Companies need to supply more cashflow information

Friday 7th December 2001

Comments accompanying financial reports from many New Zealand listed companies are notable for silence on cashflows, particularly operating cashflows.

The matter was discussed briefly in The National Business Review on November 23, during examination of the meat-processing industry. It was noted Richmond went from a positive operating cashflow of $13.2 million in the year ended September 30, 2000, to a negative $29.05 million in the latest year.

Richmond's overall financial position was sound but the preliminary report had no reference to negative operating cashflow.

That was not peculiar to the meat processor. Companies mention strong positive operating cashflows but gloss over negatives.

A four-part statement of cashflows and a supplementary note reconciling cash is included in the Stock Exchange's forms for company reports under listing rules. Companies must provide statements of cashflows related to operating investing and financing activities. The fourth part of the form requires figures for the net increase or decrease in cash held. Those definitions of cashflow can be distinguished from another use of the term, which relates to net profit after tax plus the non-cash item of depreciation.

The statement of cashflows related to operating activities is a vital component of corporate financial analysis because it shows receipts and payments from and for matters associated with the basic business of providing goods and/or services.

A statement of financial performance (the pre-1993 legislation's profit and loss account) is based on accrual accounting. It takes debtors as having paid and creditors as having been paid. Nothing wrong with that, given it comes within the "true and fair view" beloved of auditors when they write their reports.

The danger lies in continuing negative operating cashflows with constant increases in sundry debtors in the statement of financial situation that results in running the business through borrowings (included in cashflows related to financing activities, which includes cash proceeds "from issues of shares, options, etc") to pay for property, plant and equipment (part of cashflows related to investing activities).

I state the obvious because we have a generation of people who gloss over negative operating cashflows. That happened in pre-1987 crash days, although there is no suggestion today's operators are of the same ilk as 1987's wide boys.

Many companies in those days had minimal or no operating cashflow. They built up profit and loss accounts through revaluations of crossholdings in other companies, the latter doing the same with their shares in associates, subsidiaries and their holding companies.

Operations were built on borrowings (cashflow from financing activities) "secured" through leverage of share values.

Generating substantial internal operating cashflow is a key to a company's ability to finance outgoing business and expansion without resorting to substantial borrowings, which could affect the equilibrium of the organisation's assets and liabilities.

The alternative of raising more capital has a downside if there has been continuing negative operating cashflows.

Share prices could have been downgraded, lowering the amount raised through an issue.

Air New Zealand was an example of what could happen, although the company had positive cashflow from operating activities in the year ended June 30, according to unaudited accounts issued in September.

Operating cashflow was down 62.7% over the previous year at $146.31 million.

Investing activities provided $444.91 million from the disposal of assets, operating lease deposits and investments receipts. There was an outflow of $578.29 million, giving a negative $133.38 million. The negative was $670.55 million in the previous year. Net cashflow from financing activities was $56.02 million, compared with $681.9 million in the previous year. It included a net $279.28 million from issue of shares.

The company was unable to service that new capital, irrespective of why. Coupled with other matters, we the people now have control of an airline.

Cashflow analysis is an essential tool in the investment field. Companies should provide shareholders with much more commentary about changes, particularly when operating cashflows decline or are negative.

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