One example of these difficulties is what to do when a corporation sells property, plant and equipment. Assume an initial cost of $10 million, accumulated depreciation of $6 million, and an exit price of $7 million, which, of course, gives rise to a gain of $3 million. How do firms report the $7 million cash flow from this activity? Currently, one can find numerous ways of reporting this transaction in practice. Some companies report it as a cash flow from operating activities, while others display it as a cash flow from investing activities. Some partition the cash flow and report the book value of $4 million as cash flow from investing activities and the remaining $3 million as cash flow from operating activities. Clearly, there are inconsistencies in practice!

It matters how business entities report this cash flow because of the importance placed on operating cash flows. These are the cash flows that sustain the business. They are the cash flows used by investors and creditors to assess the quality of earnings. Also, a number of financial analysts promote employment of some cash flow ratios when evaluating firm performance. Thus, these are the cash flows that managers desire to manage so they look good.

With this background, let's consider the recent statement of cash flows by Air Products. In its 2000 annual report, Air Products shows a cash outflow for "BOC transaction costs" of $665.8 million in fiscal year 2000 and $27.7 million in fiscal year 1999. Footnote 18 clarifies the nature of these transactions. In July 1999 Air Products announced a business combination with BOC and Air Liquide; however, after almost a year of negotiations, the Federal Trade Commission decided not to approve the merger. The company properly put the costs of this attempted business combination into the income statement, costs that amounted to $730.4 million before taxes. This includes charges from various currency options and forward exchange contracts.

The question is how should Air Products report the associated cash flows. Interestingly, they display the cash flows in the section for investing activities. What makes this treatment ironic is that the investment fell through. How appropriate is it to claim that a cash flow is an investing activity when the investment gets scratched? Clearly, if the FTC had not scotched the deal, the cash flows belonged in this section. But the failed deal seems to make this treatment a non sequitur. Cash flows from investing activities are either cash outflows for actual investments or cash inflows from disinvestments. They are not cash outflows for attempted-but-failed investments.

As such, I believe that the cash flow ought to be classified within the section of cash flows for operating activities. The cash flows from these transactions would then reduce cash provided by operating activities from the reported $1,174.0 million to $508.2 million, a decrease of 56 percent. Given that some investors and creditors and analysts use cash flow ratios in their analysis, is it any wonder that Air Products placed this amount somewhere else?

More by J. Edward Ketz