Cash Flow From Operations- Do We Need Any Other Cash Flow Terms?
Keywords:
case study, financial statements, Sarbanes-Oxley Act, cash flow, cash and accrual accounting, financing activities, reporting requirementsAbstract
Jim Hines, controller, was facing a dilemma. The president of the firm asked him to consider adding two proforma, or non-GAAP, accounting terms to all financial releases and reports. The terms were EBITDA and free cash flow. As an accountant Jim was satisfied with the GAAP reporting, and he did not see a need to add non-GAAP terms to all reports. He had to research the recent requirements on proforma reporting from the Sarbanes-Oxley Act. If a firm used proforma terms, the firm had to reconcile the term to a directly comparable GAAP term, and explain why the term should be useful to investors.
Jim is at the point of writing a report to the president, but he is unsure of the tone of the report, since he knows the president favors proforma reporting. The case is intended for an undergraduate or graduate course in financial statement analysis. The case sets the scene where a non-accountant president is interested in adding non-GAAP terms to the financial reports. At the end of the case, the student must make a choice to add or not to add proforma terms to the GAAP reports. Two widely used pro form a accounting terms, EBITDA and free cash flow, are defined and compared to the GAAP term, cash flow from operations. The student must calculate the terms from the company s financial statements and compare them to cash flow from operations. The basic reporting requirements for the use of proforma terms under the Sarbanes-Oxley Act are introduced.
The case has a growth and a contraction scenario for the firm, and with the application of three cash flow terms, the student should see the vivid difference between cash and accrual accounting. The student should see the imprudence of attempting to use one summary number for a cash flow number, whether it be cash flow from operations, EBITDA, or free cash flow. The need to analyze the three components of the cash flow statement (operations, investing and financing activities) becomes evident from this case.
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