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What story do your cash disclosures tell?

What story do your cash disclosures tell?

We look at whether your cash disclosures stand up to scrutiny, and what story they tell.

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Cash is in the spotlight of both investors and regulators. Investors want a clearer discussion in the annual report of how cash is generated and spent; while the Financial reporting Council (FRC) are frustrated at the persistence of basic errors in cash flow statements and conscious of increased liquidity risk in certain sectors. The focus is unlikely to go away: in September 2019 the FRC published a Lab project report Disclosures on the sources and uses of cash and have just announced a Thematic Review of Cash flows and liquidity disclosures in annual reports in 2020.

So, do your cash disclosures stand up to scrutiny, and what story do they tell?

While a profit measure is often the first to be highlighted, the generation, availability and use of cash is fundamental to investment decisions. Not only do they facilitate assessment of past performance and stewardship, they are also the starting point for setting future expectations.

Transparency is key. Investors say the best annual reports show clearly the cash drivers of the business (both current and future), an explanation of how cash is generated, links to working capital, relevant cash metrics and how these link to directors’ remuneration, how cash is used (both currently and in the future) and the associated risks. Together, these disclosures tell the business’ “cash story”.

Slavish preparation of an accurate cash flow statement alone will not meet these needs, though care is warranted as the FRC has raised concerns about basic misclassification errors that often overstate operating cash flows, eg disposal of investments in joint ventures classified as operating instead of investing and transaction costs in a business combination classified as investing rather than operating. In addition, where the classification of cash flows is a matter of judgement, for example for complex transactions, company-specific accounting policies explaining those judgements should also be disclosed.

Related required notes should add further detail. A carefully-drafted reconciliation of liabilities from financing activities (introduced relatively recently by International Accounting Standard 7, (IAS 7) explains financing cash flows and, in conjunction with liquidity disclosures, can enhance both going concern and viability analysis.

Working capital changes can have a significant effect on cash generation, but their impact remains an area poorly served by accounting standards. Investors want to understand how working capital processes drive cash generation and the effect of the use of any specific facilities, for example debtor factoring or supplier finance. Such facilities may need elaboration as supplier financing comes in different varieties with different impacts on the cash-generation story.

To properly understand the cash story, investors expect the narrative sections of the annual report to provide further explanation; for example, where the year-end position of working capital balances or financing is not representative, further explanation is warranted.

Cash generation is often discussed in terms of KPIs or Alternative Performance Measures such as Free Cash Flow. Transparency dictates that compliance with the ESMA Guidelines for cash flow based Alternative Performance Measures (‘APMs’) is essential.

Helpfully, the FRC Lab report provides guidance on what investors are looking for in a company’s cash disclosures and give “real life” examples of useful disclosures for each part of the story. The examples provide a springboard for companies to think about how they might better tell their story through disclosures.

Weak cash disclosures in the annual report can leave investors and regulators with unanswered questions about the business, its strategy and performance. Considered and well-drafted, cash disclosures are an important part of a company’s story. What story will your cash disclosures tell?

If you would like to discuss any of the topics in more detail then please contact us

© 2020 KPMG LLP, a UK limited liability partnership, and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative, a Swiss entity. All rights reserved.

KPMG International Cooperative (“KPMG International”) is a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm.

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