In an era of full disclosure, what about cash? Given the ever-mounting investor interest in cash flows, companies should be making a concerted effort to provide such information in their quarterly earnings releases.

Charles W. Mumford, author of The Financial Numbers Game: Detecting Creative Accounting Practices, was clearly on to something when he wrote that "profit is an opinion, but cash flow is a fact." Indeed, there are countless examples of growth companies that generated impressive increases in earnings per share for a sustained period while operating cash flow was negative or negligible before suffering catastrophic earnings disappointments, costing shareholders billions of dollars in losses.

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Lucent Technologies and Nortel Networks Ltd. come to mind as former telecom high-fliers that reported a string of better-than-expected earnings that far exceeded underlying performance in operating cash flow. In each instance, the companies imploded when the telecom industry stalled and their stretched balance sheets became too much to handle, resulting in billions of dollars in writedowns of inventory, accounts receivable and other charges.

Wall Street was taken by surprise, in large part because the companies' cash flow statements--where the warning signs existed--weren't released until weeks after their quarterly earnings press releases (Lucent also did not include a balance sheet in its quarterly earnings releases at the time). Consequently, investors reacted positively to the limited available information each quarter. To their credit, today both Lucent and Nortel each issue a full income statement, balance sheet and cash flow statement in their quarterly earnings releases.

What is striking, however, is that Lucent and Nortel remain the exception in corporate America. According to PR Newswire, just 39 percent of Fortune 500 companies issued a cash flow statement in their earnings press release during the first quarter of 2004, albeit a modest improvement from 35 percent a year ago. The percentage is believed to be far lower among small- and mid-capitalization companies.

In light of the considerable advances in disclosure practices in the post-Enron era--Regulation Full Disclosure, The Sarbanes-Oxley Act, accelerated 10-Q filings, disclosure committees, etc.--it is counterintuitive that corporations still withhold such a material measure of business performance.

Lou Thompson, president and CEO of the National Investor Relations Institute, notes that NIRI's Standards of Practice for Investor Relations "recommends that corporations provide a cash flow statement in their earnings press release whenever possible. Investors clearly want this information." Thompson adds that disclosing cash flow statements in press releases "is becoming a very important topic" that merits increased attention.

Increasing Focus for Wall Street

After being scalded by a slew of corporate bankruptcies--including fiascos at Enron Corp., Sunbeam Corp. and Global Crossing Ltd. in which warning signs were most evident in their cash flow statements--the investment community has tempered its fixation on earnings per share in favor of a greater reliance on cash flows. Cash flow from operations is increasingly viewed as the best measure of business performance because it can't be easily manipulated by adjusting reserves or through creative interpretations of generally accepted accounting principles (GAAP) accounting.

"Every number that is going to be in the 10-Q needs to be in the press release," says Larry Haverty, an institutional money manager with State Street Research & Management Co. "The easiest way to see what's going on with the business is in the cash flow statement. Any company that is issuing just an income statement, without a balance sheet and cash flow, is doing a major disservice to its shareholders."

Glenn Greene, an equity analyst at ThinkEquity Partners, remarks, "It's absolutely critical that we receive cash flow information for our models." Greene earned accolades from investors for highlighting trouble signs in the cash flow statements of Electronic Data Systems Corp. before the company suffered a major earnings disappointment in 2002.

Michael Markowski, director of research for StockDiagnostics.com, an equity research firm focused exclusively on cash flows, believes that some companies may choose to disguise the poor quality of their earnings by controlling the message, "while the cash flow statement required for analysis is filed much later, without any fanfare."

Public companies, for their part, are to be commended for disclosing more information in their earnings releases than ever. Business segment information was included in more than 80 percent of earnings releases by Fortune 500 companies in the first quarter, according to PR Newswire.

So what barriers prevent disclosure of cash flow information? Discussions with many companies suggest that an extensive internal process required to aggregate cash flow data represents the most troubling hurdle to releasing that data with the earnings release. Since cash flow statements often take a few extra days to compile, that information generally isn't finalized at many corporations until after the earnings announcement. Consequently, these companies are reluctant to include preliminary cash flow numbers in press releases that could change in the period between the earnings release and the subsequent 10-Q filing with the Securities and Exchange Commission (SEC).

Less Information Sooner vs. More Later

If Wall Street's growing demand for cash flow information conflicts with the quarterly timetable for releasing earnings, the natural question becomes: "Which is more important--announcing earnings early or releasing a complete financial report?" State Street's Haverty says, "Somewhere along the line, a lot of companies received bad advice that they needed to report earnings as early as possible. I would much rather wait until the company has all its numbers together, including cash flow, to include in the press release. If [they] need to delay their report, so be it."

Highlighting the importance of analyzing cash flow statements, at a roundtable event for investor relations professionals, Rob Feingold, portfolio manager with David L. Babson & Co., recalled identifying accounting irregularities at Safety Kleen in which accounts receivable day sales outstanding (DSOs) doubled during a three-month period. The discovery was made just ahead of a major earnings disappointment disclosed by the company.

Certain corporations surveyed maintain a practice of disclosing basic elements of the cash flow statement verbally during their quarterly earnings conference calls, including: depreciation, amortization, capital expenditures and, in some cases, estimated cash flow from operations. It is noteworthy that, by not including the cash flow measures in their earnings releases, their disclosure practices are at odds with the New York Stock Exchange's Timely Alert Policy. The NYSE requires the use of a press release issued by a major wire service when disclosing material information.

On the other hand, Nasdaq recommends that material information be included in a press release, but the exchange permits the disclosure of material information on public conference calls--provided that the company advises Nasdaq in advance of the material information it intends to disclose during the call.

Some companies might question whether cash flow measures such as depreciation, amortization and operating cash flow are material. The answer is an unequivocal "yes." NIRI's Standards of Practice for Investor Relations stipulates that corporations should apply the legal definition of materiality adopted by the U.S. Supreme Court in TSC Industries Inc. v. Northway Inc. as the standard for materiality under SEC rules 10b-5 (antifraud provisions):

"There must be a substantial likelihood that the disclosure of an omitted fact would have been viewed by the reasonable investor as having significantly altered the "total" mix of information available.... Information is material if there is a substantial likelihood that a reasonable shareholder would consider it important in making an investment decision." Cash flow measures clearly meet this threshold as a material disclosure.

Benefits for Disclosing Cash Flows

While the rigors of financial reporting continue to escalate for corporate financial executives and investor relations officers, there is a bright side. James Lucas, managing director for investor relations consultancy Abernathy MacGregor Group, argues that "disclosing cash flow statements is one way for smaller corporations to differentiate themselves at a time when it is very difficult for small-cap companies to gain sponsorship, particularly among brokerage analysts."

Similarly, FedEx Corp., a Standard & Poors 500 company, has earned praise for disclosing cash flow statements in quarterly earnings announcements and for narrowing the gap between its 10-Q and earnings release to a few days through internal reporting efficiencies. According to Jim Clippard, FedEx's vice president of investor relations, "In the context of improved disclosure and greater transparency, including cash flow in our earnings release has helped increase investor confidence in our guidance, as well as in the analyst's estimates by giving them the tools they need to do their jobs."

Without question, such disclosure in earnings releases promotes greater transparency and provides investors and analysts with the critical data they need to enhance shareholder value. It is in the best interests of corporate America to raise the bar for corporate disclosure by including this important data within every quarterly earnings announcement.

RELATED ARTICLE: Cash Flow Disclosure

BENEFITS

Improved transparency

Differentiation with peers that don't disclose

Better rapport with investors

Permits more accurate analyst modeling

DIFFICULTIES

Difficult internal process to aggregate data

Lack of coordination with 10-Q filings

Exchange discrepancies over verbal vs. written notices

Uncertainty about materiality thresholds

Erik Randerson is Director of Investor Relations for online banking provider Digital Insight in Calabasas, Calif. He can be reached at [e-mail] or 818.878.6615.