When you review a company's balance sheet or income statement, you run into a breakdown of cash flow. Ostensibly, the cash flow is the difference between how much money is generated versus how much is spent in operations. However, it isn't always that straightforward. Companies are fully aware that investors and lenders are monitoring their cash flow statements. Accountants sometimes manipulate cash flow to make it appear higher than it otherwise should. A high cash flow is a sign of financial health. A better cash flow can result in higher ratings and lower interest rates. Companies often finance their operations by raising equity capital or through debt, and it is extremely useful to be able to present a healthy company. Study a company's cash flow under its operating cash flow entry. This is in the cash flow statement, which is presented after the income statement and the balance sheet. Operating cash flow can be distorted in several different ways.

Changing Accounts Payable

Accountants have to determine when to recognize payments made by the company, which are recorded under accounts payable. Suppose a company writes a check and does not deduct that payable amount before the check is actually deposited, allowing the funds to be reported instead in operating cash flow as cash on hand. Another technique that a company might use involves paying overdrafts. Generally accepted accounting principles allow overdrafts to be added into accounts payable and then combined with operating cash flow, making it appear larger than it otherwise should.

Misusing Non-operating Cash

Companies sometimes generate income from operations that are not related to their normal business activity, such as trading in the securities market. These are typically short-term investments and have nothing to do with the strength of the business's core model. If the company adds these funds into its normal cash flow, it gives the impression that it regularly generates more receivables through its standard operations than it actually does.

Accelerate Collection of Receivables / Delay Accrued Expenses or Payables

The working capital accounts are most directly responsible for the reporting of cash flow. Receivables increase cash flow, while accounts payable decrease cash flow. A company could artificially inflate its cash flow by accelerating the recognition of funds coming in and delay the recognition of funds leaving until the next period. This is similar to delaying the recognition of written checks. These are only short-term fixes; by accelerating receivables for the current period, the company is actually reducing them for the next period.

Selling Accounts Receivable

Companies might securitize their receivables, which mean that they sell their outstanding receivables (money that is almost certain to come in but has not yet) to another company for a lump sum, which shortens the length of time that receivables are outstanding. This inflates operating cash flow figures for a short period of time. One method of dealing with potential accounting trickery is by looking at free cash flow (FCF). FCF is calculated as operating cash flow minus capital expenditures, which reveals how much cash flow is actually on hand versus how much is reported. This isn't foolproof, but it is a popular alternative measurement.

  1. How do net income and operating cash flow differ?

    Net income is the profit a company has earned for a period while cash flow from operating activities measures, in part, the ... Read Answer >>
  2. What is the difference between cash flow and fund flow?

    See how cash flow and fund flow differ from each other, and why fund flow can be used very differently by accountants and ... Read Answer >>
  3. What are some examples of cash flow from operating activities?

    Learn about cash flow statement and cash flows from operating activities. Understand how these examples differentiate investing, ... Read Answer >>
  4. What is the difference between a cash flow statement and an income statement?

    Learn how a cash flow statement measures the sources and uses of a company's cash, while an income statement measures a company's ... Read Answer >>
  5. What factors decrease cash flow from operating activities?

    Understand the types of factors that reduce cash flow from operation activities. Discover how declining net income and efficiency ... Read Answer >>
Related Articles
  1. Investing

    Corporate Cash Flow: Understanding the Essentials

    Tune out the accounting noise and see whether a company is generating the stuff it needs to sustain itself. Learn how to read the cash flow statement.
  2. Investing

    Operating Cash Flow: Better Than Net Income?

    Differences between accrual accounting and cash flows show why net income is easier to manipulate.
  3. Investing

    Evaluating A Statement Of Cash Flows

    The metrics for the Statement of Cash Flows is best viewed over time.
  4. Investing

    Free Cash Flow Yield: The Best Fundamental Indicator

    Cash in the bank is what every company strives to achieve. Find out how to determine how much a company is generating and keeping.
  5. Investing

    Cash flow statements: Reviewing cash flow from operations

    Discover why cash flow from operating activities is significant to businesses, and learn the direct and indirect methods for calculating it.
  6. Tech

    Cash Flow Is King: How to Keep it Running

    Why is cash flow so important, and what steps can a business take to improve it?
  7. Retirement

    Picking Retirement Stocks: Dividends vs. Free Cash Flow

    Instead of focusing on dividend payments, a better metric for choosing stocks for your retirement portfolio could be a company’s free cash flow (FCF).
  1. Non-Operating Cash Flows

    Non-operating cash flows are inflows and outflows of cash that ...
  2. Cash Flow

    Cash flow is the net amount of cash and cash-equivalents being ...
  3. Cash Flow From Investing Activities

    Cash flow from investing activities reports the total change ...
  4. Operating Cash Flow Ratio

    The operating cash flow ratio is a measure of how well current ...
  5. Free Cash Flow Yield

    Free cash flow yield is a financial ratio that standardizes the ...
  6. Free Cash Flow Per Share

    On a per share basis, free cash flow per share is cash available ...
Trading Center