Standard & Poor’s has issued a report highlighting the problems with how Canadian income funds calculate and report their distributable cash.

“The current state of financial reporting among Canadian income funds leaves much to be desired,” it declares. “Even the initial starting point to the distributable cash calculation is plagued with distortion and information risks that, if left unattended, will undoubtedly result in misinformed investor decisions.”

“Coupled with insufficient and inconsistent disclosure by management, the information risks inherent in this area of the Canadian capital markets continue to be quite significant,” it adds.

The report notes that cash generation calculations used are non-GAAP and nonstandard. “Furthermore, reported cash generation will not necessarily equal actual cash generation due to certain accounting conventions,” it explains. “Second, distributable cash calculations are commonly adjusted for discretionary items, the disclosure and subjectivity of which vary in quality from fund to fund.”

“Investors should be aware of these financial reporting differences and disparities between reported cash and actual cash when making investment decisions,” it notes.

Standard & Poor’s Ratings Services says it examined distributable cash calculations among a sample of 40 income funds, finding that 10% of them had cash generated and available for distribution that was lower than what was reported by management and insufficient to cover distributions over a two- to three-year period.

Overall, income funds in the sample experienced average two-year available cash reporting distortions of 12%, it reports, with some funds as high as 27% to 66%. The energy sector led the way with average distributable cash distortions of 18.5% in the past two years. The REIT sector tended to have the least amount of distortion due to the relatively small amount of working capital required for operating in that sector.