Chapter 12: Statement of Cash Flows

Statement of cash flows

A financial statement that highlights the major activities that impact cash flows and affect the overall cash balance

Free cash flow

A measure that assesses a company's ability to fund its capital expenditures and dividends from its net cash provided by operating activities

Direct Method

A method of computing the net cash provided by operating activities in which the income statement is reconstructed on a cash basis from top to bottom

Indirect method

A method of computing the net cash provided by operating activities that starts with net income and adjusts it to a cash basis

Basic Equation for Asset Accounts =

Beg. Balance + Debits - Credits = Ending Balance

Basic Equation for Contra Assets, Liability, and Stockholders' Equity Accounts =

Beg. Balance - Debits + Credits = Ending Balance

Cash equivalents on the statement of cash flows consist of any investment that can be converted into cash within one year.

FALSE

Cash received from the sale of equipment the company had used in its own operations would be considered an operating activity on a statement of cash flows.

FALSE

Investing activities on the statement of cash flows generate cash inflows and outflows related to borrowing from and repaying principal to creditors and completing transactions with the company's owners such as selling or repurchasing shares of common stocks and paying dividends.

FALSE

Negative free cash flow suggests that the company generated enough cash flow from its operating activities to fund its capital expenditures and dividend payments.

FALSE

When a company pays a supplier for inventory it has purchased, the cash outflow is recorded in the investing activities section of the statement of cash flows.

FALSE

When computing the net cash provided by operating activities under the indirect method on the statement of cash flows, an increase in prepaid expenses would be added to net income.

FALSE

Cash Equivalents

Short-term, highly liquid investments such as Treasury bills, commercial paper, and money market funds, that are made solely for the purpose of generating a return on temporarily idle funds

Buying property, plant, or equipment would be reported as a cash outflow on the investing activities section of the statement of cash flows.

TRUE

Collecting the principal on a loan to another company would be reported on the investing activities section of the statement of cash flows.

TRUE

Insurance and utility expenses are considered operating activities on the statement of cash flows.

TRUE

Money received from issuing bonds payable would be included as part of a company's financing activities on the statement of cash flows.

TRUE

Negative free cash flow does not automatically signal poor performance.

TRUE

Paying interest to lenders is classified as an operating activity on the statement of cash flows.

TRUE

Paying taxes to governmental bodies is considered a cash outflow in the operating activities section on the statement of cash flows.

TRUE

Paying wages and salaries to employees is classified as a cash outflow in the operating activities section of the statement of cash flows.

TRUE

The direct method of preparing the statement of cash flows will show the same increase or decrease in cash as the indirect method.

TRUE

Under the indirect method of determining the net cash provided by operating activities on the statement of cash flows, a loss on the sale of an asset would be added to net income.

TRUE

Under the indirect method of determining the net cash provided by operating activities on the statement of cash flows, an increase in accounts receivable would be subtracted from net income.

TRUE

When a company pays cash to repurchase its own common stock, this is reported as a cash outflow in the financing activities section of the statement of cash flows.

TRUE

Net cash provided by operating activities

The net result of the cash inflows and outflows arising from day to day operations

Investing activities

These activities generate cash inflows and outflows related to acquiring or disposing of noncurrent assets such as property, plant, and equipment, long term investments, and loans to another entity

Financing Activities

These activities generate cash inflows and outflows related to borrowing from and repaying principal to creditors and completing transactions with the company's owners, such as selling or repurchasing shares of common stock and paying dividends

Operating activities

These activities generate cash inflows and outflows related to revenue and expense transactions that affect net income