Unlike in the accrued accounting world, cash flow is an effective way for investors to measure a company’s financial health and operational strength. The whole idea of recognizing revenue when it is realized or realized can be tricky when an investor has to make a financial decision regarding a particular company. By contrast, having a good understanding of where the money comes from and how it is spent is much more useful to an investor. However, calculating and analyzing cash flow is not as easy as finding the difference between what money came in and what money went into a company’s cash register. The problem arises from the tricks companies use to manipulate their cash flow statement. Companies often try to promote the good and hide the bad in their financial reports, which is why the cash flow statement has seen some manipulation over the years. The following explains how this is done.
When looking at a cash flow statement, there are three sections that the inventory is divided into: operating, investing and financing. The most important section for an investor would be the operations section because this is where you can find the money a company generates from its activities. Investors want to see more cash generated from a company’s operations rather than from loans or equity transactions.
Unfortunately, it is not always clear where a company generates its cash from. One way in which the company skews its operations section is through misclassification of inventory purchases. The cost of purchasing stock that will eventually be sold to customers must be classified as an item in the operating section of the cash flow statement. However, some companies disagree and believe that stock purchases are an investment outflow, which will increase operational cash flows. This method of accounting should be questioned because large investment outflows should not occur as part of a company’s normal operating costs.
In addition to misclassifying inventory purchases, many companies capitalize on some spending, increasing a company’s bottom line. When a company activates costs, they gradually write off the cost of an asset in installments rather than taking all costs at once. This allows companies to record cash that goes out as an investment activity because the cash disbursements are considered an investment rather than a deduction from the net income or operating section. As a result, corporate cash flow from operations remains the same and looks much better than it really is.
Next, companies give their operating cash a boost by selling their accounts receivable. This speeds up a company’s cash flow, but it also forces the company to accept fewer dollars than if the company had waited for customers to pay. This action can adversely affect a company’s operations department. The fall in receivables means that more cash has been made in the sale of receivables, but this will give investors the wrong message. By speeding up collections, a business does not improve operations, they just find another way to increase the operations section of the statement.
Another manipulation of the cash flow statement is through accounts receivable. Sometimes there is a significant increase in the items payable to accounts, which means that payments to suppliers are not made. If these debts are left open for a long time, a company receives free financing, which increases the operating section inaccurately.
All of these examples are ways in which companies can easily manipulate their operations department. These examples allow companies to show that they have more money available for operating costs than they actually do. For example, in 2000, Enron reported that it had over $ 4 billion in cash flow from operations, which was in fact exaggerated by $ 1.5 billion.
This manipulation caused Enron’s share value to rise, which in turn led to Enron’s collapse. Another example in 2002, Tyco International delayed paying its executives their bonus in the first quarter to increase the company’s cash flow during the quarter. This move caused the company’s operating cash flow to rise by $ 200 million.
The above examples show how easy it is to manipulate the cash flow statement. This shows that investors should be cautious when looking at this particular financial statement. An investor must be aware of any manipulation that may cause dishonest financial information. Finally, the cash flow statement is the most useful financial statement for an investor, but just as cash easily changes hands, the cash flow statement can be just as easily manipulated.