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This report examines cash flow trends for the S&P 500 non-financials and the drivers behind those trends. Included are data on selected cash flow measures and their drivers, insights to the cash cycle and recent earnings quality indicator trends. Among the findings noted for the four-quarters ended June 30, 2006 relative to March 31, 2006:

• Core operating cash flow and operating cash flow continued to increase, driven by revenue increases and an improvement in the operating cushion %. The cash cycle, however, lengthened slightly, in-line with seasonal trends.

• Free cash flow declined, even as operating cash flow increased, due to an increase in capital spending.

• The Earnings Quality Indicator declined due to an increase in earnings at a rate that was faster than the observed increase in operating cash flow. Year-end data, calculated to exclude seasonal factors, should be reviewed carefully for definitive trends.

Data for this research was provided by Cash Flow Analytics, LLC. Charles Mulford is a principal in Cash Flow Analytics, LLC.


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In this research report we examine the cash flow classification of distributions received from equity-accounted investments and find some problematic classifications. Distributions exceeded by investee earnings are considered to be returns oninvestment, indicating an operating cash flow classification is appropriate. Distributions that are returns of investment, that is, paid out of capital, are properly classified as investing cash flow. Out of a sample of 107 firms, 70 classify all of the distributions received into operating cash flow. This is not surprising since these investor firms report equity earnings that appear to exceed the distributions received. However, 19 firms classify all distributions received into investing cash flow. For 13 of these firms, earnings exceeded all of the distributions received, suggesting that they too were being paid a return on investment. As a result, the distributions received arguably should be included in operating cash flow. A revision of the operating cash flow of these 13 firms increases their operating cash flow by as much as 107%, with mean and median increases of 16% and 5%, respectively. Direct clarification obtained from some of the sample firms sheds light on the decisions made. However, even with clarification, an operating cash flow classification appears to be more appropriate.

Given the importance of operating cash flow to a firm's performance, the report's findings have implications for analysts and investors who will want to make sure that distributions received are properly classified. Managements and auditors will want to review cash flow classifications for distributions received from equity-accounted investments to ensure accurate reporting.


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In this report, we focus on the financial performance of the average technology firm. The average technology firm is defined using the relative market capitalization of each firm in five general technology groups: Computer hardware & peripherals, telecommunications equipment, computer software, information technology services, and semiconductors and related capital equipment. We focus on cash flow, presenting certain cash flow measures that are analyzed using selected fundamental drivers.

For the average technology firm, core operating cashflow, operating cash flow, and free cash flow declined over six percent in the four quarters ending March 2006 from the four-quarter period ending December 2005. Contributing to the decline in cash flow were a decrease in revenue and an increase in the cash cycle, caused by an increase in inventory days and a decline in payables days. Operating cushion trended higher in the March 2006 annual period, partially offsetting the effects on cash flow of the revenue decline and the cash cycle increase. As such, each of the cash flow measures can move significantly higher if a future increase in revenue were accompanied by a return to earlier levels of inventory and/or payables days.

Data for this research was provided by Cash Flow Analytics, LLC. Charles Mulford is a principal in Cash Flow Analytics, LLC.


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Understanding the extent to which transactions create recurring cash flow is vital to investment and credit analysis. Two measures of recurring cash- operating cash flow and its closely-related metric, free cash-flow- are of paramount importance to a firm's financial performance. In addition to cash flow, the extent to which a firm uses borrowed funds or financial leverage to finance its operations impacts its overall financial health.

In this research report we look at the financial statement effects of customer receivable securitization transactions and their effects on analysis from two points of view - their impact on cash flow and financial leverage. The report includes a discussion of why companies choose to use the securitization tool, how they use it, and what goals they achieve.

Our findings indicate that securitizations can have significant effects on a firm's apparent ability to generate sustainable cash flow and on its use of debt financing.


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With this report, we introduce a series of cash flow indices for the non-financials of the S&P 500. Each index, consisting of cash flow measures and their fundamental drivers, are calculated as a value-weighted average. The objective is to permit us to look closely at the cash flow performance of the S&P and to better isolate the factors underlying that performance. Future reports will look at industry subsets of all public companies, such as technology, biotechnology, and other groups that are of particular interest.

Our analysis of the S&P 500 indicates that counter to recent trends, various cash flow measures were down in the four-quarter period ending December 31, 2005. The decline was driven by decreases in revenue and operating cushion, and by an increase in the cash cycle. Also of note, our earnings quality indicator, EQI, continued a declining trend begun in 2003.

Data for this research was provided by Cash Flow Analytics, LLC. Charles Mulford is a principal in Cash Flow Analytics, LLC.


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Software companies are required by SFAS No. 86 to capitalize certain development costs of software to be sold, leased or otherwise marketed. Capitalization occurs once technological feasibility has been reached and costs are determined to be recoverable.

Capitalization ends and amortization begins when the product is available for general release to customers. These guidelines provide a great deal of flexibility to management in determining "technological feasibility" and amortization parameters.

Differences in management philosophy and judgment in dealing with the requirements of SFAS No. 86 can have a significant impact on both earnings and operating cash flow. In this report we examine how these differences impact reported financial performance and hurt comparability across companies in the software industry.


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The ability of a company to generate sustainable operating cash flow and free cash flow is an important indicator of the company's financial health.

Current treatment of income taxes paid calls for their inclusion in operating cash flow. However, some of these taxes are related to gains on investing or financing items. Their inclusion in operations can cause operating cash flow to be understated.

In this study, we examine 2004 and 2005 financial statements to identify a sample of companies where the effects of taxes on non-operating gains have a material effect on operating cash flow. We found cases where operating cash flow was understated by a significant amount. In one case, the removal of the taxes paid on non-operating gains caused an increase of operating cash flow by nearly forty-five percent. A supplemental table looks at the effects of such taxes on free cash flow with similar findings.


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Cash flow is at the heart of any discussion of financial performance and valuation. Investors, creditors and the analysts who serve them are all interested in whether a firm is generating cash flow and whether that cash flow can be expected to recur. The level of debt retirements, dividends, stock buybacks, acquisitions and investments all require that firms generate discretionary, that is, free cash flow. A careful analysis of the fundamental drivers behind that cash flow can shed much light on whether reported amounts will recur.

In this research report, we look at long-term cash flow trends and carefully examine the fundamental drivers underlying those trends. A supplementary analysis is provided of trends in capital expenditures, dividends, cash balances and market cap. A summary of important findings are presented on page 2.


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