "compelling" because "operating cash flows are 4.3 times 1990 earnings". Another analysts encouraged purchase of a major tobacco company's stock because of its "tremendous surplus cash flows". [Also included in 1(b) and 1(c)] [PREVITS, p. 18]
Cash flows seem to be more important to [equity sell-side] analysts in evaluating smaller companies, and less so in evaluating larger companies, with the exception of highly leveraged larger companies or ones in which a dividend cut is possible. One report, for example, states that "The important figure . . . for evaluation of smaller petroleum . . . companies is operating cash flow per share." Another stated that in comparison with cash flow "historical financial results of [the company] are irrelevant". [Also included in 1(b) and 1(c)] [PREVITS, p. 18]
Examples of unorthodox cash flow formats [presented by equity sell-side] analysts in addition to free cash flow and discretionary cash flow arrangements are: [Also included in 1(b) and 1(c)] [PREVITS, p. 18]
Net income
+/- all effects except cash interest
= cash flow available to common
- cash interest
= net cash flow
Direct operating cash flows
- priority outflows
- discretionary outflows
+ financial inflows
= change in cash
[Also included in 1(b) and 1(c)] [PREVITS, p. 18]
It was also intriguing to discover an example where the "foreign exchange cash flow" in a statement of cash flows was presented outside the three traditional categories of the SFAS 95 format. [Also included in 1(b) and 1(c)] [PREVITS, p. 18]
__________
[Context] The following brief summary of the topic "Income and Cash Flow Statements," is from the "Executive Summary" of the report the AIMR's Financial Accounting Policy Committee (FAPC):
Throughout the report, there are repeated recommendations that the FASB needs to develop its concept of "comprehensive income." Much of this section of the report is devoted to integrating those references and explaining in much greater detail all the reasons why that development is needed and how it should proceed. [Also included in 5(a)] [AIMR/FAPC92, p. ix]
The other part of this section deals with the cash flow statement. Most financial analysts were pleased with the issuance of FAS 95, which requires that a cash flow statement replace the less useful statement of changes in financial position. They are not pleased with the quality of information contained in many of the cash flow statements they currently receive. First, virtually no companies have chosen to present cash flows from operations on the direct method. Failure to do so has been accompanied by arguments that are unconvincing because they are contradictory. Second, because so many cash flow statements contain detectable errors, we call for establishment of an authoritative literature on cash flow statement preparation. [Also included in 5(a)] [AIMR/FAPC92, p. ix]
[Context] It indicates the scope of the discussion of the topic and lists the report's major recommendations, providing an introduction to the following excerpts from the report.
Over the span of the FASB's existence, its pronouncements have become more and more oriented to the statement of financial position. This is meant as an observation, not criticism. [Also included in 5(a) and 5(b)] [AIMR/FAPC92, p. 41]
Perhaps the most apt example is FAS 109, "Accounting for Income Taxes." It fixes its attention on identifying at a point in time those transactions and events that are deemed to have future tax consequences, then measuring the effect on financial position of the benefit(s) and/or obligation(s) resulting from them. Their effect on periodic income is calculated only as the necessary consequence of those financial position assessments. This is an approach opposite from the now-superseded Accounting Principles Board Opinion 11 in which the objective was to measure the deferred portion of the current period's provision for income taxes, with resultant balance sheet residuals called deferred tax liabilities and/or assets. [Also included in 5(a) and 5(b)] [AIMR/FAPC92, p. 41]
We applaud the efforts and accomplishments of the FASB in making balance sheet amounts more meaningful than before. Prior to FAS 109 (and its short-lived predecessor, FAS 96), deferred tax accounts on the balance sheet had little meaning since they were remnants of past income statements, whereas today they depict amounts that the enterprise expects to result in future cash flows. However, as FAS 109 and various other standards have been promulgated we feel that the development of the income statement has been neglected. We also feel as if more could be done to make cash flow statements more accurate and more useful to analysts. The purpose of this short section is to summarize our views on those matters: (a) with respect to the income statement, primarily to summarize information scattered throughout earlier parts of this report; (b) with respect to cash flow statements to introduce new material. [Also included in 5(a) and 5(b)] [AIMR/FAPC92, p. 42]
The Statement of Cash Flows
Financial analysts have mixed feelings about FAS 95, "Statement of Cash Flows." We are gratified that it was issued because it mandates that a cash flow statement be issued and codifies the form and content of the statement. That brought to a welcome demise the old statement of changes in financial position and it eliminated many of the variations in practice among companies that did publish cash flow statements. [AIMR/FAPC92, p. 44]
Since the issuance of FAS 95, the cash flow statements that have appeared in published financial reports have been much less useful in analysis than we might have expected. First, almost no public company presents its cash flows from operations using the direct format; virtually all use the indirect format. We have learned since the issuance of FAS 95 that it is extremely difficult or impossible in most cases to calculate reasonable estimates of gross operating cash flows (direct-method) using only the data provided in financial reports using the indirect method.14 A second deficiency is the imprecision with which FAS 95 appears to be applied. There is need of an authoritative literature to resolve a variety of ambiguous situations as well as to forestall the many detectable errors we have encountered in published cash flow statements since FAS 95 was issued. We can only speculate on the number of undetectable errors that must also occur. [AIMR/FAPC92, p. 44]
The Direct Method of Reporting Cash Flow From Operations
FAS 95 states, in paragraph 27:
In reporting cash flows from operating activities, enterprises are encouraged to report major classes of gross cash receipts and gross cash payments and their arithmetic sum--the net cash flow from operating activities (the direct method). [AIMR/FAPC92, p. 44]
E36, Exposure Draft 36 of the International Accounting Standards Committee, Proposed Statement, "Cash Flow Statements" states, in paragraph 23: [AIMR/FAPC92, p. 45]
Enterprises are encouraged to report cash flows from operating activities using the direct method. [AIMR/FAPC92, p. 45]
Both standards-setting bodies cite the direct method as the preferred method of presenting cash flows from operations. Investment professionals represented by AIMR have expressed their desire for the direct method. We have observed that the Robert Morris Associates, representing over 15,000 bank loan and credit officers in the United States, has adamantly advocated the direct method.15 Despite the overwhelming expressions of support for the direct method by virtually all professional users of financial statements, it is the indirect method that appears almost without exception in published financial reports. [AIMR/FAPC92, p. 45]
Two contradictory reasons are given to support the indirect method over the direct. First, it is asserted by some that the specific items used in the indirect method to reconcile income to net cash flow from operations can easily be evaluated by an analyst as to the individual revenues and expenses to which they apply. It is said that the revenues can then be adjusted to determine gross cash collected, the expenses to compute gross cash outflows. Second, it is asserted by many reporting firms that they do not keep their records in such a way as to permit reporting operating cash flows in gross amounts, thereby making the direct method prohibitively expensive to implement. [AIMR/FAPC92, p. 45]
With respect to the first argument, as a practical matter, there seldom is sufficient detail given in published financial statements of the individual reconciling items to make the adjustments suggested. More often than not, a multitude of individual items appear in the operating section of the cash flow statement as a single number described as "Other," "Other assets and liabilities--net," "Other noncash credits," "Other, net," "Other adjustments--net," etc. In many cases, the level of detail presented in the enterprise's income statement is inconsistent with that in the cash flow statement and it is consequently impossible to make all of the necessary adjustments. Finally, if the reconciling items "can easily be evaluated by an analyst," they can even more easily (and accurately) be evaluated by the reporting enterprise. Not only that, but evaluation and adjustment, if done by the reporting enterprise, need be done only once, thus saving the greater efforts and lesser accomplishments of the scores of individual analysts who may follow that firm. [AIMR/FAPC92, p. 45]
The second argument, professing the high cost of preparing direct format cash flow statements, also is unpersuasive. First, it directly contradicts the first argument, that conversion from direct to indirect is easy, even by analysts relying only on publicly-available data. Second, one must inquire as to who bears the costs of preparing financial statements. The costs are paid out of general corporate funds and, ultimately, are borne by the firm's investors, that is the users of financial statements. If financial statement users demand information in a particular form, then it should be provided. If the costs of providing such information truly are prohibitive, the demand will cease as investors refuse to absorb the concomitant decrease in the value of their holdings. [AIMR/FAPC92, p. 45-46]
A reasonable solution to this apparent impasse is not unattainable. Although neither the FASB has seen fit to mandate the direct method nor is it likely that the IASC will, both endorse it as the preferable method. Nothing other than inertia prevents progressive firms that seek favor with analysts from adopting the direct method. We reiterate, not only is the direct method permitted, it is preferred! As professional associations representing financial statement preparers and their auditors consider how they may better provide information that is valuable to financial statement readers, they should take it upon themselves to champion the direct method of reporting cash flow from operating activities. [AIMR/FAPC92, p. 46]
Need for an Authoritative Literature on Cash Flow
The need for such a body of authoritative literature manifests itself in two ways. First, there are a variety of accounting matters where the correct treatment on a cash flow statement is not readily apparent. Inasmuch as cash flow is factual, totally exchange-based and devoid of allocations, these are entirely questions of classification. Some examples are: [AIMR/FAPC92, p. 46]
APBO 30 specifies that the income statement shall present discontinued operations separately from continuing operations and sets up appropriate definitions and procedures.16 It is unclear from FAS 95 as to whether cash flows from operating activities should similarly be classified into two distinct components. If the response is affirmative, to what extent and how should taxes paid be allocated between the components of operating activity on the cash flow statement, a question similar to that of intraperiod tax allocation on the income statement. [AIMR/FAPC92, p. 46]
FAS 94 requires the consolidation of all majority-owned companies. Many of these are finance and insurance subsidiaries. Some are integral parts of the parent enterprise's operating activities, others finance and insure primarily unrelated customers, whereas others are a blend. To what extent, and following what criteria, are the cash flows related to their receivables and payables to be treated as part of operating activities, as opposed to investing and financing? [AIMR/FAPC92, p. 46]
Certain enterprises manufacture product that may either be sold or be converted to use as plant assets of the enterprise itself. Examples include certain real estate developments and computers that may be either rented (on operating leases) or sold. How is the cash spent to produce these items to be classified (operating or investing?) when the enterprise itself does not know their final disposition until after they have been produced? [AIMR/FAPC92, p. 46]
There are many other similar questions of classification, but we wish only to illustrate the nature of our concerns. [AIMR/FAPC92, p. 47]
The second need for authoritative literature is as a bulwark against the myriad errors we have seen in published cash flow statements. We can only speculate as to whether they are the result of ignorance, thoughtlessness or carelessness. The following examples are illustrative.17 [AIMR/FAPC92, p. 47]
One firm showed as a cash outflow from financing activities the total amount of $30,197 of dividends declared. The $325 increase in its dividends payable account was added to net income in the computation of cash flow from operations. [AIMR/FAPC92, p. 47]
Another corporation included among its investing cash outflows for capital expenditures, and among its financing cash inflows from long-term borrowing, the amounts of assets and liabilities recorded at the inception of capital leases during the year. [AIMR/FAPC92, p. 47]
Several companies show bank overdrafts as current liabilities on their balance sheets. These companies then place the amount of the change in that liability on the cash flow statement as an adjustment of income in the calculation of cash flow from operations. That treatment is tantamount to making the cash flow statement directly contradictory to the balance sheet. The balance sheet asserts that payments have been made by overdrawing a bank account; the cash flow statement asserts that the payments were not made. One of those statements has to be false and misleading. [AIMR/FAPC92, p. 47]
A firm states in the notes to its financial statements that it "acquired 168 businesses, all of them accounted for as purchases, for $303,601,000 in cash and notes." The cash flow statement shows a cash payment of $303,601,000. The amount paid for with notes should not have been reported on the cash flow statement; it should have appeared as supplementary data. [AIMR/FAPC92, p. 47]
That same firm shows an increase in its "Investment in a less-than-majority-owned affiliate" from a beginning balance of $-0- to an ending balance of $249,718. The firm's cash flow statement shows a deduction from net income for $5,017 of equity earnings from the investment; yet the supplementary data state that the cost of the investment in the affiliate (none paid in cash) was $249,718. [AIMR/FAPC92, p. 47]
A third violation by that same firm is its deduction from income in computing cash flow from operations of an after-tax gain of $11,354 recognized from certain nonmonetary transactions, even though the gain was properly reported on the income statement in its pre-tax amount. [AIMR/FAPC92, p. 47]
The solution to the sorts of problems listed above has two facets. First is the need for detailed procedural guidance to the preparation of cash flow statements well beyond that incorporated in intermediate accounting textbooks. Second, both the preparers and auditors of financial statements need to educate their personnel. We deliberately use the word "education," not "training." We believe that instruction in procedural matters is secondary to an understanding of the role of the statement of cash flows as a major financial statement and the philosophy of its system of classification into operations, investing, and financing. We suspect that in practice it frequently is prepared in haste as a derivative of the audited balance sheets and income statement without due consideration for its unique and eminent position among the major financial statements. [AIMR/FAPC92, p. 48]
[Context] Meeting of the Investor Discussion Group on December 9, 1992. The first part of the meeting was devoted to the topic of disaggregated information. During the discussion, comments were made on cash flow statements.
Committee/Staff/Observer
How about the third bullet? If consolidating financial statements are required, should they include consolidating cash flow statements? And should the direct or indirect method be required or should the format be optional? [Also included in 3(e)] [TI 12/9, p. 26]
Participant I-6
Yes, they should be required. I think the cash flow statement is extremely important. [Also included in 3(e)] [TI 12/9, p. 26]
Committee/Staff/Observer
We don't seem to have a strong feeling one way or the other on the direct versus indirect method question. [Also included in 3(e)] [TI 12/9, p. 26]
Committee/Staff/Observer
I'm surprised there's not more reaction for a change to the direct method of cash flow reporting because I have heard that before. [Also included in 3(e)] [TI 12/9, p. 26]
Participant I-12
I'm still waiting for someone to come up with a decent definition of cash flow in a financial company. [Also included in 3(e)] [TI 12/9, p. 26]
[Context] Meeting of the Investor Discussion Group on January 13, 1993. Part of the meeting was devoted to the topic of display.
Committee/Staff/Observer
How disruptive would it be if you didn't have a balance sheet? [Also included in 5(b) and 11(c)] [TI 1/13, p. 36]
Participant I-8
Very. I can remember when quarterly balance sheets were a rarity. An income statement is worthless without a balance sheet. I would also love to see a quarterly cash flow statement. [Also included in 5(b) and 11(c)] [TI 1/13, p. 36]
Committee/Staff/Observer
Let's move to cash flow statement display, which is our last question in the general area of display. Under current rules, amounts on the cash flow statements are classified in one of three categories: operating, investing, or financing. Operating activities is the catch-all category. In other words, amounts in the operating activities category include all cash flows except those that can be specifically identified as belonging in investing or financing activities. Companies can report cash flows from operating activities under either the direct or indirect method. Although the rules encourage companies to follow the direct method, the vast majority of companies follow the indirect method. [TI 1/13, p. 37]
The meeting materials identified two areas in which better display might assist you. First, perhaps it could assist you in the identification of unusual or nonrecurring cash flows. Second, better display on the cash flow statement might improve your insight into the company's business. The meeting materials provided some ideas in each of those categories. We are interested in your reactions to those ideas, and other ideas that you have about display on the cash flow statement. [TI 1/13, p. 37]
Participant I-11
There is some appeal to getting the distinctions you get from the direct method, but to talk about cash received from customers and cash paid to suppliers and employees is worthless. I don't care about that; I do care about what's happening with receivables, with inventory, with depreciation. So I understand why the companies are opting for the indirect method. [TI 1/13, p. 37-38]
Committee/Staff/Observer
Does it help you if you tie the cash flow statement and the information you get from the direct method together with the comments made earlier about income statement display? Comments about the cash and noncash charges and the nature of expenses, for example. [TI 1/13, p. 38]
Participant I-11
Some of the information about the direct method, other than cash paid to suppliers and employees and cash received from customers, is useful information to have, but that's less useful to me than understanding more clearly where that cash is going. [TI 1/13, p. 38]
Participant I-8
I prefer the indirect method. [TI 1/13, p. 38]
Participant I-15
I prefer the indirect method also. [TI 1/13, p. 38]
Committee/Staff/Observer
What if we had the operating section of the cash flow statement look just like the P&L does? Would that be useful? [TI 1/13, p. 38]
Participant I-5
That's fine. [TI 1/13, p. 38]
Participant I-11
It might but I don't know; I've never seen one. [TI 1/13, p. 39]
Participant I-12
I haven't seen a meaningful cash flow statement for a financial company yet. We're starting to see much more transactions that have accretions. So you have phantom income these days, as well as amortization, and that needs to be highlighted. We would like to know what that is. [TI 1/13, p. 39]
Committee/Staff/Observer
I have two questions in the area of cash flows. One, I'm wondering if you make adjustments in an attempt to arrive at free cash flows? And if you do, how do you define free cash flows and would you find a common definition of free cash flows helpful to you? [TI 1/13, p. 39]
Participant I-8
You have to start with an estimate of earnings and capital expenditures. Your estimate of earnings has an assumption of revenue. So, how much working capital, based on historic ratios, do I need and how much dividends will I pay? Everything else is free cash. Then, you have to say whether you want core free cash flow or something else. [TI 1/13, p. 39]
Participant I-12
It's reminiscent of the LDC loan loss reserve where [name deleted] set aside billion of dollars, and it looks like something like a third of that is going to have to come back into the income statement at some point. It's a similar issue. [TI 1/13, p. 40]
Committee/Staff/Observer
The second question is: would you find cash flow per share useful? [TI 1/13, p. 40]
Participant I-14
Where would you put this? I would find putting it in the front page very dangerous, because we're not the only people who read annual reports and unless you want to say it's only for people over 21 . . . That's just a dangerous number to have floating around. [TI 1/13, p. 40]
Participant I-8
For example, for a leasing company, if you only put gross cash flows and not consider capital expenditure, you are going to get terrible distortions. It's dangerous if somebody tries to use that number without understanding the implications of the different businesses. [TI 1/13, p. 40]
Committee/Staff/Observer
Would you prohibit it, as is currently prohibited, or would you allow companies to disclose it? I'm thinking of a company that has a lot of acquisitions and amortization of intangibles is a big number. [TI 1/13, p. 40]
Participant I-8
We had a lot of that discussion when we talked about acquisitions and how you account for them. What came out was we will make that adjustment; it's easy. [TI 1/13, p. 40]
Committee/Staff/Observer
And you take it one step further and compute a per share basis? [TI 1/13, p. 40]
Participant I-8
We do. [TI 1/13, p. 40]
Participant I-5
I would like to get quarterly cash flow statements in 10-Qs, just for the three month period. [Also included in 11(b)] [TI 1/13, p. 41]
Participant I-7
Every company should be required to issue 4 quarters of information, the final quarter specifically. [Also included in 11(b)] [TI 1/13, p. 41]
Participant I-11
And the quarter should include the quarterly cash flow. [Also included in 11(b)] [TI 1/13, p. 41]
Participant I-12
And we need to have a reconciliation between the annual report and the four quarters. [Also included in 11(b)] [TI 1/13, p. 41]
Participant I-5
I feel passionately about providing quarterly information including the fourth quarter and each quarter's cash flow statement. [Also included in 11(b)] [TI 1/13, p. 42]
[Context] Meeting of the Investor Discussion Group on March 17, 1993. Part of the meeting was devoted to the topic of interim reporting. During the discussion, comments were made on interim cash flow statements.
Participant I-12
The big difference between the two is cash versus accrual accounting. If we had quarterly cash flow statements, a lot of these factors would be captured; for example, the compensation example, the advertising example, the repair example. We would know that the particular event happened in a specific quarter but we would also have statements that would allow us to do the trend line analysis that is essential to our work. [Also included in 11(c) and 11(d)] [TI 3/17, p. 45]
__________
Participant I-12
Like [participant I-11], I would tend to lean toward the integral approach [of interim reporting] if I could get quarterly cash flow statements. [Also included in 11(c) and 11(d)] [TI 3/17, p. 47]
Participant I-5
I would be leaning toward the integral approach with greater disclosure, particularly if you can build the disclosure through the cash flow statement. But if you take away the cash flow statement, then I switch and go with the discrete method. [Also included in 11(c) and 11(d)] [TI 3/17, p. 47]
[Context] Meeting of the Creditor Discussion Group on December 8, 1992. Part of the meeting was devoted to the topic of creditors' objectives and approaches. During the discussion, comments were made on display.
Participant C-2
I would like to see direct method cash flow presentation, for cash from operations. The gross cash flows are very important to us, and the indirect method does not let you get at those with any source of comfort. You can back into them mathematically and assume that the number you get mathematically is equivalent to cash flows, but I think a direct method cash flow would be a big improvement for presentations. I would put that first as my first priority. I think we can get at disaggregated information a lot of times in our dealings with our borrowers, but getting the direct method cash flow as part of an audit or reviewed statement is important. [Also included in 15] [TC 12/8, p. 27]
__________
Participant C-5
I think the direct method of cash flow reporting is something that I think is overdue. We end up reconverting everything that we receive on a cash flow format. So that's just a simple one of format and readability and understandability that I think would go a long way. I don't know how to emphasize that enough. [Also included in 1(b)] [TC 12/8, p. 40]
Committee/Staff/Observer
I'd like to follow up on that. When we've had FASB 95 out for five years, most users and most preparers and auditors use the indirect method. I've tried to challenge in my own practice why I should go the direct method, and I'd love to understand what the information content is there that you're looking for? [Also included in 1(b)] [TC 12/8, p. 40]
Participant C-5
For me, I'm a financial analyst as well as an accountant, and I think the source of the information is more fitted to the indirect method, but the use of the information is fitted to the direct method. [Also included in 1(b)] [TC 12/8, p. 41]
Participant C-1
The only comment I have on direct versus indirect cash flows is that I've had one company report both. It's very nice to have direct cash flow. The problem is that you can never jibe the two, it never worked, and there was always a different number for direct versus indirect, and they were never consistent. [Also included in 1(b)] [TC 12/8, p. 42]
[Context] Meeting of the Creditor Discussion Group on February 2, 1993. Part of the meeting was devoted to the topic of display.
Committee/Staff/Observer
There are two questions here about the detail included in a cash flow statement. And the format of that cash flow statement. Is the format question an important question? What does the current indirect format, which is acknowledged to be the one that is highly used, failed to do for you the direct format would solve? And would you want the cash flow information in the same level of detail as the income statement, including identifying non recurring and unusual items separately? [TC 2/2, p. 21-22]
Participant C-5
I am a strong proponent of getting cash flow information in a different format than we currently get it. I didn't hear anybody suggest at the last meeting a full cash income statement. But it sounds like a nice proposal. I need more and a better format for cash flow; in a comparable income statement format on a cash basis would be probably the only way to do it. Then the question is again, cost. And I've got to be fair to the borrowers who I've worked with that "am I demanding too much?" and "is there a cheaper way to get it?" I wouldn't expect it to be a high cost approach to the problem. It clearly would be a satisfactory approach. We still are going to end up converting statements prepared under the indirect method to the direct method. We start with the EBIT line and work our way down to a OCF type of number (operating cash flow) which is prior to working capital changes, then a supplemental analysis of the effects of working capital changes on cash flow ultimately coming to a cash from operations. And then working into our understanding of the demands on cash flow, that being interest and fixed charges, what we consider investing, financing activities. Where we end up with cash flow, I think we understand it well, but it's just we have to do a lot of work. [Also included in 2(d)] [TC 2/2, p. 22]
Committee/Staff/Observer
[Participant C-13] are you at a disadvantage vis-a-vis [participant C-15] in terms of what you have in front of you to work with? Do you go ahead then and do reformatting? [TC 2/2, p. 22]
Participant C-13
We try. It's frequently not possible based on current disclosures. [TC 2/2, p. 22]
Committee/Staff/Observer
When you're reformatting or are you reformatting working toward the EBIT line? Or were you trying to reformat first to get to a direct kind of format? [TC 2/2, p. 22]
Participant C-13
To get to a direct kind of format. We then try and do the operating cash flow that [participant C-5] talked about. That's what we're trying to establish. [TC 2/2, p. 22]
Participant C-14
Under the indirect method, we use the investing and financing activities segments because they're pretty well laid, but cash flow from operations is not adequate. We never see the direct method among the companies that we rate. For the purpose of analysis, the cash income statement [participant C-5] mentioned would be the most useful. Short of that, we would be as [participant C-13] says making adjustments to the indirect statement. There we go to any debt, plus we take out the applicable expenditures- capital, cash taxes, etc, and getting an operating cash flow. [TC 2/2, p. 23]
Committee/Staff/Observer
Some accountants would argue that the indirect versus the direct conversion is a work sheet activity. That is, if I have the number, I can essentially squeeze the differences and I can get to the direct format from the indirect. So it's just a mechanical process. Apparently, [participant C-14], you and [participant C-13] believe that there's an information element that must be different? [TC 2/2, p. 23]
Participant C-14
I don't think I can get cash paid to suppliers. [TC 2/2, p. 23]
Committee/Staff/Observer
Well, for example, one could argue that the change in accounts payable, if the trade payables are separately shown, the change in trade payables during the year plus the change in inventory cost of sales at least would give you that. It is a mechanical process. [TC 2/2, p. 23]
Participant C-13
The problem that rises is that there is far too many statements where trade payables are not shown separately or there is an "other" caption. [TC 2/2, p. 23]
Participant C-2
I understand that some proponents want to generate them purely through a mathematic process, but there is the assurance notion also. I think the point was made that the investing and financing activities sections are useful as they're presented and that's because they're presenting gross flows. The operating segment on the indirect method is purely a reconciling item and it doesn't give anywhere near the same usefulness I would say that being able to isolate cash paid suppliers would certainly be useful. [TC 2/2, p. 23-24]
Participant C-4
A component that would be good for our use would be assessment of the gross profit collected in the cash flow statement. Also, non recurring items are very hard to determine under the current direct method. We do find the information provided under the indirect method very useful though, and many times they're reconciling back to the direct method. [TC 2/2, p. 24]
Committee/Staff/Observer
Can somebody help me understand the information content in the numbers that you talked about under the direct method: collections from customers and cash paid to suppliers as opposed to the income statement numbers and as opposed to the indirect method? [TC 2/2, p. 24]
Participant C-2
We're interested in knowing what the actual cash streams are. Also, for bankers in any case, generally, it's the gap between those revenues that are reported as sales and the actual collections that called is upon to finance the sales or to the extent the cash stream is sufficient to support the operations. [TC 2/2, p. 24]
Committee/Staff/Observer
Doesn't that show up in those changes in the working capital number, changes in receivables, and changes in payables? [TC 2/2, p. 24]
Participant C-5
With sales, and beginning balance, you can work into it. They're strictly work sheet calculations you can make for that and it's reasonable to assume that those disbursements have been made, that all sales have been collected unless they've been charged off as uncollectible receivables. We live with it. We don't live as much with the concept of how much is actually paid to suppliers, as opposed to is trade being kept current or are they being dealt with properly? Probably it's more the status of current trade as opposed to what's the total flows to trade both in and out. [TC 2/2, p. 24]
Participant C-2
I think it's useful in understanding the business's operation particularly in looking at those trends over time, the differences between the accrual and the cash gross profit levels and if you don't have that cash paid to suppliers you can't isolate that. [TC 2/2, p. 25]
Participant C-17
There are other items appearing and sometimes lumped in the receivables, from year to year, particularly for smaller firms.
Participant C-5
One of the concerns you have in this is whether the flows have really been audited themselves. If the direct format is used, there's more of a sense that there's a verification of the gross cash flows included in the statement. Maybe it gives you a higher level of comfort. [Also included in 17(a)] [TC 2/2, p. 25]
Participant C-11
I have use gross cash receipts and disbursements so infrequently because I've seen it so infrequently. I'm not saying that there's value or not; I don't know because I rarely ever see it. [TC 2/2, p. 25]
Participant C-2
I think because banks have used a model that tries to get at this for a long time, coming out of the recession and the early 1970's, that bankers are accustomed to working with this information. [TC 2/2, p. 25]
Participant C-15
To what end? What are you able to identify? [TC 2/2, p. 25]
Participant C-2
What we're trying to understand is the differences between the accrual cycle and the cash cycle to the point where companies have to be willing to step in and finance their cash. It may help us understand how the company is financing its cash requirements, and how it's matching up with its finances against what its needs are- short term needs, long term needs, etc. [TC 2/2, p. 25]
Participant C-11
I have a subsidiary point to make on the indirect method. Often times, the item lumped together is depreciation and amortization. I think that there's a real absence often of good data, both in terms of what the amortization is, as opposed to depreciation of equipment. And also in a footnote context the time period for the amortization. Everyone knows that there are now new capital ratios that give different weighting allowances for goodwill of different types. And it's astonishing to me that still very well recognized companies do not disclose goodwill at all in the published financials. So I think a lot more weight has to be put on differentiating those items than has been the case. [Also included in 5(a) and 7(a)] [TC 2/2, p. 26]
Participant C-15
I think the concept of free cash flow was mentioned earlier. I think that would be important to be able to really work it in, I'm not sure whether it's best under the direct or the indirect method. I'm not very familiar with this direct method. It seems real nice and it's very logical, as we see interest paid, cash receivable from customers, cash to be paid to employees, etc. It's very user-friendly I think. It would be more helpful if we could get additional information such as a better breakdown of cash and expenditures, what is considered to be normal maintenance, expansion; that's the value of this. [TC 2/2, p. 26]
Participant C-14
The user-friendly nature of the direct method is appealing. We all are somewhat savvy users of financial statements. But someone with less experience, it just makes sense. You get the cash in, you pay the cash out. You look at the indirect method, you look at reconciliations of net income to cash that just doesn't provide a lot. [TC 2/2, p. 26]
Participant C-2
It's not cash flows, it's not the actual flows. It might be information about cash. But it certainly isn't trailed as far as it should go. [TC 2/2, p. 26]
Participant C-5
The direct method gives you more of the grosses. From the bank's standpoint, we do get to free cash flow or operating cash flow and that is never disclosed. The most common use of cash flow is to come to a free cash flow number for the investment community. And rather than have everybody in the world calculate it out themselves, it could be a good idea to have a supplemental disclosure or calculation of free cash flow. [TC 2/2, p. 26]
Committee/Staff/Observer
Is the thinking there to continue to provide these adjustments to reconcile net income to net cash as supplemental information? Under the current accounting standards, if you choose to make the direct presentation, then a reconciliation to the indirect method is required disclosure within the statement or in the footnotes. [TC 2/2, p. 27]
Participant C-15
If I lost some of the information as displayed under the indirect method, I'd be real concerned. [TC 2/2, p. 27]
Participant C-13
I think I hope you're hearing that we have a strong preference for the direct method including the reconciliation. Then there's a question of what level of detail we need. [TC 2/2, p. 27]
Participant C-5
As [participant C-2] said, there's some assumptions in there, if you don't get the level detail, for example, if you get notes receivable mixed in with accounts receivables, your calculations are going through the roof unless you can then detail out and separate out notes receivable both at the current period and the prior period. [TC 2/2, p. 27]
[Context] Responses to the postmeeting questionnaire to the February 2, 1993 Creditor Discussion Group meeting.
QUESTION 6-Cash flow statement display
a. In general, are you satisfied with current display of information in the cash flow statement?
3 _ Yes 10 _ No
b. If NO in 6a, please indicate your preference for the following: (if you checked YES in 6a, please go to question 6c).
enter
H, M, or L
as in question 4b
____H-8,M-2,L-2 Display the operating portion of the cash flow statement like a cash basis income statement. That is, the captions in the cash flow statement would be the same as those in the income statement.
____H-8,M-3,L-1 Require the direct method (gross cash flows from customers and for major categories of expense) of reporting cash flows from operations accompanied by a reconciliation of income to cash from operations.
Participant C-4: - Let CPAs do the conversion, although we can.
- Continue with adjustments in separate section.
____H-4,M-3,L-4 Include a total titled "free cash flow".
Participant C-18: Have no idea what this means - free from what?
Participant C-13: How defined?
Participant C-4: Analyst job.
____H-6,M-4,L-1 Develop a fourth (separate) category of cash flows to capture cash flows from nonoperating, nonrecurring, or unusual activities.
____H-1 Something else. Please describe.
Participant C-3: Trading activities of financial institutions can be volatile, and should be excluded from operating cash flow.
Participant C-14: This is the area where the most benefit can be achieved.
c. If you prefer the "direct" method of reporting cash flows (the method that displays gross cash flows of revenue and expenses), please indicate the reasons for your preference (If you prefer the indirect method, please go to question 7.). Indicate:
SA Strongly Agree
A Agree
N Neutral
D Disagree
SD Strongly Disagree
The breakdown of gross cash flows into general categories
such as cash received from customers, and cash paid to employees
and vendors provides insight that is not available from the
reconciliation of net income to cash flow (indirect method). SA A N D SD
5 6 1
In concept, the operating portion of the cash flow statement
should look like a cash basis income statement. That is, the
captions in the cash flow statement should be the same as those
in the income statement. SA A N D SD
7 3 2
Participant C-2: Would be ideal, but short of that, some breakdown between direct and period expenses should be required.
Users' primary purpose in analyzing operating cash flows is
to determine free cash flows or sustainable free cash flows. SA A N D SD
7 5
Participant C-2: Yes, as compared to core accrual earnings.
Creditors use gross cash flows as a means of analyzing the "gap"
in cash flows that need financing. SA A N D SD
4 6 2
While in some cases users may be able to convert an indirect
presentation to a direct presentation, the result is unsatisfactory
because the gross cash flow estimates do not segregate cash
flows into useful categories. That is, the change in accounts
payable and accrued liabilities cannot be grossed-up to yield
separate estimates of cash flows for inventory purchases and
payments to employees. SA A N D SD
4 5 2 1
Participant C-2: Can be done as an estimate-however, this type of conversion may not screen out non-cash transactions recorded on accrual statements.
Users prefer the direct presentation because they seek auditor
association with the presented gross cash flows. SA A N D SD
1 2 7 2
Something else. Please describe. SA A N D SD
Participant C-4: It would be helpful to determine gross profit cash flows as well as income. Tie closer to the income statement.
[PMQC 2/2, p. 12-14]
[Context] Meeting of the Creditor Discussion Group on March 11, 1993. Part of the meeting was devoted to the topic of priority of improvements needed in external reporting. During the discussion, a comment was made on display.
Participant C-14
9, 11 and 13. And no particular order. Starting with number 9, display of financial information. We at one time talked about more focus in the balance sheet on liquidity going from maybe differentiating current liabilities rather than just something that matures under one year but get into how much of it is truly interest rate sensitive and how much is reflex roll over or refinancing risk. So I'd want to stress that. And also stress the things we talked about in the cash flow statement. We talked about going to a direct cash flow statement and I'm still in favor of that. 11, core earnings. I think everybody's said enough about that covers my views.
13 (financial instruments); it is very important to find a new way to assess the company's cash flow sensitivity to all those items related to financial off-balance-sheet transactions that are difficult for us to understand as they're presented today. [Also included in 5(b), 15, and 19] [TC 3/11, p. 69-70]
[Context] Responses to the postmeeting questionnaire of the December 9, 1992 and January 13, 1993 Investor Discussion Group meetings.
QUESTION 12--Cash flow statement display
a. In general, are you satisfied with the display of information in the cash flow statement?
Yes 3 No 4
b. If you checked "no" in 12a, please indicate your relative preference for the following items by marking H, M or L in each space (if you checked "yes" in 12a, please jump to question 13).
rank
H, M, or L
as in question 10b
High Moderate Low or no
potential potential potential
Display the operating portion of the cash flow 3 1
statement like a cash basis income statement.
That is, the captions in the cash flow
statement would be the same as those in the
income statement.
Require the direct method of reporting cash 2 1 1
flows from operations (which includes a
reconciliation of income to cash from
operations similar to that currently provided
by the indirect method).
Include a total titled "free cash flow". 3 1
Develop a fourth category of cash flows to 3 1
capture cash flows from nonoperating,
nonrecurring, or unusual activities.
Something else. Please describe.
c. If you prefer the direct method of reporting cash flows, please indicate the reasons for your preference by checking each of the following reasons with which you agree (if you prefer the indirect method, please skip to question 13):
check all
that apply
The breakdown of gross cash flows into general 1
catogories such as cash received from
customers, cash paid to employees, and cash
paid to vendors provides insight about the
company's business that is not available from
the indirect method.
Compared to the indirect method, reporting 1
gross cash flows under the direct method
provides more insight into whether the
company's reported income is "real".
In concept, the operating portion of the cash 1
flow statement should look like a cash basis
income statement. That is, the captions in the
cash flow statement shoud be the same as those
in the income statement. The direct method is
closer to that concept than is the indirect
method.
check all
that apply
It is sometimes not possible to convert an
indirect presentation to the direct
presentation.
Something else. Please describe.
Participant I-12: I rarely use these
statements since they are almost meaningless
for financial companies- therefore I abstain.
[PMQI 12/9 and 1/13, P. 20-22]
__________
[One analyst commented on the] following regarding her approach to securities analysis and financial reporting in general: [Also included in 1(a), 1(b), 6, and 15] [BEAR STEARNS, p. 3]
Prefers the indirect method of presenting the statement of cash flows. (She does not use the condensed cash flow statement that is provided in the Form 10-Qs and believes that it could be eliminated.) [Also included in 1(b)] [BEAR STEARNS, p. 3]
__________
AIMR's Financial Accounting Policy Committee supported development of FAS No. 95 (Cash Flows) believing that the Statement of Changes in Financial Position was an inadequate guide to changes in liquidity. Experience with the standard, however, leads to the conclusion that several provisions of the statement have not worked as intended. It was assumed that the indirect method would enable those who use financial statements to understand how reported net income differs from cash flow and to be able to reconcile the two. It was also assumed that users who wished to prepare a direct method statement would be able to do so using the data provided in the indirect method reconciliation. [AIMR/FAF91, p. 12]
Use of the statement results shows that our assumptions were incorrect. Due to lack of clarity in presentation, use of descriptions such as "miscellaneous," and netting, it is rarely, if ever, possible to use the indirect method to prepare a direct method statement. [AIMR/FAF91, p. 12]
Most analysts, therefore, have reluctantly concluded that the direct method is highly preferable because it clearly shows the sources and uses of cash segmented by operating, investing, and financing activities. Research has also shown that the individual components of cash flow from operating activities have explanatory power superior to that of cash flow from operations. [AIMR/FAF91, p. 12-13]
For this reason AIMR's Financial Accounting Policy Committee last year urged the International Accounting Standards Committee to require use of the direct method while maintaining a requirement to reconcile cash flow from operating activities to net income. [AIMR/FAF91, p. 13]
Under Precept 3 (field test question), we will discuss our belief that analyst participation in field tests could help users, accountants, issuers, and the FASB pinpoint the kind of problems that have arisen in the cash flows and deferred tax areas. [AIMR/FAF91, p. 13]
__________
User Survey Results, Users: The comments made by analysts in the focus group meetings were generally consistent with and supportive of the survey results. Although direct comparisons are not possible, inferences were drawn. The table below presents the main conclusions from the survey with responses from the focus groups: [Also included in 2(b), 2(c), 4, 5(a), 5(c), 5(d), and 13] [KPMG BANK STUDY, p. 39]
Preferred historical cost financial statements supplemented with fair value disclosures [Also included in 4, 5(a), and 5(b)] [KPMG BANK STUDY,
p. 39]
Discussions about cash flow often suffer from lack of uniform definition of terms. The table illustrates S&P's terminology with respect to specific cash flow concepts. At the top is the item from the funds flow statement usually labeled "funds from operation" or "working capital from operation." This quantity is net income adjusted for depreciation and other noncash debits and credits factored into it. Subtract the net increase in working capital investment to arrive at "operating cash flow." [Also included in 1(b) and 1(c)] [S&P, p. 25]
Next, capital expenditures and cash dividends are backed out to arrive at "free operating cash flow" and "discretionary cash flow", respectively. Finally, cost of acquisitions is subtracted from the running total, proceeds from asset disposals added, and other miscellaneous sources and uses of cash netted together. "prefinancing cash flow" is the end result of these computations, which represents the extent to which company cash flow from all internal sources has been sufficient to cover all internal needs. [Also included in 1(b) and(c)] [S&P, p. 25]
The bottom part of the table reconciles prefinancing cash flow to various categories of external financing and changes in the company's own cash balance. In the example, XYZ Inc. experienced a $35.7 million cash shortfall in year one, which had to be met with a combination of additional borrowings and a drawdown of its own cash. [Also included in 1(b) and 1(c)] [S&P, p. 25]
Cash flow summary: XYZ Corp.
($Mil.) Year One Year Two Working capital from oper. (FFO) 18.58 22.34 Dec. (inc.) in noncash current assets (33.12) 1.05 Inc. (dec.) in nondebt current 15.07 (12.61) liabilities Operating cash flow 0.52 10.78 (Capital expenditures) (11.06) (9.74) Free Oper. cash flow (10.53) 1.04 (Cash dividends) (4.45) (5.14) Discretionary cash flow (14.98) (4.09) (Acquisitions) 21.00 0.00 Asset disposals 0.73 0.23 Net other sources (uses) of cash (0.44) (0.09) Prefinancing cash flow (35.70) (3.95) Inc. (dec.) in short-term debt 23.00 0.00 Inc. (dec.) in long-term debt 6.12 13.02 Net sale (repurchase) of equity 0.32 (7.07) Dec. (inc.) in cash and securities 6.25 (2.00)
[Also included in 1(b) and 1(c)] [S&P, p. 25]
[Context] The papers are a summary of a committee and staff members' discussions with selected sell-side analysts from Goldman Sachs.
[One analyst] said the bulk of information in financial statements is used by analysts but not by most individual investors. He would like one number on the cash flow statement that shows the result of operations alone, not changes in the various assets. [Also included in 1(b) and 15] [GOLDMAN, p. 4]
__________
From what has briefly been described of the [foreign] financial analysts' work, there results a series of requirements with regard to accounting data, which are but insufficiently met at present. We have broken them down into . . . major categories. [Also included in 1(b), 2(c), 2(d), 3(c) 4, 5(a), 6, 8(a), 9, 11(b), 11(c), and 15] [BETRIOU, p. 1]
Statements of changes in financial position. They are often published by large groups, but with partially dissimilar presentations and with definitions inadequately standardized. [Also included in 1(b) and 15] [BETRIOU, p. 2]