Financial Accounting Blog

Sunday, January 25, 2004

COMPENSATION AND CASH FLOW. reports why many companies are using metrics from the cash flow statement, and not just the income statement, to measure performance and award bonuses. Cash flow, working capital, return on invested capital are now as important as revenues or earnings.

In addition to personal performance, annual bonuses are traditionally tied to metrics reflected on the income statement, such as revenue or net earnings. These targets "focus managers on driving income-statement results without a lot of regard to the balance sheet," says Cheryl Beebe, treasurer and vice president of finance at Corn Products International. That was the case at her company, too, quips Beebe, before management decided to "put skin in the game."

In 2001, Corn Products tied annual bonuses to cash flow. Now in its third year, the program links 20 percent of yearly bonuses to total working capital (current assets minus current liabilities, excluding short-term debt). The rest of the bonus is determined by operating income and personal performance. Beebe maintains that the working-capital program has cut down on dysfunctional behavior because executives are less likely to manage for top-line sales and revenue numbers. The Corn Products plan links bonuses "to what it takes to earn a profit on sales," asserts Beebe. "It's great to make a sale, but if it takes 120 days to collect the money, profit margins won't be very sturdy, and that's not the business model we want to encourage."