Summary
How should returns from investments be reported in a statement of cash flows? Does it really matter if dividends are reported as investing activities rather than operating activities? This commentary provides investment analysts with insights on how investment returns should be viewed when evaluating cash flows.
Analysis
The article suggests that there is only one “right” way to report distributions made out of earnings by joint ventures or other investment entities: such distributions must be reported as operating cash flows. In fact, the author’s intent seems to be to warn the investment community of widespread “understatements” in operating cash flows due to the misclassification of dividends as investing cash flows instead of operating cash flows.
There has never been complete agreement on this classification issue. In fact, the debate is documented in the paragraphs 86 through 90 of SFAS No. 95, Statement of Cash Flows, with the FASB concluding that a “reasonable case can be made for alternative classification of certain items.” Therefore, even though the FASB’s final rule specifically indicated that dividends should be reported as operating cash flows, this treatment is by no means “bullet proof.” In fact, the international financial reporting standards in IAS No. 7 provide much more flexibility by allowing dividends to be classified in the statement of cash flows as either operating or investing, provided they are separately disclosed, and reporting is consistent from one period to the next.
What does this all mean to the analyst? Operating cash flow numbers must be viewed with caution and subjected to critical evaluation to determine the propriety of components given the unique purpose for which the number is being used. Look at the disclosures and compute your own cash flow numbers given the detail provided. In the case of earnings distributions received from joint ventures or equity investments, these sound like investment cash flows to me, particularly if such activities do not reflect the company’s primary business activities.
