Show Me the Money, Sysco

Although headlines still spray earnings figures all over the media every day, many investors have moved past net earnings as a measure of a company's economic output. That's because an earnings statement is very often less trustworthy than a cash flow statement because it's more open to manipulation based on dubious judgment calls.

The unreliability of the income statement is one of the reasons Foolish investors often flip straight past it and the balance sheet to eyeball the cash flow statement. In general, by taking a close look at the cash moving in and out of the business, you can get a better look at whether the last batch of earnings brought money into the company or merely disguised a cash gusher with a pretty headline.

Calling all cash flows
It's worth checking up on your companies' free cash flow (FCF) once a quarter or so to see if it bears any relationship to the net income in the headlines. That's what brings us to Sysco (NYSE: SYY), which has produced $476 million in FCF over the trailing 12 months, compared with $1,158 million in net income.

That means Sysco turned about 1% of its revenue into FCF. That's not too impressive. But, it always pays to compare that figure to a company’s sector and industry peers to see how it stacks up against competitors.

Among Sysco’s competitors and peers, McDonald's comes in with the highest FCF margin (defined as FCF / trailing 12 months' revenue), with 18% of its revenue turning into FCF. And other peers have done substantially better in the last four quarters. It looks like Sysco’s got work to do.

All cash is not equal
Unfortunately, the cash flow statement isn't immune from nonsense either. That's why it pays to take a close look at the components of free cash flow from operations, to make sure that these sources of cash are of good quality: in other words, that they're real, and replicable, in the upcoming quarters and not offset by continual cash outflows that don't appear on the income statement, such as major capital expenditures.

For instance, cash flow based on cash net income and predictable depreciation? Generally good stuff. An increase in cash flow based on stiffing your suppliers (by increasing accounts payable) or stiffing Uncle Sam on taxes? Those will come back to bite investors. The same goes for decreasing accounts receivable. This is good to see, but it's ordinary in recessionary times, and you can only increase collections so much.

So, how does the cash flow at Sysco look? Take a peek at the chart below, which flags questionable cash flow sources with a red bar.

I characterize as questionable those cash flow statement line items such as changes in taxes payable, tax benefits from stock options, asset sales, and other items. That's not to say that companies booking these as sources of cash flow are weak or are engaging in any sort of wrongdoing. But whenever a company is getting more than, say, 10% of its cash from operations from these questionable sources, I feel obliged to crack open the filings and dig even deeper to make sure I am in touch with the true cash profitability.

With questionable cash sources comprising 16% of the cash flow from operations for Sysco, it’s worth digging into the financials to see what’s up. In this case, Sysco’s cash flow was hit by a swing in deferred tax benefits, which is the pendulum swinging the other way from a lot of positive tax accruals in prior years. (Thus, the big red bars from years 2005 to 2009).

Foolish final thought
If you are the kind of investor who takes the time to read past the headlines and crack a filing now and then, you're probably ahead of 95% of the rest of individual investors out there. By keeping an eye on the health of your companies' cash flow, you can spot potential trouble early or figure out if Mr. Market's pessimism is warranted by the numbers. Let us know what you think of the health of the cash flows at Sysco in the comments box below. Or, if you're itching to learn more, head on over to our quotes page to view the filings directly.