The present version of the statement that traces the flow of funds in and out of the firm, the statement of cash flows, became mandatory, under SFAS 95, for issuers with fiscal years ending after July 15, 1988.
Exhibit 4.1, the fiscal 2000 cash flow statement of battery producer Rayovac, illustrates the statement’s division into cash flows from operations, investments in the business, and financing.
The predecessor of the statement of cash flows, the statement of changes in financial position, was first required under APB 19, in 1971.Prior to that time, going as far back as the introduction of double-entry bookkeeping in Italy during the fifteenth century, financial analysts had muddled through with only the balance sheet and the income statement. Anyone with a sense of history will surely conclude that the introduction of the cash flow statement must have been premised by expectations of great new analytical insights. Such an inference is in fact well founded. The advantages of a cash flow statement correspond to the shortcomings of the income statement, and more specifically, the concept of profit. Over time, profit has proven so malleable a quantity, so easily enlarged or reduced to suit management’s needs, as to make it useless, in many instances, as the basis of a fair comparison among companies.
An example of the erroneous comparisons that can arise involves the contrasting objectives that public and private companies have in preparing their income statements.
For financial-reporting (as opposed to tax-accounting) purposes, a publicly owned company generally seeks to maximize its reported net income, which investors use as a basis for valuing its shares. Therefore, its incentive in any situation where the accounting rules permit discretion is to minimize expenses. The firm will capitalize whatever expenditures it can and depreciate its fixed assets over as long a period as possible.
All that restrains theEXHIBIT 4.1 Rayovac Corporation
Consolidated Statements of Cash Flows (in thousands, except per share amounts) Year Ended September 30, 2000
| Cash flows from operating activities Net income Adjustments to reconcile net income to net cash provided (used) by operating activities: | $ 38,350 |
| Amortization Depreciation Deferred income taxes (Gain) loss on disposal of fixed assets acquired Accounts receivable Inventories Prepaid expenses and other assets Accounts payable and accrued liabilities Accrued recapitalization and other special charges Net cash (used) provided by operating activities Cash flows from investing activities Purchases of property, plant, and equipment Proceeds from sale of property, plant, and equipment Net cash used by investing activities Cash flows from financing activities Reduction of debt Proceeds from debt financing Cash overdraft Proceeds from (advances for) notes receivable from officers/shareholders Acquisition of treasury stock Exercise of stock options Payments on capital lease obligation Net cash provided (used) by financing activities Effect of exchange rate changes on cash and cash equivalents Net increase (decrease) in cash and cash equivalents Cash and cash equivalents, beginning of year Cash and cash equivalents, end of year Supplemental disclosure of cash flow information: | 6,309 16,024 2,905 (1,297) (15,697) (20,344) (5,416) 22,126 (5,147) 37,813 (18,996) 1,051 (17,945) (215,394) 203,189 (4,971) (2,300) (886) size=1 color=black face=Cambria>621 (1,233) (20,974) (202) (1,308) 11,065 $|[9,757 |
| Cash paid for interest Cash paid for income taxes | 27,691 14,318 |
Source: Rayovac Corporation Form 10-K December 19, 2000.
public company in this respect (other than conscience) is the wish to avoid being perceived as employing liberal accounting practices, which may lead to a lower market valuation of its reported earnings. Using depreciation schedules much longer than those of other companies in the same industry could give rise to such a p erception.
In contrast, a privately held company has no public shareholders to impress.
Unlike a public company, which shows one set of statements to the public and another to the Internal Revenue Service, a private company typically prepares one set of statements, with the tax authorities foremost in its thinking. Its incentive is not to maximize, but to minimize, the income it reports, thereby minimizing its tax bill as well. If an analyst examines its income statement and tries to compare it with those of public companies in the same industry, the result will be an undeservedly poor showing by the private company.