In May 2015, we posted a commentary entitled “IASB seeks to clarify the ‘cashness’ of the king”. In it, we discussed the attributes of a likely amendment under the broad Disclosure Initiatives programme being run by the International Accounting Standards Board (IASB). We believed that this change would improve disclosure under the rule requiring companies to show historical changes in cash and cash equivalents, IAS7: Statement of cash flows.
Last Friday, the IASB issued its amendments to IAS7. Although we are very pleased with the changes, which will elucidate changes in companies’ debt positions across reporting periods, we look forward to ongoing discussions on disclosures concerning liquidity. Specifically, we’d like to see improved disclosure in the reporting of cash and cash equivalents on the balance sheet because as investors in global companies whose operations stretch across many legal jurisdictions, the improved disclosure will allow us (and others) to price liquidity risks with even more precision.
As for the announced amendments, they will require companies to provide more information about the changes in their financing liabilities. This would enable analysts to see how debt changes from one period to the next more clearly. For example, the amendments specifically address situations when the cash flow from the financing section of a cash flow statement fails to explain the change in a company’s debt position. The reason why the statement sometimes fails to explain changes in balance-sheet debt is because these are sometimes caused by non-cash events, such as debt assumed in acquisitions or the initiation of new leases. These amendments require companies to disclose some sort of reconciliation between the changes in debt on the balance sheet with the cash flows for debt on the cash flow statement. While it does not require a specific method for doing so, the IASB has added a few examples of how this could be done to IAS7.
Ultimately, what the IASB is doing is creating a debt-equivalent of IAS1: Statement of changes in equity. This additional disclosure will allow analysts to better understand the contours of the debt on the balance sheet, what embodies financial leverage metrics from one period to the next, and the characteristics of and changes to the debt portion of a firm’s enterprise value.
As credit investors, we applaud the IASB for requiring standards of disclosure of debt that is similar to what companies provide to shareholders. However, as per our previous post on this subject, we had hoped that the amendments would specifically require improved disclosure on the “cashness of the king”. As it stands, we are at the mercy of a company’s willingness to reveal just how much of the cash on its balance sheet could realistically be used to redeem forthcoming debt maturities. And, furthermore, not knowing how much of a company’s cash is truly available “overnight” means that any calculation of net debt could be erroneously underestimated because we risk deducting encumbered cash from gross debt. This could result in financial risks being inaccurately priced. This is particularly important for Hermes Credit, because we manage global credit mandates and are cognisant that cash is often not so easily repatriated from the jurisdiction where it is generated to that in which its debt obligations are actually serviced.