FSA: Accounting Shenanigans (CFS)

Question 1

Stretching out payables =

Answer 1

unsustainable method of increasing operating cash flows, by delaying payments to suppliers

examine ‘number of days’ sales in accounts payable’

Question 2

Financing accounts payable =

Answer 2

use of financing to pay accounts payable (ie purchase of inventory on credit, and use of short term financing from a third party to pay off the accounts payable when it is due)

operating cash flow DECREASES (accounts payable [L] decreases)

financing cash flow INCREASES (short term debt [L] increases)

TOTAL CASH FLOW IS UNAFFECTED

when the ST debt is paid off, an outflow of financing cash flow occurs.

Question 3

Securitizing accounts receivable =

Answer 3

borrowing against accounts receivable - the inflow of cash is FCF

securitizing accounts receivable - the inflow of cash is OCF

Accelerating OCF like this is not sustainable - AR are limited

securitizing AR: possibility of recognizing a gain (difference between book value and fair market value) when securitized AR is sold

GAAP: no rule about where gains are reported (some firms report gains as revenue (more aggressive), others reduce operating expenses by the gains, or report as part of non operating income)

Question 4

Repurchasing stock to offset dilution =

Answer 4

cash received from options exercised and cash paid for stock repurchase are FCF

exercise of options has a tax benefit, and thus increases OCF (less taxes paid?)

Analyst should: move the cash out flow to OCF rather than FCF, to better represent the substance of the transaction.

As employee stock options are part of compensation, analysts should subtract the cash outflow from operating cash flow to recognize the true cash cost of options based compensation.