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When receivables are securitized, the sponsoring company typically continues to hold an interest, referred to as a retained interest, in the underlying pool of receivables. Retained interests may be considered to be securities that the firm classifies as being held for trading, available-for-sale, or held-to-maturity purposes.

Depending on whether or not they are considered to be securities and how those securities are classified, cash flows arising when retained interests are collected may be reported as components of either investing or operating activities. Collections of retained interests arising from securitizations of customer-related receivables are in-substance operating cash flow and are best considered as such for purposes of analysis.

In this study, we examine reporting practices for retained interests arising when customer-related receivables are securitized. We propose adjustments to operating cash flow when proceeds received from retained interests are reported as investing cash flow.


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According to SFAS No. 95, Statement of Cash Flows, insurance settlement proceeds received that are directly related to investing activities such as the destruction of a building or damage sustained by equipment are to be reported as investing cash flow. Proceeds received from insurance settlements related to property, plant, or equipment are analogous to proceeds received from the sale or disposal of property, plant, or equipment, and hence, should be afforded similar treatment, as investing cash flow.

Companies, however, differ in their treatment of such insurance proceeds. Some companies report them as investing cash flow while others report such cash flows as operating cash flow, potentially distorting cross-company comparisons. Overstatements of operating cash flow can arise when PP&E-related insurance proceeds are included. In this study, we highlight the cash flow reporting practices for insurance proceeds related to property, plant, and equipment and detail the inconsistencies noted.


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Debt financing, such as bonds and notes payable, comes with an interest cost that is incurred by the borrower and paid to the lender providing compensation for the use of funds. When zero coupon bonds are issued, interest is included in the principal amount or face value of the bonds. Although coupon payments are not made during the life of the bonds, the company accrues interest expense on them, which is paid when the bonds are repurchased or redeemed at maturity. Hence, when a company repurchases or redeems zero coupon bonds, it should classify the cash outflow for the repayment of principal amount received from bondholders as a financing use of cash and the amount paid in excess of the principal as operating use of cash.

This study examines the cash flow reporting practices of companies that repurchase or redeem zero coupon bonds. We also evaluate the impact these practices have on the reported cash flows from operating activities. Our results indicate that most companies classify the cash paid towards interest on zero coupon bonds as a financing use of cash. The mean reduction in reported operating cash flow that would be caused by inclusion of interest paid on zero coupon bonds averaged approximately 11%.


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In 2003, the FASB released Interpretation No. 46, "Consolidation of Variable Interest Entities" (FIN 46), which changed the requirements for consolidation of variable interest entities, previously known as special purpose entities. The interpretation was in response to the accounting scandal surrounding Enron in 2001, where off balance sheet partnerships and questionable accounting practices were utilized to hide massive amounts of debt.

The changes for consolidation set forth by FIN 46 require all public companies to reexamine their variable interest entities. As a result, many entities that were previously carried off balance sheet must now be consolidated, resulting in an increase in each company's financial leverage. Faced with a potential increase in financial leverage, companies have dealt with FIN 46 in varying ways including consolidation as required, deconsolidation, liquidation, or a restructuring of variable interest entities to avoid consolidation. This report summarizes the guidance provided in the December 2003 revision of Interpretation No. 46 and examines the effects on leverage for companies that consolidated and those that did not consolidate.


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In February, 2005, the Securities and Exchange Commission directed the Chief Financial Officers of various companies to begin reporting customer-related notes receivable, including sales-type lease receivables, as operating cash flow. The SEC's attention was drawn to this subject, in part, by our April 2004 report titled, "Cash-Flow Reporting Practices for Customer-Related Notes Receivable." In that report we identified various companies who reported as investing cash flow changes in customer-related notes receivable and sale-type lease receivables. Following the SEC's action, these companies will now report changes in the balance of these receivables in the operating section of the statement of cash flows. This update reviews the impact of the SEC's action on the operating cash flows of the companies included in our original report.


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Noteworthy growth in free cash flow has been well reported over the past few years as company management, financial analysts, and investors increasingly focus on cash flow to validate reported earnings. Unfortunately, the calculation of free cash flow has limitations, just like earnings. For example, as capital expenditures decrease, free cash flow increases by the same amount, and vice versa. Thus, a temporary reduction in capital expenditures could cause reported free cash flow to increase in an unsustainable way.

This study examines growth in adjusted operating cash flow (operating cash flow adjusted for nonoperating and nonrecurring items), adjusted free cash flow (similarly adjusted), and capital expenditures for the non-financial firms of the S&P 100 for the years 2000 through 2003. The objective is to measure the extent to which growth observed in adjusted free cash flow is derived from operations or through reductions in capital expenditures. Our results indicate that reductions in capital expenditures have been an important contributing factor to the growth observed in adjusted free cash flow in recent years.


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In our April 2004 report, "Cash-Flow Reporting Practices for Customer-Related Notes Receivable," we expressed the view that firms who reported as investing cash flow changes in customer-related notes receivable, including sales-type lease receivables, were reporting in a way that appeared to be inconsistent with generally accepted accounting principles. Recently, the Securities and Exchange Commission sent a letter to the CFOs of numerous firms who were following such practices. In the letter the SEC indicated that these firms were violating GAAP, and it called for them to begin reporting such cash-flow activities as operating cash flow. This update reviews the points raised in our original report and highlights the names of several affected firms who we think could show material changes, including both sizable increases and reductions, in operating cash flow.


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The Free Cash Dividend Payout, calculated by dividing common dividends by adjusted free cash flow, provides useful insight into the relationship between cash flow and dividends and a company's ability to pay them in the future. As the dividend payout increases consistently through time it indicates that dividends are growing faster than adjusted free cash flow. In this case, the dividend being paid might not be sustainable and is at risk for decline. When the dividend payout decreases it indicates that adjusted free cash flow is growing faster than dividends. As a result, the dividend being paid is safer and is a potential candidate for increase.

This study calculates the dividend payout using adjusted free cash flow for the non-financial firms of the S&P 100 for the years 2000, 2001, 2002, and 2003. Adjusted free cash flow was calculated by subtracting capital expenditures and preferred dividends from operating cash flow adjusted for nonoperating and nonsustainable items. Adjusted free cash flow is more sustainable than free cash flow computed using company-reported operating cash flow and as such, a better indicator of cash available for dividend payment. Insights are provided into possible changes in corporate dividend policy at several firms.


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Cash Flow Trends and Their Fundamental Drivers:Comprehensive Review (Quarter 1, 2012)

FREE CASH MARGIN INDEX: