Business & Money

Cash flow reporting is more susceptible to manipulation than investors imagined.

Financial results are the prism through which investors view performance in the world of business. Companies may have tens of thousands of employees supplying tangible goods and services to customers, but real and diverse activities are reduced to relatively few numbers when companies are valued.

"Cash flows from operating activities" is a term defined by accountants, and like many terms in accounting, there's some degree of subjectivity involved in applying the definition to the actual preparation of a company's financial statements. That subjectivity opens up the possibility of a lack of clarity in the information being reported-or, perhaps, intentional distortion of that information.

For example, the calculation of operating cash flow or funds from operations, as some call it, can vary from financial analyst to financial analyst, agency to agency, and even from industry to industry.

Wall Street analysts typically use EBITDA (earnings before interest, taxes, depreciation, and amortization) when they focus on a company's cash flow. Unfortunately, calculation of EBITDA varies from company to company. Although the SEC permits companies to report EBITDA in their periodic public filings, provided they include a clear explanation of the differences between it and net income, it may not be included in the generally accepted accounting principles (GAAP) statement of cash flows. In any event, EBITDA is an incomplete measure of sustainable cash flow because it excludes taxes and often includes significant non-cash components of net income.