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Flashcards in Chapter 12 Deck (61):

Statement of cash flows

Reports the cash receipts and cash pyaments from operating, investing, and financing activities during a period, in a format that reconciles the beginning and ending cash balances


Statement of Cash Flows helps assess

1. The entity's ability to generate future cash flows

2. The entity's ability to pay dividends and meet obligations

3. The reasons for the difference between net income and net cash provided by operating activities

4. The cash investing and financing transactions during the period


Financing activities

Cash flow activities that include:

a. obtaining cash from issuing debt and repaying the amounts borrowed

b. obtaining cash from stockholders, repurchasing shares, and paying dividends


Investing activities

Cash flow activities that include

a. cash transactions that involve the purchase or disposal of investments and property, plant, and equipment using cash

b. lending money and collecting the loans


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


Why is operating activities considered the most important?

It shows the cash provided by company operations

This source of cash is generally considered to be the best measure of a company's ability to generate sufficient cash to continue as a going concern


Operating activities involve ___________________

income statement items


Investing activities involve _____________________

cash flows resulting from changes in investments and long-term asset items


Financing activities involve ______________________

cash flows resulting from changes in long-term liability and stockholders' equity items


Why are interest, dividends, and payments of interest to lenders considered operating activities?

Because companies report these items in the income statement, where results of operations are shown


Comparing cash from operations to net income can reveal what?

Information about the "quality" of reported net income

It can reveal the extent to which net income provides a good measure of actual performance


Examples of significant non cash 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. Exchanges of plant assets


Difference of the statement of cash flows betwen IFRS and GAAP

Noncash investing and financing activities are reported in the notes to the financial statements under IFRS


Operating activities-Income statement items

Cash inflows

From sale of goods or services

From interest received and dividends received


Operating activities-Income statement items

Cash outflows:

To suppliers for inventory

To employees for services

To government for taxes

To lenders for interest

To others for expenses


Investing activities-Changes in investments and long-term assets

Cash inflows

From sale of property, plant, and equipment

From sale of investments in debt of equity securities of other entities

From collection of principal on loans to other entities


Investing activities-Changes in investments and long-term assets

Cash outflows

To purchase property, plant, and equipment

To purchase investments in debt or equity securities of other entities

To make loans to other entities


Financing activities-Changes in long-term liabilities and stockholder's equity

Cash inflows

From sale of common stock

From issuance of debt (bonds and notes)


Financing activities - Changes in long-term liabilities and stockholders' equity

Cash outflows

To stockholders as dividends

To redeem long-term debt or reacquire capital stock (treasury stock)


Where do companies report significant financing and investing activities that do not affect cash?

In either a seperate schedule at the bottom of the statement of cash flows or in a seperate note or supplementary schedule to the financial statements

*fulfills the full disclosure principle


Product life cycle

A series of phases in a product's sales and cash flows over time

These phases, in order of occurrence, are:

1. Introductory

2. Growth

3. Maturity

4. Decline


Cash in all the stages during the introductory phase

Cash form operations - negative

Cash from investing - negative

Cash from financing - positive


Growth phase

Negative cash from investing

Positive cash from financing


Maturity phase

Cash from operations and net income are approximately the same

Cash generated from operations exceeds investing needs

Company can start to pay dividends, retire debt, or buy back stock


Decline phase

Cash from operations decreases

Cash from investing might be positive - company sells of excess assets

Cash from financing may be negative - company buys back stock and retires debt


Since the statement of cash flows deals with cash receipts and payments

The company must adjust the effects of the use of accrual accounting to determine cash flows


Information to prepare Statement of Cash flows comes from:

1. Comparative balance sheets - indicates the amount of changes in assets, liabilities, and stockholders' equities from beginning to end of period

2. Current income statement - helps determine the amount of cash provided or used by operations during the period

3. Additonal information - includes transaction data that are needed to determine how cash was provided or used during the period


Three major steps of preparing the statement of cash flows

1. Determine net cash provided/used by operating activities by converting net income from an accrual basis to a cash basis

2. Analyze changes in noncurrent asset and liability accounts and record as investing and financing activities, or disclose as noncash transactions

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


Step 1 of preparing st of csh flows

This step involves analyzing not only the current year's income statement but also comparative balance sheets and selected additonal data


Step 2 st. of csh flows

This step involves analyzing comparative balance sheet data and selected additional information for their effects on cash


Step 3 in preparing st. of csh flows

The difference between the beginning and ending cash balacnes can be easily computed from comparative balance sheets


Indirect method

A method of preparing a statement of cash flows in which net income is adjusted for items that do not affect cash, to determine net cash provided by operating activities


Direct method

A method of determing net cash provided by operating activities by adjusting each item in the income statement from the accrual basis to the cash basis.

The direct method shows operating cash receipts and payments


Two reasons companies favor the indirect method:

1. It is easier and less costly to prepare

2. It focuses on the differences between net income and net cash flow from operating activities


FASB has a preference of what method?

the direct method


Adjustments for indirect method

Net Income +/-

Add back non cash expenses (depreciation expense, amortization, or depletion)

Deduct gains and add losses that resulted from investing and financing activities

Analyze changes to noncash current asset and current liability accounts

= Net Cash Provided / Used by Operating Activities


Why is depreciation added bac?

It does not involve a current cash outflow

Thus it is added back


Adjustments for changes in current liabilities

Add increases in current liability accounts

Deduct decreases in current liabilities


Noncash charges

Depreciation expense - add

Patent amortization expense - add


Gains and losses

Loss on sale of plant asset - add

Gain on sale of plant asset - deduct


Changes in current assets and current liabilities

Increase in current asset account - deduct

Decrease in current asset account - add

increase in current liability account - add

decrease in current liability account - deduct


When companies issue stocks or bonds for cash, the actuall proceeds will appear _____________________

in the statement of cash flows as a financing inflow


Payment of the dividends (not declaration) is reported as a ______________________________________

cash outflow that the company reports as a financing activity


Free cash flow

Describes the cash remaining from operations after adjustment for capital expenditures and dividends


What indicates the cash-generating capability of a company?

Cash provided by operating activities


What does cash provided by operating activities fail to take into account?

That a company must invest in new fixed assets just to maintain its current level of operations

That companies must at least maintain dividends at current levels


What provides additional insight regarding a company's cash-generating ability?

Measurement of free cash flow


Free Cash Flow Formula

Free Cash Flow = Cash Provided by Operations - Capital Expenditures - Cash Dividends


What does it mean if cash from operations exceeds net income?

Lends credibility to income number as an indicator of potential future performance.

If anything, net income might understate actual performance


Price to cash flow

Company stock price / Cash flow per share

high => suggests stock price is high relative to the company's ability to generate cash

low => stock might be a bargain


Cash-based ratios are derived from what?

The statement of cash flows


Disadvantage of cash-based measures

There are no readily available industry averages for comparison


Disadvantage of the current ratio

It uses year-end balances of current asset and current liability accounts

These year-end balances may not be representative of the company's position during most of the year


Current Cash Debt Coverage Ratio

Cash Provided by Operations

Average Current Liabilities

Considered better measure of liquidity on the average day because cash provided by operating activities involves the entire year rather than a balance at one point in time

below .40=> casue for addional investigation of a company's liquidity



Cash debt coverage ratio

Cash Provided by Operations

Average Total Liabilities

Indicates a company's ability to repay its liabilities from cash generated from operations, that is, without having to liquidate productive assets such as property.

below .20 => cause for additional investigation


Issued bonds for $200,000 cash

Financing activities


Purchased equipment for $180,000

Investing activity


Sold land costing $20,000 cash

Investing activity


Declared and paid a $50,000 cash dividend

Financing activity


Free Cash Flow is used for what?

Liquidity AND Solvency