25. Understanding Cash Flow Statements

Question 1

Dividends declared

Answer 1

net income less the increase in retained earnings

Question 2

Dividends paid equation

Answer 2

dividends declared - dividends payable

Question 3

The only section of the statement of cash flows that must be adjusted to convert a statement of cash flows from the indirect to the direct method is:

Answer 3

cash flows from operations

Question 4

Purchases of equipment are considered to be

Answer 4

cash flows from investing under U.S.GAAP

Question 5

Interest paid or received and dividends received are considered to be

Answer 5

cash flows from operations under U.S.GAAP

Question 6

How would a stock split be reported on the statement of cash flows? A stock split would

Answer 6

not be reported on the statement of cash flows because it is a non-cash event.

Question 7

Gains or losses will be found in

Answer 7

cash flows from investments

Question 8

The difference between cash flow from operations (CFO) under the direct method and CFO under the indirect method is

Answer 8

always equal to zero.The direct and indirect methods are two ways of presenting the same total for cash from operations.

Question 9

An increase in notes payable would be classified as

Answer 9

An increase in notes payable is classified as financing cash flow

Question 10

Free cash flow to equity (FCFE)

Answer 10

cash flow from operations (CFO) - net fixed capital expenditures + net borrowing

Question 11

How can a cash flow statement be presented?

Answer 11

in common-size format by expressing each line item as a percentage of total revenue or by expressing each inflow of cash as a percentage of total cash inflows and each outflow as a percentage of total cash outflow

Question 12

why is expressing each line item of the CF statement as a percentage of revenue useful?

Answer 12

is useful in forecasting future cash flows since revenue usually drives the forecast

Question 13

A decrease in accounts receivable represents an

Answer 13

increase in cash so this should be added to sales

Question 14

Increases in accounts payable represent an

Answer 14

increase in cash so these should be subtracted from cost of goods sold

Question 15

Increases in inventory represent a

Answer 15

use of cash so these would be added to cost of goods sold

Question 16

Direct method benefits

Answer 16

1. presents operating cash receipts and payments and is thus more consistent with the objectives of the cash flow statement
2. provides more information than the indirect method and is preferred by analysts who are estimating future cash flows

Question 17

Depreciation is added back to net income when determining CFO using

Answer 17

the indirect method

Question 18

Independence, Inc. reports interest received and dividends paid as part of its cash flow from operations. This treatment is acceptable under

Answer 18

IFRS but not under U.S. GAAP

Question 19

Under U.S. GAAP, the actual coupon payment on a bond is reported on the statement of cash flow as

Answer 19

an operating cash outflow.

Question 20

What is the difference between the direct and the indirect method of calculating cash flow from operations?

Answer 20

The direct method starts with sales and follows cash as it flows through the income statement, while the indirect method starts with net income and adjusts for non-cash charges and other items.

Question 21

Which balance sheet accounts are most closely related to the operating activities on a firm’s cash flow statement?

Answer 21

to the working capital accounts (current assets and current liabilities) on the balance sheet

Question 22

Which balance sheet accounts are most closely related to the investing activities on a firm’s cash flow statement?

Answer 22

to non-current assets

Question 23

Which balance sheet accounts are most closely related to the financing activities on a firm’s cash flow statement?

Answer 23

to non-current liabilities for transactions with creditors, or equity for transactions with shareholders

Question 24

What does the reinvestment ratio measure?

Answer 24

firm’s ability to acquire long-term assets with cash flows from operations

Question 25

What does the investing and financing ratio measure?

Answer 25

the firm’s ability to purchase assets, satisfy debts, and pay dividends

Question 26

What does the cash-to-income ratio measure?

Answer 26

the ability to generate cash from a firm’s operations and is a performance ratio for cash flow analysis purposes

Question 27

What does the debt payment ratio measure?

Answer 27

the firm’s ability to satisfy long-term debt with cash flow from operations but it is more of a coverage ratio than a performance ratio

Question 28

Interest payments, either as part of a coupon payment or to creditors, are considered which type of cash flow under U.S. GAAP?

Answer 28

operating cash flow

Question 29

reinvestment ratio

Answer 29

CFO/ cash paid for long-term assets