Problems with Statements of Cash Flow

Mistakes in the statement of cash flows is the number two reason for restatements of public company financials filed with the SEC. What’s interesting is these restatements aren’t because the transactions were recorded wrong in the income statement or on the balance sheet, but because there was a classification problem on the statement of cash flows. Have you ever heard or said, “well, that’s only a geography issue” implying that somehow classification was not really critical. Well, tell that to the 168 companies that had to file a restatement because of a problem with their statement of cash flows last year. Face it, geography is critical on the statement of cash flows because geography is what that statement is all about.

A big part of the problem with the cash flow statement is that the original data capture does not consider how the transaction needs to be reflected in the cash flow statement–we don’t differentiate between cash and non-cash transactions and we don’t focus on the accounts that might be split between operating, financing & investing. For example, if you give a long term note in payment for that big piece of equipment that is not an investing activity (the purchase of the equipment) or a financing activity (the issuance of debt), but is a non-cash activity, that needs to be disclosed in the footnote rather than the statement of cash flows itself.

Also certain things need to be reported gross like issuance and payoff of debt, but the information gathered for the balance sheet accounts is often viewed on a net basis. The kicker is that when something goes wrong and you make a mistake on the cash flow statement, that means you also have an internal control deficiency as well. In fact, many companies may want to take a serious look at their controls over their statement of cash flows. Unlike the income statement and balance sheet, the statement of cash flows often has a much more significant portion of manual input, and that manual input often does not get the same level of scrutiny by management as critical judgments on other statements like bad debt rates, impairment tests and contingent liabilities.

The FASB has recently issued an Exposure Draft on how to classify eight cash flow issues. Looking at how your statement of cash flow process may be impacted by these proposed changes may be the perfect opportunity to take a deeper look at the overall process. Are there changes you can make to gather more information up front when the transactions are first added to the general ledger? Are there changes in controls that can be made to better capture non-cash transactions? These are questions we should all be asking, or restatements resulting from problems in the statement of cash flows may move to number one.

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