Scrubbing the Numbers

Cleaning up the balance sheet boosts year-end cash flow, but it can leave some messy problems.

The holiday season is not a happy time for many finance executives. While others attend parties and eat turkey, finance departments in companies with a calendar year-end often spend the two months between Halloween and New Year’s Eve frantically ducking check requests, dumping inventory, and chasing collections. The goal: a pretty cash-flow picture on December 31. Finance teams whose final quarter falls in other months may get to enjoy their holidays a bit more, but none of them escapes the annual scramble at fiscal year-end.

One of the easiest ways to beautify cash flow is by reducing days of working capital—a measure of how much of a company’s cash is tied up in payables, receivables, and inventory. Indeed, companies that consistently lower their overall working capital year-over-year are admired as best-practice leaders. But a look at several years of sales adjusted quarterly working-capital numbers, conducted for CFO magazine by London-based REL Consultancy Group, shows a widespread pattern: across industries, net working capital drops dramatically in the last quarter of the fiscal year, only to shoot back up once the annual report has gone to press.

Whether that swing is the result of a deliberate effort, a side effect of other year-end pushes, or a little of both, the upshot is that most corporate cash flows look better on the last day of the fourth quarter than they do at the end of the first, second, or third. While not illegal, such window dressing can be misleading. After all, many of today’s investors, already well aware that earnings tend to spike at the end of the fiscal year, now consider cash flow to be a more reliable measure of company performance.

Enron, of course, proved that cash-flow numbers are not immune to manipulation. But even without outright fraud, it appears that year after year, Corporate America manages its cash flow by adjustments to working capital—delaying payments to vendors, stepping up collection efforts, allowing inventory levels to fall, or some combination of the three. And beyond the potential for misleading investors who focus on cash flow, the annual seesaw in these numbers suggests companies actually could do a better job of managing working capital year-round.

Swingers

Neri Bukspan, chief accountant for Standard & Poor’s rating service in New York, is cautious about drawing conclusions from REL’s results. While the numbers are “interesting,” he says, he notes that many year-end events can affect working capital. For example, he says, a company may keep a collection effort open until year-end tax time forces it to write off the effort for a tax deduction. And, he says, attempts to optimize inventory tend to happen periodically—once a year—so “it makes sense to get rid of most of it before you count.” Companies may also delay purchasing if their warehouse employees are busy counting what’s already there. “There are certain things you do once a year because it’s inefficient to do them every day,” he argues. “You clean the house before Christmas.”

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