Businesses should better disclose sources of cash, says FRC

The FRC's Financial Reporting Lab ('the Lab') makes recommendations and shares best practice on corporate reporting. Its latest report (58-page / 6MB PDF) is based on interviews with a small sample of investors, but provides examples of good disclosure from over 20 companies.

The main method used by UK companies to share how they generate and use cash, and how much money is available to the business at any given time, is the cash flow statement section of the annual report. While this document provides clear information to investors about the flow of cash and equivalent funding streams through the business, it is not always clear to investors how cash is, and will be, generated and used, according to the Lab.

"Our project would suggest that the disclosures that are most helpful to investors in answering their questions about cash are often provided outside of the cash flow statement, and may be outside of the annual report completely," the Lab said in its report. "Investors told us that what they want, at a high level, is an overall discussion on a company's cash drivers, supported by further details."

"The investor view of where disclosures are deemed to add value is in an overall, narrative discussion of a company's cash drivers, supported by further details on the sources and the uses of cash," said corporate governance expert Tom Proverbs-Garbett of Pinsent Masons, the law firm behind Out-Law. "In particular, the view is that whilst companies often do a good job of explaining some aspects of wider performance, cash metrics and cash generation are often not fully explained."

"The project was relatively limited with 15 investors being interviewed. Nevertheless, the extensive examples from over 20 companies in the 57-page report provide a very clear explanation of why those exemplars are regarded as helpful by investors, and how internal key performance indicators (KPIs) can be better explained to the market so that assessment of current and future value is made easier for those looking in," he said.

According to the report, investors want disclosures that provide them with a clear description of the drivers of the company's current and future cash performance and position, supported by appropriate metrics. Disclosures require both "numbers and narrative", ideally combined in a way that "shows how future cash generation is underpinned by current cash generation".

Approximately 60% of companies listed on the FTSE 100 include a cash-related metric amongst their KPIs, with 'net debt' being the most common and 'free cash' flow being the second most common. However, there is very limited consistency in the way in which these metrics are calculated.

"In terms of sources of cash, the business model disclosure is still important," said Proverbs-Garbett. "The report suggests that key aspects of cash generation that could be enhanced in any disclosure include a disaggregation of profit generation and more detail around the conversion of profit into free cash - or other cash metric as selected and explained by the company. A connection between cash and working capital and, separately, cash generation of different businesses and companies within groups could also be better explained."

Once investors are clear about how the company generates cash and the quality and sustainability of its generation, they then what to understand what the company intends to do with it. This helps investors to value the business, and to support their consideration of the quality of management's stewardship. Investors would like more information that supports their own assessment of the likely future use of cash, particularly around the priorities of the business; and on how those priorities are actioned and impacted on by relevant risks and variabilities.

The report goes on to consider disclosure of distributions to shareholders. Investors would like to see better disclosures about the timing and size of any returns and the availability and nature of dividend resources currently accessible to the parent company; as well as more information about the risks, restrictions and variabilities that might impact returns in the future, according to the report.