Are you clear about your cash?

15 October 2019

The FRC’s Financial Reporting Lab has issued a Lab Project Report about disclosures on the sources and uses of cash. Highly practical, it explains what information investors are seeking in this area and features many examples of good practice.

Disclosures on the sources and uses of cash

The Lab Report explains that understanding of the generation, availability, and use of cash is fundamental to the investment process because investors use this information both to assess management’s historical stewardship of a company’s assets and in supporting analysis of future expectations.

The Report suggests that disclosures on how cash will be generated and used in the future are often provided outside of the cash flow statement and may be outside of the annual report completely. However, these disclosures are often the most helpful to investors who are seeking to understand an entity’s broader cash position and, therefore, the Report focuses on these supplemental cash flow disclosures.

Greater clarity

The Lab Report sets out the need for a clear description of the drivers of current (and future) performance and position, in the context of cash, supported by appropriate metrics. It explains that many companies give greater attention to performance-focused metrics (such as profit or adjusted profit) with cash metrics featuring more as a supporting or supplementary metric.

Furthermore, the Report highlights that cash metrics and cash generation are often not fully explained. It points out that the most effective disclosures are those where numbers and narrative are combined in a way that shows how future cash generation is underpinned by current cash generation. After this general disclosure, the Lab Report calls for further more detailed disclosures on:

The sources of cash

  • An explanation of how the company’s business model generates cash
  • The drivers of performance that generated cash in the period, and
  • A link to strategy, working capital and risks to allow an assessment of future cash generation.

In this context, the Lab Report suggests disclosures such as:

  • A disaggregation of profit generation by product line, segment or geography and details of the conversion of profit into free cash.
  • Highlighting when businesses within an entity have very different working capital requirements or approaches.
  • An explanation of the entity’s specific approach to financing, such as the use of factoring or reverse factoring.

The uses of cash

  • An explanation of the framework of priorities for the cash generated
  • Information that supports an understanding of the priorities in action, and
  • An acknowledgement of the relevant risks, restrictions and variabilities associated with those priorities.

In this context, the Lab Report suggests disclosures such as:

  • How the entity considers the range of possibilities for future cash use and how it prioritises those different possibilities.
  • The link between the risks facing the company and the outturn in cash generation, use and dividend payment.
  • The restrictions on current or future cash, either through capital or exchange controls, availability of dividend resources or other items.

Good practice

In addition to making clear what information investors are seeking on cash, the Lab Report highlights 23 separate examples of good practice.

In recent months (following the collapse of Carillion) the FRC has been focussing on deals with reverse financing (sometimes known as ‘supplier financing’). The report includes an appendix with some illustrative examples of the nature of disclosures that would be help investors understand a company’s reverse financing position.

Read the Lab Report.

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