Cash Flow

Minority Interest Muddies Cash Flow

CFOs could get a better handle on free cash flow if they hone their skills in the reporting of noncontrolling interests.
Kathy HoffelderJanuary 10, 2013

CFOs need a new list of best practices for the way their company reports the dividends paid to noncontrolling investors on their cash-flow statements, a leading accounting expert says. That’s because under the current mixed bag of options for reporting such payouts, companies have a bewildering range of styles: a range that can cause them to misjudge the amount of cash that’s available for such payments.

Noncontrolling interests is just one of the many areas where you see disparity in reporting among companies, says Charles Mulford, director of the Georgia Tech Financial Reporting & Analysis Lab and author of a recent study on noncontrolling interests. But it’s an area that, he says, can lead to a lot of confusion for the CFOs and upper management who need to know exactly how much cash they have for current and future outlays as well as for investors who are looking to buy stock in those firms.

Better guidance on how CFOs should report noncontrolling interests on the cash-flow statement is needed since the methods used today differ from what is acceptable under regulations governing income statements. While regulators such as the Financial Accounting Standards Board have firmed up reporting standards for noncontrolling interests on income statements with net income clearly defined from the majority as well as noncontrolling shareholders, cash-flow statements do not require the same kind of clarity.

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“Cash flow doesn’t get the same sort of attention that earnings and the balance sheet get,” explains Mulford. And considering that during the recent recession, the generation of cash became the ultimate safe haven for a lot of companies, he notes, more emphasis on determining free cash flow, the amount of cash that can be readily distributed, is crucial.

Mulford hopes reports like his will shed enough light on some of the needed clarity in financial reporting to generate better guidelines for CFOs. “Given CFOs are responsible for reporting, it’s a step toward what’s a best-practice approach to this.”

So what should CFOs and their staff be doing? “At a minimum, clearly identifying in the financing section (of the cash-flow statement) any distribution made to noncontrolling interests,” notes Mulford. That way, there will be “no confusion about whose operating cash flow is it.”

That advice should be heeded by some companies that are currently combining distributions made to noncontrolling interests with dividends paid to controlling shareholders, as well as by others that do not even cite the distributions made to noncontrolling interests in their cash-flow statement at all, Mulford says.

Verizon Communications, for one, falls into the former camp. The firm was among the 24 companies Mulford studied from 2009 to 2011 with market capitalizations exceeding $1 billion and noncontrolling interests income of 15% or more of their consolidated net income. Verizon did not separate out the dividends paid to controlling and noncontrolling interests on its cash-flow statement during the period in question, Mulford’s report shows. The firm holds a 55% controlling interest in Verizon Wireless, while Vodafone Group holds the other 45% noncontrolling interest.

Despite the cash-flow distribution omission, Verizon Communications openly cited the importance of cash provided by the operating activities of Verizon Wireless in its Management’s Discussion and Analysis statement in its 10-K from December 31, 2011, Mulford explains. While net income is allocated between the controlling and noncontrolling interests at Verizon, the firm made no such allocation for cash provided by operating activities, he says.

So why does it matter? In Verizon’s case, “it would appear that total operating cash flow [was] available for distribution to the Verizon Communications (controlling) shareholders, when, in fact, the noncontrolling interests have a legitimate claim on at least a portion of that cash flow,” according to Mulford.

Verizon, however, is not alone in offering a confusing cash-flow picture. Bristol-Myers Squibb, as noted in Mulford’s analysis, reports operating cash flow that is measured after income attributable to noncontrolling interests has been removed. This method, he says, “actually understates operating cash flow by removing an income measure that is not necessarily a measure of cash flow.”

Granted, Bristol-Myers actually gives almost all of the income attributable from its noncontrolling interests back to them in the form of dividends, Mulford says; its reporting practice is just inconsistent compared with other firms. The majority of the companies in the study, 20 out of the 24, clearly labeled their cash flow as a “distribution” or “dividend” in the cash-flow statement.

But with some companies choosing to omit and others to combine noncontrolling interests payouts with controlling shareholders, Mulford says, “we can’t just look at operating cash flow and get a consistent view of what it means.”

Having one standard approach to this kind of reporting in the cash-flow statement is important since distributions to noncontrolling interests can indeed be sizable. For companies in Mulford’s study, almost 80% of the income that was attributed to noncontrolling interests on a company’s income statement generated by subsidiaries was paid out in dividends. And for some companies in the study — Alcoa, Hertz Global Holdings, Nucor Corp., and Six Flags Entertainment — the cumulative cash distributions to noncontrolling interests were so high that they actually surpassed the amount these companies contributed to total income generated by the subsidiary.

The disparity in reporting styles could also have a larger impact on financial statements, Mulford contends. If consistency is not maintained, the usefulness and comparability of the cash-flow statement would be reduced, he says, which could lead to more work for analysts in pinpointing the exact distributions a company makes and to inaccurate reporting for CFOs.