13-cash flow statement

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accounting, Wiley

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Introduction

chapter 13

Cash Flow StatementAccounting Matters!

You Have to Spend Money to Make MoneyBig-ticket leisure travel has become big business. And perhaps no company has tapped into this market more thoroughly than Vancouver-based Intrawest Corporation. Intrawest is the world's largest developer and operator of destination resorts, whose flagship Whistler/Blackcomb resort will play host to the Winter Olympic Games in 2010. The secret to the company's success is its growth formula: Start with a resort. Build a village so people stay longer. This attracts more visitors who come more often and spend more money. Build more real estate attractions, drawing in more people. This leads to the creation of shops, hotels, convention centres, and restaurants. The result: a year-round destination resort that puts the company into a financial position where it can invest in more locations. It's a fine balance of spending money to make money and making sure there is enough cash flow to cover debt. In 2003, Intrawest's formula needed a bit of tweaking. While resort operations were cash flowpositive, the real estate business was cash flownegative. To solve this problem, the company formed two partnerships with outside investors to create Leisura Developments, which takes on the most capitalintensive development projects. As a result, the amount of capital that we are required to invest in new real estate projects is significantly reduced, says David Blaiklock, Intrawest's vice president and corporate controller. The initial result was indeed significant. Cash flow from operating activities for the 2004 fiscal year was U.S. $422.9 million, compared to a negative cash flow of U.S. $20.9 million in 2003. Intrawest generated U.S. $303.1 million in free cash flow in 2004, which it used to reduce debt. A significant component of that cash flow was the one-time impact of introducing this partnershiphttp://edugen.wiley.com/edugen/courses/crs1562/pc/c13/content/kimmel6792c13_13_1.xform?course=crs1562&id=ref (1 of 3)14/04/2008 3:43:33 PM

Introduction

structure, Mr. Blaiklock stresses. Still, by selling real estate projects to Leisura, the company's cash flow requirements will be reduced. As for the 2010 Olympics, their impact on cash flow can only be positive. Since Whistler/Blackcomb already hosts World Cup alpine ski events, no infrastructure investment is required. The federal and provincial governments are spending millions on improvements to the highway from Vancouver to Whistler, which will increase real estate values and the number of resort visitors. The new athletes' village will provide affordable housing for resort employees. And then there's the prestige that comes with having been an Olympic host city. Although Whistler/Blackcomb is already a world-class destination, the Olympics will only generate more interest and more visitors, and thus more cash.

Intrawest: www.intrawest.com

The Navigator

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Introduction

Read Feature Story Scan Study Objectives Read Chapter Preview Read text and answer Before You Go On Work Using the Decision Toolkit Review Summary of Study Objectives Review Decision ToolkitA Summary Work Demonstration Problem Answer Self-Study Questions Complete assignments

Copyright 2008 John Wiley & Sons Canada, Ltd. All rights reserved.

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Study Objectives and Preview

Study ObjectivesAfter studying this chapter, you should be able to: 1. Describe the purpose and format of the cash flow statement. 2. Prepare a cash flow statement using one of two approaches: (a) the indirect method or (b) the direct method. 3. Use the cash flow statement to evaluate a company's liquidity and solvency.

Preview of Chapter 13The balance sheet, statement of earnings, and statement of retained earnings do not always show the whole picture of the financial condition of a company. In fact, looking at the financial statements of some well-known companies, a thoughtful investor might ask questions like these: How did Andrs Wines pay $3 million of dividends in a year when it had no cash but bank indebtedness instead? How did the Wilfrid Laurier University Students' Union increase its cash balance by more than $400,000 in a year in which it only earned a little more than $100,000? How did Rogers Communications finance its $25-million purchase of the SkyDome (now called the Rogers Centre)? Answers to these and similar questions can be found in this chapter, which presents the cash flow statement. The chapter is organized as follows:

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Study Objectives and Preview

Copyright 2008 John Wiley & Sons Canada, Ltd. All rights reserved.

http://edugen.wiley.com/edugen/courses/crs1562/pc/c13/content/kimmel6792c13_13_2.xform?course=crs1562&id=ref (2 of 2)14/04/2008 3:44:15 PM

Reporting of Cash Flows

Reporting of Cash FlowsThe three financial statements that we have studied so far present only partial information about a company's cash flows (cash receipts and cash payments). For example, comparative balance sheets show the increase in property, plant, and equipment during the year, but they do not show how the additions were financed or paid for. The statement of earnings shows net earnings, but it does not indicate the amount of cash generated by operating activities. The statement of retained earnings shows cash dividends declared, but not the cash dividends paid during the year. None of these statements reports the change in cash as a result of operating, investing, and financing activities during the period.

Purpose of the Cash Flow Statementstudy objective 1 Describe the purpose and format of the cash flow statement. The main purpose of the cash flow statement is to provide information about cash receipts, cash payments, and the net change in cash that result from the operating, investing, and financing activities of a company during a specific period. Reporting the causes of changes in cash is useful because investors, creditors, and other interested parties want to know what is happening to a company's most liquid resourceits cash. As the feature story about Intrawest demonstrates, to understand a company's financial position, it is essential to understand its cash flows. The information in a cash flow statement should help investors, creditors, and others assess the following aspects of a company's financial position: 1. The investing and financing transactions during the period. By examining a company's investing and financing activities, a financial statement reader can better understand why assets and liabilities increased or decreased during the period. 2. The company's ability to generate future cash flows. Investors and others examine the relationships between items in the cash flow statement. From these, they can better predict the amounts, timing, and uncertainty of future cash flows than they can from accrual-based data. 3. The company's ability to pay dividends and meet obligations. If a company does not have enough cash, it cannot pay employees, settle debts, or pay dividends. Employees, creditors, shareholders, and customers are particularly interested in this statement because it alone shows the flow of cash in a business. 4. The reasons for the difference between net earnings and cash provided (used) by operating activities. Net earnings provide information on the success or failure of a business. However, some people are critical of accrual-based net earnings because these earnings require estimates, allocations, and assumptions. As a result, the reliability of net earnings is often doubted. Cash flow is less susceptible to earnings management than net earnings. Although we suggest that relying on cashhttp://edugen.wiley.com/edugen/courses/crs1562/pc/c13/content/kimmel6792c13_13_3.xform?course=crs1562&id=ref (1 of 6)14/04/2008 3:44:30 PM

Reporting of Cash Flows

flows only and ignoring accrual accounting is inappropriate, comparing cash provided or used by operating activities to net earnings can reveal important information about the quality of the reported net earningsthat is, this comparison can show how good net earnings are as a measure of actual performance.

Accounting Matters! Investor PerspectiveDuring the 1990s, analysts increasingly used cash-based measures, such as cash provided by operating activities, instead of, or in addition to, net earnings. The reason for the change was that they had lost faith in accrual-based measures. Sadly, nowadays even cash flow is not always what it seems to be.

Take, for example, Alliance Atlantis Communications Inc. The company reported cash flow provided by operating activities of $686.5 million in 2001. Looks impressive, right? However, in 2002, the company's cash flow statement for 2001 was restated to report cash used by operating activities of $59.9 million. What happened? Accounting standard-setters decided that money spent to acquire, develop, and produce films and television programs was an operating expense, not an investment. In other words, Atlantis' cash flow did not actually change, but its reporting did. The moral of this story is that accounting principles can alter not only reported earnings, but also cash flow. Source: Fabrice Taylor, Show Me the Real Money, Report on Business Magazine, November 2002, 109.

Format of the Cash Flow StatementThe general format of the cash flow statement is organized around the three act