Transmile - The Importance of Cash Flow Statement

Transmile Group Berhad's manipulation of its account receivables might have come as a big surprise to anyone who follows the news. It was reported that a huge chunk of its invoices issued could not be substantiated. Being one of the flagship companies of Malaysia richest man Tan Sri Robert Kuok, nobody had expected this to be happened. If the big boss has been screwed and deceived indeed, what else can you expect from the small investors? Can Security Commission (SC) do something to protect small investors? Or should we rely on ourselves when making investment decision?

My choice would be the latter. Instead of relying SC to protect us, we should better equip and protect ourselves from the bogus accounting practice. Most of the public companies can easily and legally manipulate their Income Statements but find it extremely difficult to manipulate the Cash Flow Statement. This is because the bank balance in a company account cannot lie. So, it would be advisable to look at the Cash Flow from Operating Activities section first in the Cash Flow Statement next time before looking at the profit figure in the Income Statement.


(Let's look at an article discussing this issue.)

Cash flow indicates company’s health

Smart investors look at the cash flow statement of companies first instead of the income statement to understand the actual financial health, says US-based fund manager Jay Taparia.

There were always cases of companies manipulating their accounts to make their figures “a bit rosier”, said Taparia, who is the principal of Sanskar Investments, a fund management company in Chicago.

He said on Aug 2 such manipulation was abetted by loopholes in accounting standards. The Generally Accepted Accounting Principles (GAAP) were more open for manipulation compared to simple cash accounting, he said.

“Small business accounting has always been on a cash basis and it is much harder to manipulate,” Taparia said at a luncheon talk in Kuala Lumpur on “Identifying Potential Financial Reporting Abuses”.

He said income statements are prone to manipulation, as there are multiple ways to account for every line item on income statements.

As for revenue, he cautioned that it could be recognised under three different scenarios – when cash came in the door, when contract signed but no cash received and when probability that contract will be signed is high.

For instance, revenue overstatement could occur via “channel stuffing” where companies place inventory on client sites and booked them as revenue even though the cash was not received, he added.

“Honestly, as an investor and money manager, I do not use the income statement anymore and I do not care about earnings per share or price-to-earnings ratios,” he added.

Taparia said he preferred to use the cash flow statement as it was relatively the same each time as the corporate cheque book had to be reconciled to cash.

“The bottomline is – if you see revenue and net income increase and cash flow from operations decrease, be suspicious about tomfoolery. Cold hard cash never lies,” he said.

He said that investors wanted ethical and motivated management whose main objective was to maximise cash flow and thus shareholder value alongside with their own.

“Shareholder-friendliness and management who care about how their employees are treated have always paid well to shareholders,” he said.

Companies under pressure to manipulate financials are:

• High growth (expectation) industries – companies under heavy pressure from competitors and shareholders – high-risk industries (for example technology and biotechnology companies;
• Management under fire to short-term results (for example, first net profit, turnaround, new management team, post acquisition);
• Managements that stand to gain short-term personal windfalls for “results”, i.e. share options;
• Companies inordinately dependent on high share price to support continuing operations (ability to get loans, acquisitions); and
• In a market of “irrational exuberance” – any company afraid of being left behind.