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Profit figures are notoriously prone to massage. Experienced investors turn to the cash flow statement for the real story. US chemicals group Chemours, known for making Teflon, shows that even this is not foolproof.
The company’s cash is real enough. But some is going to have to go back. This month, Chemours, a spinout of DuPont, said an investigation revealed that its senior management showed a “lack of transparency” when approached about accounting irregularities.
Specifically, recent financial results had been manipulated higher, including cash flow. The motivation may have been their role in determining executive bonuses. Shares of Chemours initially fell by a third after the company put executives on leave last month.
In the fourth quarter of 2023, Chemours improperly pulled forward collections of recorded sales — known as accounts receivables — as well as delayed disbursements to its vendors — known as accounts payable — in order to juice cash flow figures.
This is a silly way to get your bonus. Cash collected today cannot be recollected tomorrow. As such, accounts receivable and accounts payable will simply reverse in the current quarter and cash flow will even out in the current year. The chief executive officer and chief financial officer of Chemours, who were put on leave, presumably would need some new trick or improvement in the underlying business to meet 2024’s cash flow target.
Chemours’ annual cash bonuses as well as long-term incentives were granted upon hitting performance metrics. Chemours specifically targeted “adjusted ebitda” and “free cash flow” results, both non-GAAP measures, as the basis for executives unlocking grants.
Ebitda is an income statement figure that is often seen as akin to cash-based operating profit. Free cash flow, however, reconciles those book accounting accruals of the P&L ledger to capture the real flows of actual dollars coming in and out. Free cash flow will include not just receivables and payables but also changes in inventory and capital expenditures, both of which do not classically run through the income statement.
Free cash flow should not be easy to manipulate. Yet calls sent to the Chemours whistleblowing hotline indicating allegations of cooked books were not promptly investigated, said the company.
Cash pulled forward will naturally have to be pushed back in order for books to be balanced. In this sense, a receivables and payables scheme is an odd stunt, even for bonus-hungry executives.
As cold and unyielding as accounting may be, human psychology remains truly mysterious.
Read the full article here