WHAT DOES CFFO MEASURE ?
What Is It?
Cash Flow From Operations (CFFO) is the top section of the thee sections within the Statement of Cash Flow found in all Financial Statement packages. Its calculation involves three steps.
- It starts with the reported Net Income from the Income Statement.
- Then it reverses out the line items on the Income Statement that measure only accounting accruals (without any cash transaction) of long-life assets (e.g. Depreciation, Deferred Income Tax, Goodwill writedowns). A subtotal at that point measures 'cash earnings'. It may not be included.
- Lastly, the net increase in working capital is subtracted This adjusts the accruals for sales and cost of sales to sales receipts and supplier payments .
Non-accountants think the statement results from measuring actual
cash flows - a different system from the production of the other accounting numbers. In reality accountants line up the Balance Sheets (opening
and closing) and subtract across each line.
- CFFO tries to measure the cash generated by operations that can be used to buy replacement long-life assets, pay off debts, pay dividends, expand, or just stay solvent.
- There is very little new information in the CFFO Statement.
It is simply the mathematical fallout from the presumptions and
decisions used to prepare the Balance Sheet and Income Statement. All
the problems with those are implicit in the Cash Flow.
- Note that when the value of the company's assets shrink (a
bad thing) cash flow increases (supposedly a good thing). Does that
make sense to you?
- Each and every line of the cash flow statement, after Net
Income, is a measure of this asset shrinking (+cash) and expanding
(-cash). None of the line items exist because someone thinks "it
What it Misses
- The operations of a business depend on physical assets that must be replaced periodically. CFFO misses these costs completely. Some adjustment is necessary, but then you end up with something very much like the Depreciation you just cancelled out. Is the value of your adjustment more accurate than Depreciation?
- Takeovers of operating businesses are recorded in the Investing portion of the Statement of Cash Flow. The long-term assets are lumped together with inventory and accounts payable, and other working capital. None of those working capital changes show up in the CFFO section. They are assumed to be 'expansions' rather than cash flows of the ongoing business. But businesses reconfigure themselves all the time, without it necessarily being an 'expansion'.
- A major question that the Statement of Cash Flow should answer is "What investments are being made to enable growth, and in what types of assets?". Because all purchased working capital is buried under Investments, that answer is not available.
- Another question most everyone has is "What cash taxes are paid?". Everyone ignores the tax expense, thinking that cash-taxes-paid are much smaller. It would be simple for the CFFO to include a line item that reverses out the Income Statement's accrued tax (just like it reverses Depreciation). A second line item would disclose the cash taxes paid. But the Statement buries all that information because firms consider their tax strategies to be proprietary.
- Changes in working capital have large effects on CFFO. E.g. Paying your suppliers faster in good times to build up goodwill is a good business practice - but results in lower CFFO. Not paying your bills would indicate problems - but results in higher CFFO. Re-scheduling the year-end cheque run from Dec 31 to Jan 1 makes no economic difference - but sure does change CFFO.
Think twice before using this metric.