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.
Measuring the Effects of Non-cash Investing and Financing Activities
In this study, for a sample of 120 companies, we identify and recast the statement of cash flows for the implied cash effects of
six general categories of non-cash activity, transactions affecting 1) capital expenditures and operating activities, 2)
capital expenditures and other investing activities, 3) capital expenditures and financing activities, 4) other
investing activities and operating activities, 5) other investing activities and financing activities, and 6) financing
activities and operating activities. We focus on the implied cash effects of two key non-cash activities from
category three, debt issued for capital assets and capital lease financing of capital assets. These are transactions
that directly affect capital expenditures and free cash flow. When revising the statement of cash flows to include
the implied cash effects of these two non-cash transactions, we find a reduction in free cash flow in 62 instances
for a median amount that comprised 2.8% of reported free cash flow. Among the 62 firms, 24 saw free cash flow
decline by more than 5%, 16 by more than 10% and 9 by more than 25%.
Given the importance of non-cash capital expenditures to calculations of free cash flow, the FASB may wish to revise its
stance regarding the exclusion of all non-cash activities from the statement of cash flows. As to analysts and investors, in the
absence of changes to the reporting of non-cash activities, such users of financial statements will want to ensure that such non-cash activities are given explicit consideration when analyzing financial results.
This research report is adapted from the paper, Mulford, C. and Pfeffer, A., “Measuring the Effects of Non-cash
Investing and Financing Activities,” Journal of Applied Research in Accounting and Finance, Vol. 9, No. 1,
2014, pp. 27-43.
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.