The Georgia Tech Financial Analysis Lab conducts unbiased research on issues of financial reporting and analysis. Unbiased information is vital to effective investment decision-making. Accordingly, we think that independent research organizations, such as our own, have an important role to play in providing information to market participants.
Because our lab is housed within a university, all of our research reports have an educational quality, as they are designed to impart knowledge and understanding to those who read them. Our focus is on issues that we believe will be of interest to a large segment of stock market participants. Depending on the issue, we may focus our attention on individual companies, groups of companies, or on large segments of the market at large.
A recurring theme in our work is the identification of reporting practices that give investors a misleading signal, whether positive or negative, of corporate earning power. We define earning power as the ability to generate a sustainable stream of earnings that is backed by cash flow. Accordingly, our research may look into reporting practices that affect either earnings or cash flow, or both. At times our research may look at stock prices generally, though from a fundamental and not technical point of view.
Accounting and Reporting Practices for Restricted Cash
For a sample of 41 nonfinancial companies with market caps exceeding $10 billion, we find that restricted cash comprises approximately .80% of total assets. Restricted cash for some firms, however, can constitute several percent of total assets. Most companies report restricted cash as a current asset, though, depending on the restrictions placed on cash, a noncurrent designation may be used. Two companies include restricted cash with unrestricted cash and cash equivalents on the balance sheet.
Within our sample we find ten general types of restrictions placed on cash. Cash may be restricted for bankruptcy reorganization, equity transactions, financing obligations, hedging activities, income tax purposes, insurance claims, investment purposes, litigation purposes, operational obligations, and for regulatory purposes. Seven firms provide no explanation for the restrictions placed on cash.
Twenty two of the sample companies disclose the change in restricted cash on the statement of cash flows. Three companies classify the change as operating cash flow, sixteen firms as investing cash flow and four companies as financing cash flow. Two companies separate the change in restricted cash into both operating and financing activities. With a few exceptions, we find a general consistency between the primary reasons for the restrictions placed on cash and the classification of the change in restricted cash on the statement of cash flows.
Earnings Quality: Reports on Individual Companies
In these reports we examine one or more dimensions of earnings quality: the cash flow support of earnings, the sustainability of earnings, or the quality of the balance sheet.