Cash flow manipulation is real

Implications: You can never judge a book by its cover or a seminar by its flier, but Harris Solutions is on to something here.  If you have accepted the SCF as pure and not manipulable, you may very well want to attend to find out more about the sly maneuvers on the fringes of GAAP that pump up the operating cash flow.  A couple of examples appear below.

Analysis: I have come across two companies that have used GAAP idiosyncrasies to make their cash and/or cash flows look better.  If I have found these two through an unsystematic search, there surely are many others.

Hertz:  the trick used by management is to treat what are payments under de facto operating leases for vehicles into investing outflows.  This causes the operating cash flows to be presented at a much larger number while the investing section presents the appearance that management is investing that huge sum in productive assets.  The guise that’s used is repurchase agreements with the car factories in which Hertz “pays” a purchase price and the factor agrees to “buy” the cars back after 10-12 months for a fixed price.  The delta is obviously a cash outflow comparable to rent under a short term operating lease.  What happens is that Hertz calls this differential depreciation and adds it to net income to produce the operating cash flow.  Presto, a huge increase in cash flow!  How big?  In 2006, the SCF shows $2.6 billion of OCF after adding $1.8 billion of depreciation.  Because the depreciation is really paid in cash, the OCF is only about $0.8 billion.

Abercrombie & Fitch:  the management uses a different trick that presents a prettier picture than would appear if they used common sense and understood that their schemes are transparent.  Their guise is to show their outstanding checks at year end as a liability instead of a reduction in the cash balance.  They’ve written the checks against a “zero-balance” account that is technically overdrawn at the balance sheet date, although a deposit is made first thing the next day to take the checking account balance up to zero.  Under archaic rules, overdrawn accounts in one bank cannot be offset against positive balances in another bank.  The result at the end of the fiscal 2006 was a real $60 million cash balance that looked like it was $80+ million.  Worse yet is the impact on the operating cash flows because the change in the outstanding checks is treated as a financing flow, not operations.  Sometimes the result is an exaggerated reported OCF and sometimes it’s diminished.  It could be a trick or just the consequence of ignorantly following old-fashioned rules too closely, but the results (and management) cannot be trusted.

So, yes, it may be worth the time and cost to see what Harris can teach you.