Accounting Ch. 13
Of the three types of business activities summarized in a statement of cash flows, which type is least likely to show positive net cash flows in a successful, growing business? Explain your reasoning.
Among the classifications shown in the cash flow statement, a successful and growing company is least likely to report a positive cash flow from investing activities. A growing company is usually increasing its investment in plant assets, which generally leads to a negative cash flow from investing activities. In fact, negative cash flows from investing activities may be a very favorable sign for a growing business. If the company is successful and growing, however, the cash flows from operating activities and from financing activities usually are positive.
During the current year, the following credit entries (increases) were posted to the paid-in capital accounts of Crawford Shipyards: ● Capital Stock ................................ $15,000,000 ● Additional Paid-in Capital ................. 27,500,000 Explain the type of cash transaction that probably caused these credit changes, and illustrate the presentation of this transaction in a statement of cash flows.
Credits to paid-in capital accounts usually indicate the issuance of additional shares of capital stock. Assuming that these shares were issued for cash, the transaction would be presented in the financing activities section of a statement of cash flows as follows: Proceeds from issuance of capital stock ($15,000,000 + $27,500,000)..... $42,500,000
Define the term Free Cash Flow. Explain the significance of this measurement to a. Short-term creditors
Free cash flow is that portion of the net cash flow from operating activities that is available for discretionary purposes after the basic obligations of the business have been met. From a short-term creditor's point of view, free cash flow is a "buffer," indicating that the business brings in more cash than it must have to meet recurring commitments.
Define the term Free Cash Flow. Explain the significance of this measurement to a. Stockholders
From the stockholders' viewpoint, free cash flow indicates a likelihood of future dividend increases or, perhaps, expansion of the business, which will increase future profitability.
In the long run, is it more important for a business to have positive cash flows from its operating activities, investing activities, or financing activities? Why?
In the long run, it is most important for a business to have positive cash flows from operating activities. To a large extent, the ability of a business to generate positive cash flows from financing activities is dependent upon its ability to generate cash from operations. Investors are reluctant to invest money in a business that does not have an operating cash flow sufficient to assure interest and dividend payments. Also, a business cannot sustain a positive cash flow from investing activities over the long run. A company can only sell productive assets for a limited period of time. In fact, a successful and growing company will often show a negative cash flow from investing activities, as the company is increasing its investment in plant assets.
Define the term Free Cash Flow. Explain the significance of this measurement to a. Long-term creditors
Long-term creditors view free cash flow as evidence of the company's ability to meet interest payments and to accumulate funds for the eventual retirement of long-term debt.
Define the term Free Cash Flow. Explain the significance of this measurement to a. Management
Management views free cash flow positively because it is available for discretionary purposes rather than already committed to basic operations In summary, everyone associated with the business views free cash flow favorably—and the more, the better.
Why are payments and receipts of interest classified as operating activities rather than as financing or investing activities?
Net cash flow from operating activities generally reflects the cash effects of transactions entering into the determination of net income. Because interest revenue and interest expense enter into the determination of net income, these items are classified as operating activities
Identify three factors that may cause net income to differ from net cash flows from operating activities.
Net income may differ from the net cash flows from operating activities as a result of such factors as: 1. Depreciation and other noncash expenses that enter into the determination of net income 2. Short-term timing differences between the cash basis and accrual basis of accounting. These include changes in the amounts of accounts receivable, inventories, prepaid expenses, accounts payable, and accrued liabilities. 3. Nonoperating gains and losses that, although included in the measurement of net income, are attributable to investing or financing activities rather than to operating activities.
Frost, Inc., acquired land by issuing $770,000 of capital stock. No cash changed hands in this transaction. Will the transaction be included in the company's statement of cash flows? Explain.
One purpose of a statement of cash flows is to provide information about all the investing and financing activities of a business. Although the acquisition of land by issuing capital stock does not involve a receipt or payment of cash, the transaction involves both investing and financing activities. Therefore, these activities are disclosed in a supplementary schedule that accompanies the statement of cash flows.
Explain the concept of peak pricing and provide an example from your own experience
Peak pricing means charging higher prices in periods in which customer demand exceeds the company's capacity, and lower prices in "off-peak" periods. This serves the dual purposes of increasing revenue during peak periods, and allowing the business to serve more customers by shifting excess demand to off-peak periods. Common examples include restaurants, which charge higher prices at dinner time, and movie theaters, which offer low matinee prices during the daytime.
Give two examples of cash receipts and two examples of cash payments that fit into each of the following classifications: a. Operating activities
Receipts: Cash received from customers Dividends and interest received Payments: Cash paid to suppliers and employees Interest paid Income taxes paid
Give two examples of cash receipts and two examples of cash payments that fit into each of the following classifications: Investing activities
Receipts: Sales of investments Collecting loans Sales of plant assets Payments: Purchases of investments Lending cash Purchases of plant assets
Give two examples of cash receipts and two examples of cash payments that fit into each of the following classifications: Financing activities
Receipts: Short-term or long-term borrowing Issuance of capital stock Sales of treasury stock Payments: Repayment of debt Purchase of treasury stock or retirement of outstanding shares Payment of dividends
Explain why speeding up the collection of accounts receivable provides only a one-time increase in cash receipts
Speeding up the collection of accounts receivable does not increase the total amount collected. Rather, it merely shifts collections to an earlier time period. The only period(s) in which cash receipts actually increase are those in which collections under both the older and newer credit periods overlap.
At the beginning of the current year, Waxler Corporation had dividends payable of $1,600,000. During the current year, the company declared cash dividends of $4,500,000, of which $970,000 appeared as a liability at year-end. Determine the amount of cash dividends paid during this year.
The amount of cash dividends paid during the current year may be determined as follows: Dividends declared during the year................................................. $4,500,000 Add: Decrease during the year in the liability for dividends payable ($1,600,000- $970,000) ................................................................ $630,000 Dividends paid during the year ....................................................... $5,130,000
The only transaction recorded in the Plant Assets account of Pompei Company in the current year was a $263,000 credit to the Land account. Assuming that this credit resulted from a cash transaction, does this entry indicate a cash receipt or a cash payment? Should this $263,000 appear in the statement of cash flows, or is some adjustment necessary?
The credit to the Land account indicates a sale of land and, therefore, a cash receipt. However, the $263,000 credit represents only the cost (book value) of the land that was sold. This amount must be adjusted by any gain or loss recognized on the sale in order to reflect the amount of cash received.
Briefly explain the difference between direct and indirect methods of computing net cash flows from operating activities. Which method results in higher net cash flows?
The direct method identifies the major operating sources and uses of cash, using such captions as "Cash received from customers." The indirect method, on the other hand, reconciles net income to the net cash flows from operating activities by showing a series of adjustments to the net income figure. Both methods result in exactly the same net cash flows from operating activities.
Does a statement of cash flows or an income statement best measure the profitability of a financially sound business? Explain.
The income statement provides the better measurement of profitability, especially when the business is financially sound and short-run survival is not the critical issue. The statement of cash flows is designed for measuring solvency, not profitability. An income statement, on the other hand, is specifically designed to measure profitability but gives little indication of solvency.
Briefly state the purposes of a statement of cash flows.
The primary purpose of a statement of cash flows is to provide information about the cash receipts and cash payments of a business. A related purpose is to provide information about the investing and financing activities of the business.