How do we measure the quality of a panel discussion? If we measure it by the subsequent discussion it generates, the AAA panel on Financial Statement Presentation was definitely a success. Bob Lipe and I had a chance to talk with a number of people afterward, and I thought I would put in my own two cents on what we might take away about the benefits of direct method cash flow reporting. Up front let me emphasize that these thoughts aren’t my own invention; many of them are from analysts who can’t post their own comments or even have comments attributed to them due to their employment contracts.

My key take-away from these conversations is that analysts’ request for the direct method is in part a request for symmetry in how information is displayed/disaggregated across the financial statements, and a way to encourage companies to give equal weight and equal treatment to each of the primary financial statements. GAAP net income is largely an accrual-based number and the income statement disaggregates that accrual-based number into accrual-based line items. Total assets, total liabilities, and shareholders’ equity are disaggregated on the balance sheet into the components that constitute those totals. This lets users identify the sources of those totals and assign different valuations to each asset and liability component if they choose to (especially since many of the line items are measured at historical cost).

For some reason, operating cash flow under the indirect cash flow method does not receive the same treatment. The total operating cash flow number is the only item in the operating section of the cash flow statement that is a true cash-based number. The indirect cash flow statement is an itemized list of changes in the other financial statements that are necessary to get from net income to operating cash flow. As a result, unlike with the income statement, an analyst cannot make judgments about which components belong and don’t belong in a normalized operating cash flow number because the analyst does not know what the operating cash flow cash components actually are! In that regard, operating cash flow is a bit of a “black box.”

I confess, I still find myself wondering how much effect direct cash flow reporting will have on decision making. More information is better—free disposal, and all that–but there are other ways of conveying cash flow information (such as extensive footnote disclosure). One possibility is that a direct cash flow report would focus more analyst attention on cash flows, which in turn would lead to more and earlier cash flow disclosures in earnings announcements, more discussion of in conference calls, and so on. Unfortunately, direct cash flow reporting is so rare in the US, and so abbreviated in other countries (compared to what the FASB and IASB are proposing) that it is hard to infer the benefits of the proposals from existing data.

How do we measure the quality of a panel discussion? If we measure it by the subsequent discussion it generates, the AAA panel on Financial Statement Presentation was definitely a success. Bob Lipe and I had a chance to talk with a number of people afterward, and I thought I would put in my own two cents on what we might take away about the benefits of direct method cash flow reporting. Up front let me emphasize that these thoughts aren’t my own invention; many of them are from analysts who can’t post their own comments or even have comments attributed to them due to their employment contracts.

My key take-away from these conversations is that analysts’ request for the direct method is in part a request for symmetry in how information is displayed/disaggregated across the financial statements, and a way to encourage companies to give equal weight and equal treatment to each of the primary financial statements.  GAAP net income is largely an accrual-based number and the income statement disaggregates that accrual-based number into accrual-based line items.  Total assets, total liabilities, and shareholders’ equity are disaggregated on the balance sheet into the components that constitute those totals. This lets users identify the sources of those totals and assign different valuations to each asset and liability component if they choose to (especially since many of the line items are measured at historical cost).

For some reason, operating cash flow under the indirect cash flow method does not receive the same treatment.  The total operating cash flow number is the only item in the operating section of the cash flow statement that is a true cash-based number.  The indirect cash flow statement is an itemized list of changes in the other financial statements that are necessary to get from net income to operating cash flow.  As a result, unlike with the income statement, an analyst cannot make judgments about which components belong and don’t belong in a normalized operating cash flow number because the analyst does not know what the operating cash flow cash components actually are!  In that regard, operating cash flow is a bit of a “black box.”

I confess, I still find myself wondering how much effect direct cash flow reporting will have on decision making. More information is better—free disposal, and all that–but there are other ways of conveying cash flow information (such as extensive footnote disclosure). One possibility is that a direct cash flow report would focus more analyst attention on cash flows, which in turn would lead to more and earlier cash flow disclosures in earnings announcements, more discussion of in conference calls, and so on. Unfortunately, direct cash flow reporting is so rare in the US, and so abbreviated in other countries (compared to what the FASB and IASB are proposing) that it is hard to infer the benefits of the proposals from existing data.