Making the case for revisiting companies’ cash flow statements.

  • Making the statement of cash flows more relevant would be a triple win.
  • For analysts, it would help us to better understand the business and forecast cash flows.
  • For companies, better disclosure tends to be rewarded by the market.
  • For society at large, capital markets would be more efficiently priced.

Analysts spend a lot of time scrutinizing trends in turnover, profit and cash. Arguably, cash is paramount, because the fundamental question for any investor is how much to pay today in return for cash flows expected in the future. Given the importance of forecasting cash flows, one might expect the statement of cash flows to be extremely helpful. Unfortunately this is not the case. In fact, I would argue that the current accounting standard IAS 7, which prescribes how to present information in a statement of cash flows, urgently needs to be revisited to make it more relevant.

In my opinion, there are two main problems with the cash-flow statement: confusing subtotals and excessive aggregation. I would like to propose some improvements.

Confusing Subtotals

Companies often use different definitions for operating, investing and financing cash flows, hindering comparability. For example, sometimes interest received is classified as an operating cash flow, and sometimes it is classified as an investing cash flow. Personally, I don’t mind what the accounting classification is; what I really need to know is where to find the information. As an analyst, I exercise my own judgement as to how much interest received should be classified as an operating cash flow on a company-by-company basis. I therefore welcome the proposals in the IASB’s (International Accounting Standards Board) Exposure Draft (ED) General Presentation and Disclosures (Primary Financial Statements) to remove optional classifications in the statement of cash flows.

A more fundamental problem is that operating, investing and financing categories are also used in the other primary statements, but they can have very different meanings. For example, in the statement of cash flows, operating cash flow is defined as post-tax, while in the statement of profit or loss, operating profit is defined as pre-tax. Why not define operating cash flow as pre-tax also, and introduce a separate tax category in the statement of cash flows? This would help investors clearly see how much profit is converted into cash. Category labels should be coherent across all the primary financial statements; it is confusing to use the same label for a different concept.

Excessive Aggregation

Investors build their own derived statement of cash flows based on projected statements of profit or loss and financial positions rather than using the company’s statement of cash flows directly. This is because excessive aggregation often makes it impossible to link the numbers in the statement of cash flows to those in the other primary financial statements. Better disclosure is urgently needed to address the problem of excessive aggregation. It should be possible for an analyst to derive the statement of cash flows from the other primary statements along with the additional disclosure in the notes.

For example, depreciation, amortization and impairment charges are often aggregated into a single number within cash flows from operations. For a traditional industrial company, this single number mostly relates to the depreciation of owned assets which is easy to understand and can be compared to capital expenditure. However, for an acquisitive high-technology company, this single number is very hard to interpret because it represents a mixture of very different items: some amortization comes from internally generated assets and some from acquired assets; part of the deprecation comes from leased assets and part comes from owned assets. These different items need to be analyzed separately. Disaggregating this single number from the outside is sometimes impossible, and when it is possible using information from the notes, it is time-consuming trying to find it. Ensuring that material information is easy to find would be helpful not only to analysts, who are under considerable time pressure when preparing for earnings calls, but also to companies, as the market rewards better transparency.

Making the Case for Change

Making the statement of cash flows more relevant would be a triple win: for analysts, it would help us to better understand the business and forecast cash flows; for companies, better disclosure tends to be rewarded by the market; and, for society at large, capital markets would be more efficiently priced.


Your email address will not be published.

Newton does not capture and store any personal information about an individual who accesses this blog, except where he or she volunteers such information, whether via email, an electronic form or other means. Where personal information is supplied, it will be used only in relation to this blog, and will not be collected or stored for any other purpose. Comments submitted via the blog are moderated, and, as a result, there may be a delay before they are posted.

Any reference to a specific security, country or sector should not be construed as a recommendation to buy or sell this security, country or sector. Please note that strategy holdings and positioning are subject to change without notice.

Important information

This is a financial promotion. Issued by Newton Investment Management Limited, The Bank of New York Mellon Centre, 160 Queen Victoria Street, London, EC4V 4LA. Newton Investment Management Limited is authorized and regulated by the Financial Conduct Authority, 12 Endeavour Square, London, E20 1JN and is a subsidiary of The Bank of New York Mellon Corporation. 'Newton' and/or 'Newton Investment Management' brand refers to Newton Investment Management Limited. Newton is registered in England No. 01371973. VAT registration number GB: 577 7181 95. Newton is registered with the SEC as an investment adviser under the Investment Advisers Act of 1940. Newton's investment business is described in Form ADV, Part 1 and 2, which can be obtained from the website or obtained upon request. Material in this publication is for general information only. The opinions expressed in this document are those of Newton and should not be construed as investment advice or recommendations for any purchase or sale of any specific security or commodity. Certain information contained herein is based on outside sources believed to be reliable, but its accuracy is not guaranteed. You should consult your advisor to determine whether any particular investment strategy is appropriate. This material is for institutional investors only.

Personnel of certain of our BNY Mellon affiliates may act as: (i) registered representatives of BNY Mellon Securities Corporation (in its capacity as a registered broker-dealer) to offer securities, (ii) officers of the Bank of New York Mellon (a New York chartered bank) to offer bank-maintained collective investment funds, and (iii) Associated Persons of BNY Mellon Securities Corporation (in its capacity as a registered investment adviser) to offer separately managed accounts managed by BNY Mellon Investment Management firms, including Newton and (iv) representatives of Newton Americas, a Division of BNY Mellon Securities Corporation, U.S. Distributor of Newton Investment Management Limited.

Unless you are notified to the contrary, the products and services mentioned are not insured by the FDIC (or by any governmental entity) and are not guaranteed by or obligations of The Bank of New York or any of its affiliates. The Bank of New York assumes no responsibility for the accuracy or completeness of the above data and disclaims all expressed or implied warranties in connection therewith. © 2020 The Bank of New York Company, Inc. All rights reserved.

In Canada, Newton Investment Management Limited is availing itself of the International Adviser Exemption (IAE) in the following Provinces: Alberta, British Columbia, Ontario and Quebec and the foreign commodity trading advisor exemption in Ontario. The IAE is in compliance with National Instrument 31-103, Registration Requirements, Exemptions and Ongoing Registrant Obligations.