chapter 17
What are the cash inflows and outflows for operating activities?
Cash Inflows: - From sale of goods or services - From interest received and dividends recieved Cash Outflows: To suppliers for inventory To employees for services To government for taxes To lenders for Interest To others for expenses
When numerous adjustments are necessary, companies often use a cash flow worksheet instead of preparing a statement of cash flows
F
When prepaid expenses decrease during a period, expenses on the accrual-basis are lower than they are on a cash-basis.
F
True of False: Cash and cash equivalents are considered cash receipts or cash disbursements for SCF purposes.
False. They are not considered either of these because they are seen as identical and interchangeable.
Definition: This SCF cash flow classification includes activities related to cash flows form the issuance and retirement of debt and the issuance and repurchase of capital stock Also includes dividends.
Financing Activities
For external reporting purposes, the FASB recommends that the direct method of determining the net cash provided by operating activities be used for the statement of cash flows.
T
In the statement of cash flows, increases in a company's capital stock accounts are generally treated as a "source" rather than as a "use" of cash.
T
Investors use the debt ratio to rate the ability of the business to pay its current and long-term liabilities.
T
Noncash investing and financing activities are disclosed either in a separate schedule or in a separate note to the financial statements
T
The debt ratio is an example of a solvency ratio.
T
The dividend yield is an example of a market ratio.
T
The indirect method adjusts net income for items that affected reported net income but did not affect cash
T
The issuance of stock dividends is entered on the cash flow worksheet, but is not reported in the statement of cash flows
T
The net cash provided by operating activities on the statement of cash flows will generally be different than net income.
T
The net increase (decrease) in cash reported on the statement of cash flows should reconcile the beginning and ending cash balances reported in the comparative balance sheets.
T
The operating margin gives investors the best indication of how effectively a business is earning a profit from its normal business operations.
T
The statement of cash flows provides information to help investors and creditors assess the cash and noncash investing and financing transactions during the period.
T
To perform vertical analysis on an income statement, each amount is divided by net sales.
T
Under the indirect method of determining the net cash flow from operating activities on the statement of cash flows, a gain on the sale of equipment would be subtracted from net income.
T
When accounts receivable decrease during a period, cash-basis revenues are higher than revenues reported on an accrual basis
T
profitability ratio.
T
True or False: The SCF shows the effects on cash of a business's operating, investing, and financial activities for the accounting period.
TRUE
What 2 things do creditors use the SCF for?
1) Ability to pay bills 2) Need for additional financing
What 2 things do investors use the SCF for?
1) Ability to pay dividends 2) Need for additional financing
What are the 4 purposes that users use the SCF for?
1) Assess the firm's ability to generate positive future net cash flow 2) Assess the firm's ability to meet obligations (pay bills) 3) Assess the difference between net income and cash receipts/disbursements 4) Assess both cash and non-cash investing and financing activities
What are the three major user groups of the SCF?
1) Management (Internal) 2) Investors (External) 3) Creditors (External)
What 4 things does management use the SCF for?
1) to assess the firm's liquidity 2) to assess its financial flexibility 3) to determine its dividend policy 4) to plan investing and financing needs
What are the three sources a statement of cash flows is prepared from?
1. Comparative balance sheets: Information in this balance sheet indicates the amount of changes in assets, liabilities, and stockholder's equity from the beginning to the end of the period 2. Current Income Statement: Information in this statement helps determine the amount of cash provided or used by operations during the period. 3. Additional Information: Such information includes transaction data that are needed to determine how cash was provided or used during the period.
What are significant noncash activities?
1. Direct issuance of common stock to purchase assets 2. Conversion of bonds into common stock 3. Direct issuance of debt to purchase assets 4. Exchange of plant assets
What are the classifications of Cash Flows and what do they include.
1. Operating Activities: Include the cash effects of transactions that create revenues and expenses. 2. Investing Activities: Include (A) acquiring and disposing of investments and property, plant, and equipment +(B) obtaining cash from stockholders, repurchasing shares and playing dividends. 3. Financing activities: Include (A) obtaining cash from issuing debt and repaying the amounts borrowed and (B) obtaining cash from stockholders, repurchasing shares, and paying dividends.
What does a statement of cash flows accomplish?
1. Shows an entity's ability to generate future cash flows 2. Shows the entity's ability to pay dividends and meet obligations 3. Shows cash investing and financing transactions during the period 4. Explains reasons for differences between net income and net cash by operating activities
What is a statement of cash flows?
A basic financial statement that reports the cash receipts, cash payments, and net changes in cash resulting from operating, investing, and financing activities during a period.
Statement of cash flows
A basic nancial statement that provides information about the cash receipts, cash payments, and net change in cash during a period, resulting from operating, investing, and nancing activities. (p. 728).
Indirect method
A method of preparing a statement of cash ows in which net income is adjusted for items that do not affect cash, to determine net cash provided by operating activities. (pp. 732, 734).
Direct method
A method of preparing a statement of cash ows that shows operating cash receipts and pay- ments, making it more consistent with the objective of the statement of cash ows. (pp. 732, 745).
What are the cash inflows and outflows for investing activities?
Cash Inflows: - From sale of property, plant and equipment - From sale of investments in debt or equity securities of other entities - From collection of principal
What is cash defined as in relation to the statement of cash flows?
Cash and cash equivalents
Financing activities Cash
Cash flow activities that include (a) obtaining cash from issuing debt and repaying the amounts borrowed and (b) obtaining cash from stock- holders, repurchasing shares, and paying dividends. (p. 728).
investing activities
Cash flow activities that include (a) purchasing and disposing of investments and prop- erty, plant, and equipment using cash and (b) lending money and collecting the loans. (p. 728).
Operating activities
Cash flow activities that include the cash effects of transactions that create revenues and expenses and thus enter into the determination of net income. (p. 728).
Under the indirect method of determining the net cash provided by operating activities on the statement of cash flows, increases in current liabilities such as accounts payable are subtracted from net income.
F
Definition: This method of reporting net cash flows from operations shows cash receipts from sales and cash disbursements for expenses. This method requires that each item on the income statement be converted from an accrual basis to a cash basis.
Direct method
A change in deferred taxes is considered to be a financing activity on the statement of cash flows.
F
A company should add back bond premium amortization to net income to arrive at net cash flow from operating activities
F
A corporation's earnings per share can only be compared to the earnings per share of other corporations in the same industry.
F
A horizontal analysis ratio is calculated by dividing the difference between the current and prior period amounts by the current period amount.
F
A vertical analysis ratio for accounts receivable above the target range may indicate that ThreeGreen is too restrictive in extending credit to its customers.
F
Best Company's target range for its debt ratio is 20.0% to 25.0%. The company's debt ratio decreased from 34.5% to 26.7%. This is an unfavorable trend.
F
Cash payments for operating expenses are computed by subtracting an increase in prepaid expenses and a decrease in accrued expenses payable from operating expenses
F
Dividends received on stock held as an investment should be treated as an investing activity onthe statement of cash flows
F
Gross profit is also referred to as the rate of return on sales.
F
If accounts receivable increase during a period, then the amount of cash collected from customers will be greater than the amount of sales reported on the income statement for the period
F
If the income statement shows a loss for the period, then the net cash provided by operating activities on the statement of cash flows cannot be positive.
F
Income from an investment in common stock using the equity method is added to net income in computing net cash provided from operating activities
F
Investors are willing to pay a higher P/E ratio for income stocks than for growth stocks.
F
Reducing the amount of operating expenses always has a positive impact on a business.
F
The FASB encourages the use of the indirect method over the direct method
F
The direct method, also called the reconciliation method, reports cash receipts and cash disbursements from operating activities.
F
The first step in the preparation of the statement of cash flows is to determine the net cash flow from operating activities
F
The income statement is the primary source of data to calculate liquidity ratios.
F
The primary purpose of the statement of cash flows is to provide cash-basis information about the company's operating, investing, and financing activities
F
Transactions that involve acquiring or disposing of noncurrent assets are generally classified asfinancing activities on the statement of cash flows.
F
Under the accrual basis of accounting, net income is usually the same as net cash flow from operating activities
F
Under the direct method of determining net cash provided by operating activities on the statement of cash flows, the net income figure is adjusted for changes in current assets and liabilities.
F
Under the direct method of determining the net cash provided by operating activities on the statement of cash flows, an increase in accounts payable would be added to cost of goods sold to convert cost of goods sold to a cash basis.
F
Definition: This method for determining net cash flows from operations starts with net income. Net income is then adjusted for non-cash items included on the income statement.
Indirect method
Definition: This SCF cash flow classification includes activities related primarily to cash flows from the acquisition and disposal of noncurrent assets, especially property, equipment, and investments. Also included are cash flows from the purchase and disposal of short-term investments (marketable securities).
Investing Activities
Free cash flow
Net cash provided by operating activities adjusted for capital expenditures and dividends paid. (p. 742).
Are noncash investing and financing activities in the body of the statement of cash flows?
No, they are reported in separate schedules.
Definition: This SCF cash flow classification includes cash transactions related to revenues and expenses. Revenues are cash inflows and expenses are cash outflows. Also includes interest payments.
Operating Activities
What are the 3 classifications of cash flows for the SCF?
Operating, Investing, and Financing activities
Every transaction classified as "source" or "use" of cash for purposes of constructing a statement of cash flows involves a change in some noncash balance sheet account
T
Definition: Financial statement that shows the sources and uses of cash for the accounting period.
Statement of Cash Flows (SCF)
What are the three major steps to preparing a statement of cash flows?
Step 1: Determine net cash provided/ used by operating activities by converting net income from an accrual basis to a cash basis. Step 2: Analyze changes in non current asset and liability accounts and record as investing and financing activities or disclose as noncash transactions. Step 3: Compare the net change in cash on the statement of cash flows with the change in the cash account reported on the balance sheet to make sure the amounts agree.
A benchmark ratio can be stated as a single value or a range of values.
T
A business should never make a business decision for the sole purpose of meeting a benchmark ratio.
T
A company can convert net income to net cash flow from operating activities through either the direct method or the indirect method.
T
A supplementary schedule of non-cash investing and financing activities must be included with the SCF.
T
An increase in merchandise costs reduces the gross margin.
T
An increase in taxes payable between the beginning and the end of the year would be added to net income when determining the net cash provided by operating activities under the indirect method on the statement of cash flows.
T
Best Company's benchmark operating expense ratio is between 29.0% and 31.0%. A decline in its operating expense ratio from 34.5% to 33.6% is a favorable trend.
T
Cash dividends paid to the owners of a company would be classified as part of financing activities on the statement of cash flows.
T
Cash receipts from customers are computed by adding a decrease in accounts receivable to revenue from sales.
T
Companies classify some cash flows relating to investing or financing activities as operating activities
T
Companies report the cash flows from purchases and sales of trading securities as cash flows from operating activities
T
Earnings per share (EPS) is the most widely recognized measure of a corporation's financial performance.
T
What is the major purpose of the SCF?
To provide information regarding the cash receipts and disbursements of a business that will help users (investors, creditors, managers, etc.) assess the business.
FREE CASH FLOW
net cash provided by operating activities - capital expenditures - cash dividends = free cash flow