3.5 Understanding Cash Flow Statement Flashcards
The cash flow statement
provides information about cash receipts and cash payments
It also provides information about cash transactions from investing and financing activities.
Classification of Cash Flows and Non-Cash Activities
Operating Activities
Investing Activities
Financing Activities
Operating Activities
are a company’s day-to-day operations, including sales, inventory purchases, and paying employees.
Cash flows from trading securities are also included in this category.
Investing Activities
include purchasing and selling long-term assets, such as property, equipment, and intangible assets.
Purchases and sales of long-term and short-term investments (e.g., equities and bonds) are also included in this category, but cash equivalents and trading securities are excluded.
Financing Activities
include cash flows between the company and its capital providers, such as inflows from new debt issues or outflows in the form of dividend payments.
Summary of Differences between IFRS and US GAAP
Compared to US GAAP, IFRS allow more discretion with respect to classifying cash activities
The main differences between the two sets of accounting standards (US GAAP and IFRS) on this issue are summarized below:
Interest received
IFRS: Operating or Investing
US GAAP: Operating
The main differences between the two sets of accounting standards (US GAAP and IFRS) on this issue are summarized below:
Interest paid
IFRS: Operating or Financing
US GAAP: Operating
The main differences between the two sets of accounting standards (US GAAP and IFRS) on this issue are summarized below:
Dividends received
IFRS: Operating or Investing
US GAAP: Operating
The main differences between the two sets of accounting standards (US GAAP and IFRS) on this issue are summarized below:
Dividends paid
IFRS: Operating or Financing
US GAAP: Financing
The main differences between the two sets of accounting standards (US GAAP and IFRS) on this issue are summarized below:
Bank overdrafts
IFRS: part of cash equivalents
US GAAP: Financing
Cash flow from operating activities can be reported using either the direct method or the indirect method
The direct method
shows specific cash inflows and outflows.
It eliminates all accrual impacts and shows the sources of operating cash receipts and payments.
Cash flow from operating activities can be reported using either the direct method or the indirect method
The indirect method
derives the cash flow from operations from the reported net income.
Adjustments are made to net income for non-cash items and non-operating items.
This approach highlights the differences between net income and operating cash flows.
It also mirrors common forecasting approaches. Depreciation is a big adjustment for mature companies.
Under US GAAP, which of the following would an auto manufacturer most likely classify as a financing activity on its statement of cash flows?
A
The sale of a trading security
B
The repurchase of common stock
The payment of interest on a ten-year note
B
The repurchase of common stock
Financing activities include obtaining and repaying capital, like debt or equity. Thus, the repurchase of common stock (part of equity) would be considered a financing activity under US GAAP.
Selling a trading security would be considered an operating activity, whereas selling a non-trading security would be treated as an investing activity.
Under US GAAP, the cash paid for interest is included in operating cash flows. Note that interest payments may be classified as either operating or financing activities under IFRS.
A stock buyback would most likely be considered what type of activity?
A
Operating
B
Investing
C
Financing
C
Financing
A stock buyback involves interactions with its providers of capital, so it would be a financing activity.
If the company bought a different company’s stock, that would be considered either an investing or operating activity
Which of the following transactions will most likely have the smallest impact on the amounts reported in a company’s statement of cash flows?
A
Making €5 million in payments owed to holders of convertible debt
B
Issuing new convertible debt with a face value of €100 million
C
Existing convertible debt with a face value of €50 million being exchanged for an equivalent value of common stock
C
Existing convertible debt with a face value of €50 million being exchanged for an equivalent value of common stock
Dividends paid can be calculated using the following formula:
beginning retained earnings
+ Net Income
- Ending retained earnings
The process of calculating operating cash flows using the indirect method is described below:
Start with net income
Add back depreciation and amortization expenses
Add back any amortization of discounts on long-term bonds
Subtract any amortization of bond premiums
Add back any losses (or subtract any gains) attributable to asset sales, write-downs, or debt retirement
Subtract any increases in current operating assets (e.g., accounts receivable, inventory, prepaid expenses,
but ignore changes in cash)
Add back any increases in current operating liabilities (e.g., accounts payable, accrued expenses)
Add back any increase in deferred tax liabilities
If the equity method is used to account for investments in other companies, add back any losses and subtract any income
Conversion of Cash Flows from the Indirect to the Direct Method
Step 1: Aggregates all revenues and expenses.
Step 2: Determine the total value of expenses net of non-cash item
Step 3: Convert accrual amounts to cash flows by adjusting for working capital changes.
Major sources and uses of cash between operating, investing, and financing activities
Mature companies will primarily get cash flows from operating activities.
These cash flows can be used for investing activities if there are good opportunities to grow the business.
If not, they should be returned to capital providers as a financing activity.
Operating cash flows are often negative for new companies.
Primary determinants of operating cash flow
Companies get cash from customers and pay cash to employees and suppliers.
Operating cash flow should exceed net income for mature companies.
Primary determinants of investing cash flow
Analyzing this section sheds light on a company’s investing activities.
Also, this analysis aids in understanding why assets are sold.
Primary determinants of financing cash flow
Companies can either raise capital or repay the capital.
Free cash flow
the excess of operating cash flow over capital expenditures.
Free cash flow to the firm (FCFF)
is available to providers of both debt and equity capital.
It can be computed from net income or operating cash flow.
Free cash flow to equity (FCFE)
available to common stockholders
Which is an appropriate method of preparing a common-size cash flow statement?
A
Show each item of revenue and expense as a percentage of net revenue.
B
Show each line item on the cash flow statement as a percentage of net revenue.
C
Show each line item on the cash flow statement as a percentage of total cash outflows.
B
Show each line item on the cash flow statement as a percentage of net revenue.
An analyst has calculated a ratio using as the numerator the sum of operating cash flow, interest, and taxes and as the denominator the amount of interest. What is this ratio, what does it measure, and what does it indicate?
A
This ratio is an interest coverage ratio, measuring a company’s ability to meet its interest obligations and indicating a company’s solvency.
B
This ratio is an effective tax ratio, measuring the amount of a company’s operating cash flow used for taxes and indicating a company’s efficiency in tax management.
C
This ratio is an operating profitability ratio, measuring the operating cash flow generated accounting for taxes and interest and indicating a company’s liquidity.
A
This ratio is an interest coverage ratio, measuring a company’s ability to meet its interest obligations and indicating a company’s solvency.
A company recently engaged in a non-cash transaction that significantly affected its property, plant, and equipment. The transaction is:
A
reported under the investing section of the cash flow statement.
B
reported differently in cash flow from operations under the direct and indirect methods.
C
disclosed as a separate note or in a supplementary schedule to the cash flow statement.
C
disclosed as a separate note or in a supplementary schedule to the cash flow statement.
When computing net cash flow from operating activities using the indirect method, an addition to net income is most likely to occur when there is a:
A
gain on the sale of an asset.
B
loss on the retirement of debt.
C
decrease in a deferred tax liability.
B
loss on the retirement of debt.
Which of the following would most likely be considered a financing activity on a cash flow statement under US GAAP?
A
Receipt of dividends
B
Payment of interest on long-term debt
C
Principal repayments on long-term debt
C
Principal repayments on long-term debt
Which of the following is an example of a financing activity on the cash flow statement under US GAAP?
A
Payment of interest.
B
Receipt of dividends.
C
Payment of dividends.
C
Payment of dividends.
Payment of dividends is a financing activity under US GAAP. Payment of interest and receipt of dividends are included in operating cash flows under US GAAP
Under which section of a manufacturing company’s cash flow statement are the following activities reported?
Item 1: Purchases of securities held for trading
Item 2: Purchases of securities held for investment
A
Both items are investing activities.
B
Only Item 1 is an operating activity.
C
Only Item 2 is an operating activity.
B
Only Item 1 is an operating activity.
Which of the following would most likely be considered a financing activity on a cash flow statement under US GAAP?
A
Receipt of dividends
B
Payment of interest on long-term debt
C
Principal repayments on long-term debt
C
Principal repayments on long-term debt
A conversion of a face value $1 million convertible bond for $1 million of common stock would most likely be:
A
reported as a $1 million investing cash inflow and outflow.
B
reported as a $1 million financing cash outflow and inflow.
C
reported as supplementary information to the cash flow statement.
C
reported as supplementary information to the cash flow statement.
Cash flows from taxes on income must be separately disclosed under:
A
IFRS only.
B
US GAAP only.
C
both IFRS and US GAAP.
C
both IFRS and US GAAP.
Which of the following transactions will most likely have the smallest impact on the amounts reported in a company’s statement of cash flows?
A
Making €5 million in payments owed to holders of convertible debt
B
Issuing new convertible debt with a face value of €100 million
C
Existing convertible debt with a face value of €50 million being exchanged for an equivalent value of common stock
C
Existing convertible debt with a face value of €50 million being exchanged for an equivalent value of common stock
A stock buyback would most likely be considered what type of activity?
A
Operating
B
Investing
C
Financing
C
Financing
A stock buyback involves interactions with its providers of capital, so it would be a financing activity.
Which of the following statements is most accurate? A company’s cash flow statement links to its balance sheet by showing the change in the value of:
A
equity.
B
an asset.
C
net income.
C
net income.
When computing net cash flow from operating activities using the indirect method, an addition to net income is most likely to occur when there is a:
A
gain on the sale of an asset.
B
loss on the retirement of debt.
C
decrease in a deferred tax liability.
B
loss on the retirement of debt.
