Enron--a case for better understanding of Cash Flows. (Selected Topics).(financial reporting)(Statistical Data Included)

Like a fantasy, Enron's "house of cards came tumbling down-driven by an unquenchable thirst of success at whatever the cost. It has been such a disgusting experience to learn how a company could have not only manipulated its financial reporting but investors and creditors alike to lead them to believe Enron was a trustworthy company. We have been left pondering how unscrupulous individuals could have conjured up such financial shenanigans to project Enron as a different and successful company. And then, how Arthur Andersen, a major accounting firm, could have supported such unethical practices, and in the process, violated the trust of audited financial reporting.

The recent collapse of Enron has added a new dimension to the credit analysis process. Up to now, having audited financial data offered a degree of comfort that facilitated credit decisions. Audited financial information was accepted under the premise that no major errors or omissions were present and gave this data an aura of validity that relaxed the credit controls and, to some extent, the effort that went into analyzing the data. Not only did Enron catch the financial world by surprise with its unexpected demise, but has proven this comfort zone to be a mistake. Is it the time to reengineer your credit practices? You bet it is!

The sudden meltdown of Enron has brought to light that manipulation of data is possible even in some of the strongest and largest companies in corporate America. To make matters worse, Arthur Andersen - the outside auditors - became part of this conspiracy, further complicating the financial reporting landscape. This is shocking news that has sent the credit profession to review their credit files in search of other Enrons, and left the world of credit and financial markets asking what went wrong and why it was not prevented-questions to which often there are not answers if the damage is fait accompli. Directionally, the most immediate challenge to the profession is to expose companies that may have similar financial disclosure problems. Going forward, the real question is what measures the credit profession must take to feel confident their credit decisions can be justified.

There is always a lesson learned in the world of credit following a large bad debt loss. The Enron case is not different. Yes, the data from Enron was audited, and even if the data would have been accurate, there were fundamentals performing below par that raised several warning flags. Enron did a magnificent job hiding its off-thebooks shenanigans, and in the process managed to project an image of a pristine and successful company.

The truth is that Enron's 10K report for the year ended 2000 suggests the company's cash flows were insufficient to meet its operating needs. As shown in the table below, Cash Flows from Operations were in excess of $7.6 billion for the three reporting years ending December 2000. If a credit analysis stops here, the question asked most likely would have been not whether to grant open account terms but how much. Cash Flows from Operations were too good to pass this opportunity. Cash flow analysis though goes beyond cash flows from operations. A closer look at the Investing Activities shows Enron used $11.7 billion of cash creating a deficit in excess of $4.0 billion. If we add paid dividends of about $1.4 billion, the deficit jumps to $5.4 billion. A further review of the Financing Activities reflects Enron increased its long-term borrowing and issued new stock of approximately $2.0 billion each to bridge its cash deficit during this period of time. These findings should have sent enough distress signals to a credit organization to further investigate the financial condition of Enron before committing to continue granting open account. At this juncture, the company's cash generation was of concern, and it should have provided enough basis to consider a program to reduce exposure.

Asset, Liability and Income statements are very important in the overall risk/reward process. But you should also look at the Consolidated Statements of Cash Flows. What is material is how much cash is generated, how much cash is used and the cash components. Analyzing cash flows from a high level will not yield the results you expect to reach a sound ...