Access
the financial statements of Bombardier Inc. for the year ended January 31,
2010, and January 31, 2008, from the company’s website or SEDAR (www.sedar.com).
Instructions
Changes
in non-cash working capital items can have a significant impact on operating
cash flows. Using the financial statements, answer the following questions.
(a)
What does Bombardier do? When is revenue and related costs recognized? Comment
on the timing of revenue and expenses, and cash receipts and payments related
to operating activities.
(b)
What were Bombardier’s net earnings from 2007 to 2010? What were the operating
cash flow amounts for the same periods? Calculate the difference between net
income and operating cash flows for each year. In which years was the operating
cash flow higher or lower than net earnings? Calculate the year over year
percentage changes in net earnings. Calculate the year over year percentage
changes in operating cash flows. Comment on these differences in dollar amounts
and year over year percentage changes.
(c)
What is causing these differences in net income and operating cash flows to
occur? Highlight significant differences and explain why these arise.
(d)
Comment on the ability to predict cash flows for this company. Which approach
in preparing operating cash flows (direct or indirect) would be most useful to
potential investors?
(a) Bombardier
Inc. manufactures and sells state-of-the-art trains and airplanes. As a result, they have a long manufacturing
and cash cycle. As described in note 1:
·
Revenues from the sale of
commercial aircraft and light business aircraft are recognized on delivery.
·
Revenues from the sale of
fractional shares in aircraft are recognized in revenue over the period that
the services are provided – up to five years.
At the time of the sale, cash received is reported as deferred revenues
and then allocated to revenues over the period of the contract. This is similar to the treatment of the
related costs which are also deferred and recognized as cost of sales over the
contract period.
·
Revenues from long-term contracts
related to design, engineering, manufacturing and maintenance are recognized on
a percentage of completion basis. This would also differ from when the cash
flowed related to these contracts.
Progress payments received for work done is deducted from the related
inventory amounts. Advance payments are
included in liabilities for progress billings in excess of related costs.
As can be seen from the above, there may be significant
timing differences between the time cash is received on a sale and the time
revenue is recognized. In addition,
there will also be significant differences in timing as to when cash payments
are made for costs and costs are reported in net income.
(b) The schedule below shows the net income and
operating cash flows for each year.
|
In
US$ millions
|
2010
|
2009
|
2008
|
2007
|
|
|
|
|
|
|
|
Net
income
|
707
|
1,026
|
317
|
243
|
|
Net
cash flow from operating activities
|
552
|
909
|
2,380
|
891
|
|
Difference
|
(155)
|
(272)
|
2,063
|
648
|
|
Year
over year percentage increases (decreases) in net earnings
|
-31%
|
224%
|
30%
|
|
|
Year
over year percentage increases (decreases) in operating cash flows)
|
-39%
|
-62%
|
167%
|
|
For 2010 and 2009, the net earnings were higher than the
operating cash flows by US$155 million and US$272 million, respectively. For 2008 and 2007, however, operating cash
flows were significantly higher than net earnings by US$2,063 million and
US$648 million, respectively. It appears
that operating cash flows do not trend by the same amount or in the same
direction as earnings. From 2007 to
2008, net earnings increased 30% whereas operating cash flows increased by
167%, representing a significant difference.
From 2008 to 2009, although net income increased by 224%, operating cash
flows actually declined by 62%. From
2009 to 2010, both net income and operating cash flows declined by similar
amounts, 31% for net income and 39% for operating cash flows. From the above analysis, there appear to be
significant differences as to when cash flows are received and paid and when
the amounts are reported as revenue and expenses on the income statement.
(c) The schedule below highlights the causes of significant
differences between net income and operating cash flows. Note 21 (2010 financial statements) provides
information for major differences in the non-cash balances.
|
US$
millions
|
2010
|
2009
|
2008
|
2007
|
|
Net
income
|
707
|
1,026
|
317
|
243
|
|
Amortization
|
498
|
555
|
512
|
518
|
|
Total
of Other Non-cash items
|
18
|
92
|
168
|
(49)
|
|
Changes
in non cash working capital
|
(671)
|
(764)
|
1,383
|
179
|
|
Net
cash flow from operating activities
|
552
|
909
|
2,380
|
891
|
|
Some
of the most significant changes year
over year (Note note below):
|
2010
|
2009
|
2008
|
2007
|
|
Change
in inventories:
|
466
|
(1,211)
|
220
|
(47)
|
|
Change
in accounts payable and accrued
liabilities
|
143
|
778
|
(237)
|
(82)
|
|
Advances
and progress billings in excess of related long term contracts
|
(401)
|
(263)
|
652
|
159
|
|
Advances
on aerospace programs
|
(889)
|
88
|
1,051
|
|
|
Accrued
benefit liabilities
|
(71)
|
(85)
|
(467)
|
|
|
Total
of other items
|
81
|
(71)
|
164
|
149
|
|
Net
change in non-cash balances.
|
(671)
|
(764)
|
1,383
|
179
|
Often the change in the balance sheet account will not
agree to the change as reported in the cash flow statement due to non-cash
transactions that might take place such as foreign exchange changes. Also, if the company has acquired other
businesses during the year, then the investment in these businesses will show
as an investing activity and not operating activities.
As can be seen from the above schedule, there are
significant changes in inventories, accounts payable, advances and billing in
excess of long term contracts and advances on aerospace programs. All of these accounts are impacted by the
timing of recognizing revenue (and related costs) and cash receipts from
customers and payments for expenses.
These large variations each year indicate that cash flows for this
particular company from operating activities are very different from reported
earnings.
(d) As seen from the
above analysis, predicting of cash flows will be extremely difficult given the
large variations from year and year, with little tie to net earnings
trends. In this case, a direct approach
might be more helpful, given that the cash flows from customers and payments to
suppliers and employees would be more transparent. Using the indirect approach, it is impossible
to calculate the cash receipts and cash payments from normal operating
activities.
