Markets

Why Business Insider's Henry Blodget Is Wrong About Groupon's Cashflow

By Jim Edwards

Updated on: June 13, 2011 / 12:24 PM EDT / MoneyWatch

Henry Blodget, the editor and CEO of the Business Insider, made an interesting argument over the weekend about how Groupon (GRPN) is actually cashflow positive, despite the history of losses reflected on its income statement.

His take on Groupon's management of cash is worth a read. Blodget, however, is wrong. Groupon's positive cashflow is nothing to celebrate, and investors shouldn't take their eye off the bottom line. Here's why.

Follow the money
Blodget's argument relates to the difference between Groupon's income statement and its cashflow statement.

The difference between the two is complicated, but in essence an income statement is prepared according to generally accepted accounting principles, or GAAP, which includes a number of non-cash charges and ignores certain cash transactions that occurred outside the quarter reflected. In other words, it's an artificial construct designed to show investors what the business looks like "officially," with all messy bits left out.

The cashflow statement, by contrast, reflects what actually happened to the cash in the business. Blodget notes that:

Of Groupon's $413 million loss in 2010, $203 million was a non-cash "acquisition-related" expense. ... So the actual operating loss was about $210 million.

He also shows that because Groupon pays its merchants after it collects money from subscribers, its cash float only grows: In 2010, Groupon collected $149 million that it did not pay merchants. It also delayed payments on another $95 million in bills. The net is that despite a paper loss of $456 million, Groupon actually ended the year with $107 million more in cash than it started with.

Similarly, in Q1 2011, despite "losing" $147 million, Groupon actually generated $90 million more in cash. Blodget uses different numbers -- this entire debate is about which numbers you like and don't like -- but the principle is the same: Groupon loses money on its income statement but generates cash on its cashflow statement.

Late payments aren't a business model
All this would suggest that the cashflow statement is a lot more important than the income statement. After all, the actual movement of cash is more important than some GAAP gobbledegook, right?

Not here. Groupon may be generating cash, but only because it's not paying its merchants and vendors in a timely fashion. Those merchants won't go away. They will eventually want to be paid. Groupon does not get to keep these cashflows -- it's money owed. That's why the income statement reflects a loss: It counts Groupon's net income as if the bills it generated to make those sales have already been paid. (It does reflect well on Groupon's management that they have constructed their bill-paying systems like this, however.)

The Golden Rule
Blodget also forgets the Golden Rule of accounting: Over time, GAAP accounting and cash accounting end up the same. It's like a law of gravity -- you can't show a profit on one set of books and a loss on the other forever. Eventually, everything equals out.

In Q1, Groupon generated positive cashflow only because it did not pay $122 million in bills owed to merchants and $36 million in other bills. Sure, the cash is temporarily in Groupon's account, but is making money by delaying payments to your customers a good business?

Groupon's cashflow structure looks "good" only in the way your checking account looks good when you pay all your bills with a credit card. In the short term, you appear to be saving a lot of money. No cash is leaving your checking account because you're paying everything with Visa. In the long-run, as you know, Visa gets its money back.

And that is what will happen here unless Groupon does something significant to the actual cost structure of its business -- as reflected on its income statement.

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