Chapter 19: Reporting and Analyzing Cash Flows
Beyond the Numbers
See your instructor for suggested solutions to these exercises, available to faculty in this Online Learning Centre's instructor area.
Reporting in Action
Wendy Geiger is working late on a Friday night in preparation for a meeting with her banker early Monday morning. Her business is just finishing its fourth quarter. In the first year the business experienced negative cash flows from operations. In the second and third years, cash flows from operations turned positive. Unfortunately, her inventory costs rose significantly in year four and her net income will probably be down about 25% after this year's adjusting entries. Wendy is hoping to secure a line of credit from her banker which will be a nice financing buffer. From prior experience with her banker she knows a focus of the meeting on Monday will be cash flows from operations. The banker will scrutinize the cash flow numbers for years one through four and will want a projected number for year five. Wendy knows that a steady upward progression of cash flows in years one through four will really help her case for securing the line of credit. Wendy decides to use her discretion as owner of the business and proposes several adjusting entries and business actions which will help turn her cash flow number in year four from negative to positive.
Communicating in Practice
Your friend, Maddy Massola, recently completed his second year in his own business. Maddy just received annual financial statements from his accountant. Maddy says he finds the income statement and balance sheet quite informative but he does not understand the statement of cash flows. He says the first section is particularly confusing and he cannot get much beyond it. He says it contains a lot of additions and subtractions that do not make sense to him. Maddy added "I'm not concerned. It's probably just one of those extra forms accountants are required to fill out. The Income Statement tells me the business was more profitable than last year and that is what's most important. If I want to know about cash or cash changes, I can look at the Balance Sheets from this year and last."
Taking it to the Net
Use the Sedar database at http://www.sedar.com to access the December 31, 1997, annual report for Canadian Pacific Corporation. Locate this company's consolidated statement of changes in financial position for the years ended December 31, 1997, 1996, and 1995. (Note that under the current accounting recommendations this statement would be called a statement of cash flows.) Answer the following questions.
Teamwork in Action
The aim of this activity is to provide team support for "putting it all together" with the statement of cash flows. After completing each of the three sections below, members should report to the team. Team members are to confirm or correct teammate's responses.
Hitting the Road
Visit the Motley Fool Investment Web site at http://www.fool.com. Click on the sidebar link entitled "School." Select the link "Valuation: Principles and Practice." How does the Fool's school define cash flow? Per the school's instruction why do analysts focus on earnings before interest and taxes (EBIT)? Visit other links at the Web site that may interest you such as "A Journey Through the Balance Sheet" or find out what the "Fool's Ratio" is.
Read the article, "Are profits shakier than they look?" in the August 5, 1996, issue of Business Week.
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