Business Acumen VI: Corporate Performance StatementCash is king.
You've probably heard this expression. In the context of business performance, it means that a company's financial situation is most fundamentally tied to how well it is doing at bringing in more cash from its operations than it is sending out. The volatility of the cash flow is also important because it is a major factor in determining how risky the business is.
Alfred Rappaport, a professor emeritus at Northwestern University's Kellogg School of Management, provides an eminently clear tool for assessing corporate performance in terms of generating cash in the September 2006 issue of the Harvard Business Review. In an article titled "Ten Ways to Create Shareholder Value" (all of which is well worth reading), Rappaport touts Berkshire Hathaway as an exemplar of the shareholder value creed, and then offers "The Corporate Performance Statement" as a way of coherently assessing how well any company is living up to the creed.
I won't go into technicalities here. Rather, I'll describe what the statement records and how this information is used. The statement has three sections:
- Operating Cash Flows This section records actual net cash inflow from operations (hopefully, positive) and then deducts cash spent on investments (e.g., machinery and R&D). The bottom line is free cash flow cash available for distribution to the company's debt holders and shareholders.
- Revenue and Expense Accruals These amounts are estimates of "future cash receipts and payments triggered by current sales and purchase transactions. Management estimates three scenarios most likely, optimistic, and pessimistic ..."
- Management Discussion and Analysis "Management presents the company's business model, key performance indicators (both financial and nonfinancial), and the critical assumptions supporting each accrual estimate."
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