Reviewed by Kathryn A. S. Lancaster Texas A&M University
The book is a collection of 14 papers that reflect a long-standing interest of Dr. Gerald Lawson in cash flow accounting/ analysis (CFA) and provide insight into the development of the Statement of Cash Flows as it is currently presented. Since Dr. Lawson has taught at the University of Manchester in England, a number of his papers are written from an United Kingdom accounting methodology standpoint. Some of the papers do not stand alone, which makes the glossary of symbols included at the end of the book a helpful tool to refer to while reading the papers. The papers focus on the measurement of the creation of ownership value inherent in cash flow market value accounting and span a decade from 1981 to 1992. At the time Dr. Lawson began examining CFA, the U.K. Accounting Standards Committee (ASC) advocated a fund flow of the following form in SSAP 10:
Sources of Funds = Applications of Funds
where sources came from operating activities, the sale of assets, loans raised, and equity shares issued. Applications of funds went towards assets acquired, taxes paid, loans repaid, and dividends paid. Dr. Lawson believed the above approach led to the “erroneous impression that funds generated from operations constitute part of a pool which, at management’s discretion, can then be deployed in alternative uses including periodic working capital investment” [p. 274]. To correct for this perceived mud-
dying of the water, he proposed the following identity, which is a reorganization and reclassification of the information in-cluded in the fund flow statement:
ENCF = LCF + SHCF
where ENCF is entity cash flows, LCF is lender cash flows, and SHCF is shareholder cash flows. In this form, the user would be able to identify the source of funds as being generated by the entity or by investing/financing activities more readily. This basic identity formula is expanded on in several of the papers, with the most straightforward explanation being provided in Paper 8, “The Valuation of a Business as a Going Concern.
This reader recommends beginning with Paper 12, “Call for SSAP 10 Reform.” This paper provides the motivation for the studies and cases included in the other 13 papers and helps make sense of some of the other papers. Also, any unfamiliarity with U.K. accounting standards is mitigated by reading the papers in the order outlined. The papers all focus on the use of Lawson’s proposed cash flow identity that facilitates analysis of management decisions and corporate performance. The motivation is further clarified in Papers 9 and 10, each a case study of a firm that experienced financial difficulty in the late 1970s or the early 1980s. In Paper 9, “Was Woolworth Ailing,” Dr. Lawson examines Woolworth’s cash flows and concludes that entity generated cash flows did not cover dividend payments, lender’s contributions did. This resulted in an increasing debt to equity ratio, which Lawson believes was the basis of Woolworth’s difficulties. He speculates if CFA via the Lawson model had been employed by the firm, both management and shareholders would have realized dividends based on historical levels were not feasible, and that cash flows generated by operating activities were not sufficient to cover the dividends. Paper 10, “Why the Current UDS Takeover Bids Became Inevitable,” presents the same type of analysis for a firm that did adjust dividends for reduced revenue. In it, Dr. Lawson concluded management al-tered dividend and debt policies with some skill, but provided adequate returns for lenders at the expense of shareholders.
After reading Papers 12, 9, 10, and 8 the reader will be better prepared for progressing through the other papers as presented. The Introduction provides the conceptual linkage between the papers. Papers 1 and 2, “Assessing Economic Performance and Corporate Financial Policies on a Cash-Flow Market Value Basis” and “Ownership Value Creation and the Evaluation of Alternative Plans,” the second co-written with H. Chong, delve deeper into the cash-flow identity relationship and explain Dr. Lawson’s conviction that cash flows should be evaluated after-trie-fact and included in the budgetary process. Paper 3, “Contract Costing and the Negotiation of Contract Prices” co-written with J. van den Berge, and Paper 4, “Pricing of Non-competitive Government Contract” co-written with R. C. Stapleton, examine the use of cash-flow accounting in preparing more accurate contracts. In Paper 4, the authors examine the use of net present value calculations in contract pricing, which they contend should play a part in contract preparation. This is related to CFA through the periodic cash flows generated by a contract.
Lawson includes a couple of application-based papers that can be used in the classroom. Although lacking a proper intro-duction, Paper 5, “Specifying a Mutiperiod, Computer-based Fi-nancial Model,” is developed as a student assignment which re-quires the student to develop a multiperiod cash-flow budget. “Zones, Ltd.,” Paper 7, is a case study that can be incorporated either into a lesson on cash-flow versus accrual-based account-ing or into a lecture on break-even calculations. It compares traditional break-even analysis to break-even analysis that incor-porates cash-flow timing into the traditional break-even model. The traditional model assumes all cash flows occur in the period under question, when in reality both cash inflows and outflows often have a built-in lag where the company is acting as either a credit grantor or taker.
Papers 8, 13, and 14 contain examples of how to apply Lawson’s cash-flow identity model. Paper 8 addresses the importance of combining cash flow analysis with present value calculations and compares this to accrual-based valuation methods. He surmises that the cash flow approach more closely estimates the realizable value of a firm, in spite of the requirement that future cash flows be estimated. Paper 13, “Equity Values and Inflation: Dividends and Debt Financing,” is a response to a study by Professor Basil Moore that professed to show that dividend shortfalls were the cause of the decline in UK equity values. The paper, which was co-written by A. W. Stark, provides theoretical evidence that the decline is due to declining cash flow performance. Paper 14, “Bankruptcy Prediction – An Investigation of Cash-Flow Based Models,” co-written by A. Aziz and D. Emanuel, applies Lawson’s cash flow based (CFB) identity to the bankruptcy model developed by Altman. The results provide evidence that the theory-based CFB model predicts bankruptcy as well as or better than previous models.
In conclusion, the collection of papers included in this book provides an interesting background to one side of the contro-versy surrounding the development of the current cash-flow model. From a historical standpoint, they helped this reader understand why the previous flow model was inadequate.
