Betting on the right cousin

A balance sheet or income statement, most people would intuitively say, is the most important statement reflecting the financial position performance of a company.

But what about the cash flow statement (CFS)? Is it that distant cousin at a wedding party, who is there but does not get attention?

Arguably, CFS is as important as its more illustrious cousins in reflecting the financial performance of a company.

While it is popular amongst some sophisticated stakeholders, CFS still remains enigmatic to a significant population.

To the sophisticated, CFS would be the most important statement.

Enhancing shareholder value Typically, analysts, rating agencies and some key investors use this information effectively to perform valuations.

It would seem rather inappropriate that the remaining stakeholders do not derive as much benefit out of such an important piece of information, which when combined with the balance sheet and income statement, provides an extremely powerful tool to analyse transactions, forecast performance and to an extent gauge risks.

While the income statement shows the profit or loss generated at the end of the reporting period using the accrual concept, CFSshows the cash generated or spent during a period.

Therefore, it is used as a good tool to compare top line growth forecasts with growth in operating cash flow.

With the introduction of complex financial products and business arrangements in the market, understanding the cash flow statement is gaining more relevance as a decision making tool for stakeholders.

But it is not just about stakeholders, even companies can use this tool to demonstrate robustness of their performance.

Increased transparency and comparability in CFS can go a long way in enhancing shareholder value and providing access to cheaper sources of capital.

Guiding principles The accounting standard provides the necessary guidance and principles using which CFS should be prepared. Companies should consider presenting meaningful cash flow information both in their financial statements as well as in their management discussion and analysis (MD&A).

This could be through narratives explaining non-recurring transactions impacting cash flows such as, say, a large acquisition or disposal of business during the year or disclosing the primary reasons for increase or decrease in items of working capital or sources of funds etc.

Thus, both from preparer and user of financial information perspectives, the maximum benefit of CFS is derived from enhanced disclosures. This may not be very easy for those who prepare financial information. Companies often face challenges with their financial reporting processes.

While many have invested in sophisticated Enterprise Resource Planning (ERP) systems, they are seldom utilised to their full potential to enhance financial reporting and building efficiency in the reporting process.

Real-time reporting It is, therefore, important that an evaluation of reporting processes is performed to ensure that information gathering is happening on a real-time basis.

The final translation of this information into the financial statements and MD&A is a critical process, which should be performed with precision and appropriate supervision.

As far as presentation of such critical information goes, there is no bright-line. What is enough is unknown. It would be ignorance to consider cash flow any less important than the balance sheet or the income statement.

Together, they provide invaluable insights into financial performance. It is about having commitment and discipline to enhance financial reporting in order to maximise shareholder value and access capital at lower costs.

(The author is Partner, Price Waterhouse.)

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