Studies in Cash Flow Accounting and Analysis (RLE Accounting)

Aspects of the Interface Between Managerial Planning, Reporting and Control and External Performance Measurement

Charles Klemstine, Michael Maher, G. H. Lawson

• Publisher: Routledge
• Year: 2013
• Print ISBN:
  9780415717120
• eBook ISBN:
  9781317976004
• Topic: Business
• Subtopic: Accounting
• Index: Business

The fourteen papers in this volume, both unpublished and originally published between 1981 and 1990 offer a comprehensive selection of G. H. Lawson's work and discuss the following:

• assessing economic performance
• ownership value creation
• pricing of non-competitive government contracts
• valuation of a business
• measurement of corporate performance according to cash flow.

Assessing economic performance and corporate financial policies on a cash flow-market value basis

by
G. H. Lawson.

Contents

Introduction

Part 1: Cash flow expectations and performance measurement

1.1 Formation of expectations about future cash flows

1.2 Periodic income measurement

1.3 Specific attributes of a cash flow-market value model

1.4 Distributable income and capital maintenance

1.5 Representational faithfulness

1.6 Compliance with recognition criteria

1.7 Other attributes of the cash flow-market value model

1.8 Summary and conclusions

Part 2: Assessing the efficiency of dividend and debt-financing policies

2.1 Introduction

2.2 Dividend policy

2.3 Shareholder wealth losses and wealth transfers to lenders

2.4 Estimating wealth transfers ascribable to mis-priced debt issues

2.5 Wealth losses and wealth transfers caused by declining entity returns

2.6 Summary and conclusions

Appendix A: Cash flow-accruals accounting relationships

Appendix B: Interpretation of the 1984–89 financial performance of Texas Instruments, Inc

References

Assessing economic performance and corporate financial policies on a cash flow-market value basis^†

Introduction

The first part of this paper justifies the use of an operationalized ex post analog of the normative discounted cash flow valuation model in meeting two preeminent objectives of accounting:

i. the disclosure of information to facilitate the formation of investor expectations about corporate cash flows; and,

ii. income measurement.

This ex post cash flow-market value (CF-MV) model is evaluated by reference to such familiar notions as distributable income and capital maintenance, representational faithfulness, recognition criteria, etc.

The second part of the paper discusses ways of assessing corporate dividend and debt-financing policies in a CF-MV accounting framework. It first considers the possible economic consequences of a MLintner-typeH dividend policy. Previous studies have suggested that the characteristic excess of historic cost profit over entity (i.e., corporate) cash flows may, result in dividends (net of new equity raised) which are financed with debt. Debt-financed divi-dends substitute debt for equity and may cause shareholder wealth losses and/or wealth transfers from shareholders to lenders. Unlike other corporate accounting models, the CF-MV model presented here can be used to analyze the efficiency of dividend and debt-financing policies.

Part 1: Cash flow expectations and performance measurement

The value and continuity of a business enterprise and the returns it can provide for its owners depend upon its cash flow-generating capacity. This implies that the past performance of a going concern and ex post ownership returns ought to be measureable on a cash flow basis. A distinction, which is crucial from an operational standpoint, between a pure cash flow accounting model and a cash flow-market value accounting model can, however, be made.

The foregoing propositions can be elaborated by reference to two paramount objectives of external financial reporting, one modern the other ancient, i.e.,

• the disclosure of such information as facilitates the formation of investor expectations about the main determinant of a firm's market value, namely, its future cash flow generating capacity; and,

• the measurement of ex post periodic income.

1.1 Formation of expectations about future cash flows

The stream of cash flows generated by a business enterprise (hereafter ‘entity’) is divided between lenders and stockholders in a ratio which reflects its dividend and debt-financing policies. This partitioning of (entity) cash flows also divides total (entity) market value into the market values of its debt and equity.

The distinction between entity and claimholder cash flows on the one hand, and between entity and claimholder market values on the other can be expressed as two simple identities. As argued hereafter, these distinctions should be explicitly allowed for in reporting performance as a guide to the formation of expectations and in measuring ex post income.

For any year j, an entity's cash flow identity, allowing for minority interests (if any), is defined as:

entity	lender	shareholder	minority
cash ≡	cash +	cash +	interests
flow(j)	flow(j)	flow(j)	cash flow(j)

or, in more compact shorthand form,

ENCF_j ≡ LCF_j + SHCF_j + MICF_j;

or, in more detailed accounting form,

(kj−hj) − (Aj + Rj − Yj) − tj − Hj ≡ (Fj − Nj − Mj) + (Dj − Bj) + [Dj ^(MI) − Bj ^(MI)]

(1)

where, in year j,

kj-hj	=	operating cash flow represented by cash collected from customers, kj, and operating payments, hj;
Aj+Rj-Yj	=	replacement investment, Aj, growth investment, Rj, and the proceeds from assets displaced, Yj;
tj	=	corporate income tax payments;
Hj	=	liquidity change, i.e., change in cash and cash equivalents;
Fj	=	interest payments;
Nj	=	medium and/or long-term debt raised (-ve) or repaid (+ve);
Mj	=	short-term debt raised (-ve) or repaid (+ve);
Dj	=	dividends paid to shareholders;
Bj	=	equity capital raised (-ve) or repaid (+ve);
Dj^(MI)	=	dividends paid to minority interests; and,
Bj^(MI)	=	equity capital raised (-ve) from, or repaid (+ve) to, minorities.

The latter cash flow identity can be contrasted with the cash flow classification prescribed by the FASB (1987) and followed by the British ASC in Exposure Draft 54 (1990), namely (ignoring minority interests),

(k_j-h_j...

Table of contents

• Cover
• Half Title
• Title Page
• Copyright Page
• Original Title Page
• Original Copyright Page
• Table of Contents
• Acknowledgments
• Introduction
• 1. “Assessing economic performance and corporate financial policies on a cash flow-market value basis” (previously unpublished)
• 2. “Ownership value creation and the evaluation of alternative plans” (previously unpublished)
• 3. “Contract costing and the negotiation of contract prices,” Journal of Oil and Gas Accountancy, Vol. 1, No. 3, 1986, 133–146
• 4. “The Pricing of Noncompetitive Government Contracts,” Managerial Finance, Vol. 10, No. 3/4, 1984, 40–48
• 5. “Specifying a multiperiod computer-based financial model” (previously unpublished)
• 6. “Some Managerial Implications of Working Capital Analysis,” revised version of “The Mechanics, Determinants and Management of Working Capital Investment,” Managerial Finance, Vol. 10, No. 3/4, 1984, 12–25
• 7. “Zones Ltd.,” in Case Studies in Financial Analysis, (ed.) P. Barnes, Simon & Schuster, 1990, 236–249
• 8. “The Valuation of a Business as a Going Concern,” in Gaugier, E., Meissner, H. G. and Thorn, N. (eds.), Zukunftsaspekte der anwendungsorientierten Betriebswirtschaftslehre, C. E. Poeschel Verlag, 1986, 161–173
• 9. “Was Woolworth ailing?” The Accountant, Vol. 187, 1982, 612–614 and 632
• 10. “Why the current UDS takeover bids became inevitable,” The Accountant, Vol. 188, 1983, 185–188
• 11. “The Measurement of Corporate Performance on a Cash Flow Basis: A Reply to Mr. Egginton,” Accounting and Business Research, Spring 1985, 99–108
• 12. “Call for SSAP 10 reform,” The Accountant, Vol. 188, 1983, 218–220
• 13. “Equity Values and Inflation: Dividends and Debt Financing,” Lloyds Bank Review, No. 139, 1981, 40–54
• 14. “Bankruptcy Prediction—An Investigation of Cash Flow Based Models,” Journal of Management Studies, 25:5, 1988, 419–437
• Glossary of Symbols