Tuning In to Cash Flow

We examined the operating cash flow of the S&P 100. Our findings? Surprisingly, there's reason to be optimistic about America's blue chips.

Cheer up, Corporate America. You’re in better shape than you look.

That conclusion stems from a recent analysis of operating cash flow for the large-cap, blue-chip companies that make up the Standard & Poor’s 100 Stock Index. The analysis was prepared for CFO by Charles W. Mulford, an accounting professor in the DuPree College of Management at the Georgia Institute of Technology, with the help of Michael Ely, an analyst in DuPree’s financial analysis lab. It shows that after adjusting for nonrecurring and nonoperating items, operating cash flow for the S&P 100 in 2001 was an average of almost 9 percent higher than reported. That represents a distinct turnaround from the average downward revision of 2 percent that Mulford made to operating cash flow reported in 2000.

To be sure, adjusted operating cash flow for companies at or near the median point of the findings–such as Johnson & Johnson, H.J. Heinz, Black & Decker, The Southern Co., Campbell Soup, and Colgate-Palmolive — was virtually the same as reported both this year and last. But given investors’ skepticism about the integrity of corporate reporting, the fact that more companies’ cash flows weren’t subject to downward revision is reason enough for optimism about the larger picture.

Mulford himself says so, though cautiously. After analyzing the financial statements of each member of the S&P 100 for the past two years to get a clearer picture of their operating cash flow, he says, “I was a little surprised at how many companies looked better, especially in 2001.” Adds Mulford, a co-author of the recently published book The Financial Numbers Game: Detecting Creative Accounting Practices, “Maybe things aren’t as bad as we thought.”

Why focus on operating cash flow when most investors remain fixated on earnings? All things being equal, cash flow presents a clearer picture of a company’s actual performance, simply because it reflects money received and paid out during a given interval, whereas earnings are based on all manner of estimates and assumptions. What’s more, a growing number of companies have been directing investors’ attention toward cash flow from operations, even as more than a few have misreported those results.

Adjusting the Flow

But the need to adjust what companies report as cash flow from operations arises even when they adhere to U.S. generally accepted accounting principles. For one thing, they often draw attention to pro forma numbers in press releases, including and excluding certain items as they see fit. That’s no problem in the eyes of the Securities and Exchange Commission, as long as they also provide GAAP numbers and show how pro forma and GAAP performance can be reconciled.

Even under GAAP, though, exactly which activities should be considered part of operating cash flow is often subject to interpretation, and the result is a range of practices. Technology companies such as Cisco Systems Inc. and Lucent Technologies Inc. have long included tax benefits from stock options in operating cash flow, while Microsoft Corp., at least until recently, included them in cash flow from financing. Reporting practices vary in the same way, and for a much wider universe of companies, when it comes to cash flow generated by the securitization of receivables. Yet with corporate scandals drawing so much public attention, any disconnect between accounting practices and economic reality quickly undermines investor confidence.


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