Making Liquidity and Capital Resources Disclosures Meaningful
By George Wilson
Many MD&A liquidity and capital resources discussions try to explain changes in operating cash flows with opaque explanations, such as “our cash from operating activities decreased because of an increase in accounts receivable.” Trying to unpack the logic behind this kind of statement to a non-accountant is almost impossible. It is far more understandable to say, “our cash collections from customers decreased resulting in a decrease in cash flows from operating activities.” The problem with this more understandable statement, which is essentially based on the direct method of preparing the statement of cash flows, is that reporting systems frequently do not provide the necessary information.
Finding the balance between convoluted statements about how changes in balance sheet accounts affect cash flows and the lack of information necessary to apply the direct method to the statement of cash flows is complex and frequently frustrating.
The SEC challenges companies on this issue when disclosure is unclear. Here is an example where a company was called upon to clarify these kinds of disclosures in MD&A.
To begin, here is the company’s operating cash flows discussion:
Operating Activities. Net cash provided by operating activities for the years ended December 31, 2019 and 2018 was $306.3 million and $199.1 million, respectively. Cash provided by operations in 2019 and 2018 resulted from our net income adjusted for non-cash charges for share-based compensation, depreciation and amortization, timing of income tax and employee related payments and changes in other working capital. The significant increase in net cash from operating activities between 2018 and 2019 is primarily due to the higher net income and changes in working capital balances.
This disclosure triggered the following comment from the SEC:
Liquidity, Capital Resources, and Financial Position
Operating Activities, page 51
It appears from the statement of cash flows changes in assets and liabilities, which include working capital items, between 2019 and 2018 of $101.6 million is the substantial cause of the $107.3 million, or 54%, increase in 2019 operating cash flows compared to 2018. Please revise your disclosure to discuss the material items and the associated underlying factors contributing to the variance. Refer to IV.B.1 of SEC Release No. 33-8350 for guidance. Quantify any factors cited, pursuant to section 501.04 of the staff’s Codification of Financial Reporting. Additionally, define what you consider to be your working capital.
And here is the company’s response, including example new disclosures:
The Company acknowledges the Staff’s comment and will include in its future Annual Reports on Form 10-K enhanced disclosure regarding the matters identified above substantially similar to the following:
Operating Activities. Net cash provided by operating activities for the years ended December 31, 2019 and 2018 was $306.3 million and $199.1 million, respectively. Cash provided by operations increased $101.6 million from 2018 to 2019 as a result of changes in the Company’s working capital balances in 2018, resulting from the transaction with GCU. The Company defines working capital as the assets and liabilities, other than cash, generated through the Company’s primary operating activities. Changes in these balances are included in the changes in assets and liabilities presented in the consolidated statement of cash flows. Additionally, for the year ended December 31, 2019 an increase in net income of $30.2 million was partially offset by decreases in non-cash reconciling items of $24.5 million over the prior year period.
Our working capital balances changed primarily due to the transaction with GCU on July 1, 2018, which resulted in operational changes that impacted cash flows of the Company in the second half of 2018. Commencing July 1, 2018, the Company transitioned to an education services company and no longer has student receivables but records a receivable each month for education services provided to university partners. These changes, along with accrual of interest on the Secured Note receivable from GCU, resulted in a combined $59.3 million reduction in cash inflows from receivables in 2018. Additionally, in 2018, accounts payable and accrued liabilities associated with our operations prior to the Transaction were settled, resulting in net cash outflows of $30.0 million.
The Company will provide similar disclosures for material fluctuations in operating cash flows in future filings.
As always, your thoughts and comments are welcome!