The Cash Flow Classification of Distributions Received from Unconsolidated Entities

Abstract

In this research report we examine the cash flow classification of distributions received from equity-accounted investments and find some problematic classifications. Distributions exceeded by investee earnings are considered to be returns oninvestment, indicating an operating cash flow classification is appropriate. Distributions that are returns of investment, that is, paid out of capital, are properly classified as investing cash flow. Out of a sample of 107 firms, 70 classify all of the distributions received into operating cash flow. This is not surprising since these investor firms report equity earnings that appear to exceed the distributions received. However, 19 firms classify all distributions received into investing cash flow. For 13 of these firms, earnings exceeded all of the distributions received, suggesting that they too were being paid a return on investment. As a result, the distributions received arguably should be included in operating cash flow. A revision of the operating cash flow of these 13 firms increases their operating cash flow by as much as 107%, with mean and median increases of 16% and 5%, respectively. Direct clarification obtained from some of the sample firms sheds light on the decisions made. However, even with clarification, an operating cash flow classification appears to be more appropriate.

Given the importance of operating cash flow to a firm's performance, the report's findings have implications for analysts and investors who will want to make sure that distributions received are properly classified. Managements and auditors will want to review cash flow classifications for distributions received from equity-accounted investments to ensure accurate reporting.