This morning CNBC had one of GroupOn’s early investors defending the company because despite its accounting problems it has strong cash flow. Does it? Harvey Weller, the investor said Groupon had free cash flow last quarter of around $155 million. This is what Groupon stated in their press release, defining free cash flow as cash flow from operations minus capital expenditures. I assume they are using net cash flow from operations as it will appear on their cash flow statement when they file their 10-Q, but that line item which the SEC requires is flawed in its nomenclature. In my investment career I have been stunned by the number of other professionals who do not know how to calculate operating cash flow analytically in a sound manner and this is another example. The cash flow statement required by the SEC includes in “operating cash flow” changes in working capital. So if you are slow paying your bills, it helps the company’s working capital and hence the SEC defined cash flow from operations, but it is not a good sign. Changes in working capital are temporary, eventually vendors need to be paid or the company goes bankrupt. Groupon is not the first company to convice Wall Street that despite massive losses on a net income basis, they are really positive on a cash flow basis.
Groupon has a business model where the retail customer pay them up from for the deal, so they have massively positive working capital – this is alone is a very good thing because it means it does not need to finance its working capital needs like other businesses. But it also means this money is owed to merchants when the deal is redeemed.
Groupon has not filed in Q1 10-Q yet so we cannot see the cash flow statement from last quarter, but we can use its annual to illustrate this. In its last full fiscal year Groupon had cash flow from operation as defined by SEC of around $290 million; but $390 million of this was from accrued merchants payable and $189 million from accrued expenses and other liabilities (not paying one’s bills). Together these two items total $579 million, meaning Groupon actually lost close to $300 million from running their business if they settled up on all their accounts and went “flat”, which voila is what their reported net income was.
There are non-cash expenses that one can correctly analytically add back to net income to get net income with all its accounting distortions closer to real cash flow. These would be items like depreciation, stock compensation expense and deferred income taxes. Groupon for 2011 has net income of negative $297.7 million (-$297.7 million). If you add back these three non-cash items, it would make their net income close to a negative $140 million (-$140 million). Losing $140 million is better than losing $300 million, but hardly a ringing endorsement.
In other words Groupon’s real operating cash flow on an analytically sound basis meaning if they paid all their bills and were flat on receivables and payables would be a negative $140 million (-$140 million) not a positive $290 million reported as cash flow operations in their SEC documents. While the SEC requires and should require companies to disclose the impact of changes in working capital on liquidity and cash flow, changes in working capital do not represent economic profits or losses and long term they have no impact on how much cash a company can put in the bank.