“Cinderella” (from Merriam Webster)
- “someone or something that is ignored but that deserves attention or credit”
- “someone or something…that is not expected to do well but that succeeds or wins in a very exciting way”
OK, so maybe the second bullet is a little over-the-top for a financial statement, but you get the point.
Surprisingly, the Cash Flows Statement is frequently ignored by management, considering it as merely the mathematical result of calculating changes in the beginning and ending balance sheet accounts (a stepchild?). Even accountants often do not give it much credit, mostly because (I think) we all remember how, early in our career, we would fear never getting it to balance when we were first assigned to prepare a cash flows statement. Thankfully, clever spreadsheet templates were developed to manage this fear. Although helpful for statement preparation, these spreadsheets encourage focus on the mechanical aspects of the Cash Flows Statement, but do nothing to educate on its usefulness as a management tool.
Strong evidence of even public companies giving the Cash Flows Statement the short shrift was reinforced in speeches at the December 2014 AICPA National Conference on Current SEC and PCAOB Developments, where the SEC noted that cash flows statement restatements have increased over the past 5 years when overall restatements have remained constant. More specifically, only 65 restatements (8.7% of total) were attributable to errors in the cash flows statement in 2009, whereas by 2013, cash flows restatements were 174 (or more than 20% of the total). Notably, the majority of errors were due to relatively less complex applications of GAAP. Somewhat surprising given the regulatory scrutiny of public reporting, but probably more evidence of the general lack of value accorded the Cash Flows Statement.
Is GAAP the problem? Some people think it is, or at least a contributing factor. That is because; unlike in many other areas of GAAP, not much guidance is codified, leaving plenty up to the interpretation of the statement preparers. This condition leads to a wide diversity in practice with respect to classification of certain cash receipts and disbursements. Why is this issue a concern? Because an important data point for financial statement users is cash flows from operating activities – how much cash is the Company generating from normal operations?
In April 2014, the FASB added a project to its agenda to consider certain aspects of the existing cash flows guidance, generally concentrating on clarifying principles on how to classify cash receipts and payments. In addition, FASB staff will research potential additional disclosures that could increase relevance of the Statement of Cash Flows for users. This project remains in the initial deliberations stage.
So what, exactly, is the big deal about Cash Flows Statements? What information can we extract from this statement that is not already reported in the balance sheet and the income statement? And, more importantly, how can we use this information to infer implications about the operational dynamics of a Company from the financial statements it presents?
In the near future, I will post some thoughts on how to get more information from a Cash Flows Statement, and how this statement can help you manage your business. See Part II.