Much ado has been made about the article written by Tommy Craggs entitled "How An NBA Team Makes Money Disappear" and discussed in the Downbeat #523.
First, I would like to lead off with the fact that I am a CPA, and I have to admit Tommy's article made me cringe. No offense to Tommy, but it seemed to me that he was trying to rationalize a point of view by quoting financial information out of context.
How can I say that? First of all, comparing financial statement info with tax return info is like comparing apples to oranges. This is because there are different rules that apply to both and both serve a different purpose. The financial accounting standards board (FASB) creates the rules for financial statements and congress creates the rules for taxes. The IRS enforces the tax rules.
Owners actually have an incentive to make their financial statements “pretty” because this is what they show to their lenders/investors. This is because lenders have certain guidelines/covenants that the owners need to maintain to keep them in good standing on their loans, and investors want to see a good return on their investments.
However, owners have the opposite incentive on their tax returns because they want to pay as little tax as possible.
Keep in mind that what you have been shown in the article are the financial statements and not the tax returns. So, in all honesty, you “should” be seeing the best numbers that can be created for the owners for their lenders/investors benefit while still helping them to minimize their tax liabilities when the numbers are transferred to their tax returns and adjusted for tax differences.
When I look at the financial statements, I see a whole different story.
What do I mean? Well, one thing that might bring some clarity on all this is the cash flow statements that are provided with the financials. A cash flow statement is a statement that is meant to show where all the cash comes from and where it goes (i.e. it takes out the non-cash items in the financial statements).
What do I mean?
If you look at page 5 of the financial statements where the cash flows are shown, you will find that 2004 had an increase of cash totaling $839,872; 2005 had an increase of cash totaling $1,080,316; and 2006 had an increase of cash totaling $1,227,104. So there is cash coming in net each year. However, it is interesting to find where the cash is coming from.
Operations for each year are net losses ($20,497,240) for 2004; ($26,752,919) for 2005; and ($39,534,772) for 2006. So operations are losing a ton of cash. The positive cash flow is coming in through the investing and financing sections; most significantly in new borrowings and contributions from members. Member contributions of money totaled $158,281,600 in 2005 and $65,667,165 in 2006.
In other words, the cash flow statements show that the operations lost ($86,784,931) in cash from 2004 through 2006, and that the ownership group ponied up $223,948,765 in cash to keep the business afloat during that same time period.
Now you can see why I cringed when I read Tommy's article. He attempts to prove his point by saying the owners are manipulating the numbers with smoke and mirror tactics and then relies on a few terms he's heard like RDA and depreciation to support his case.
However, if you follow the cash in the financial statements presented by Tommy, you'll find the cash doesn't support his case.