Analyzing Statements of Cash Flows II Flashcards
In 2022, Amazon Inc. reported $514 billion in revenue. The company’s cash flow from operations (CFO) was $46 billion, and its capital expenditures were $59 billion, resulting in negative free cash flow (FCF). Which of the following statements best describes Amazon’s cash flow position and financial flexibility?
A) Amazon’s negative FCF indicates a failure in its core business operations, suggesting it may need to raise additional external capital.
B) The negative FCF results primarily from high capital expenditures, which may reflect Amazon’s growth strategy rather than a liquidity crisis.
C) Amazon’s negative FCF signals an aggressive accounting policy, as operating cash flow should always exceed net income for quality earnings.
D) Amazon can sustain negative FCF indefinitely because its market position guarantees continuous access to external financing.
Answer Explanation:
Correct Answer: B) The negative FCF results primarily from high capital expenditures, which may reflect Amazon’s growth strategy rather than a liquidity crisis.
Amazon’s negative FCF does not necessarily indicate operational failure; it often reflects significant investments in growth, such as logistics infrastructure and technology. While CFO is positive, high capital expenditures drive FCF negative, indicating a focus on future growth rather than immediate liquidity issues.
Option A incorrectly assumes the negative FCF is due to operational issues, not investment strategy.
Option C misinterprets FCF as an indicator of accounting quality rather than cash flow usage.
Option D falsely assumes perpetual access to external funding without consideration of market conditions.
Apple Inc. reported a significant increase in CFO by reducing accounts payable by 20% and liquidating a large portion of its inventory during 2023. How should an analyst interpret these cash flow adjustments in the context of financial performance and sustainability?
A) This strategy improves Apple’s liquidity position and reflects efficient working capital management practices.
B) Reducing accounts payable and liquidating inventory enhance short-term CFO but may signal potential operational or supply chain issues.
C) The increase in CFO suggests that Apple’s operational performance has strengthened, allowing it to manage working capital more effectively.
D) These adjustments indicate high-quality earnings because cash generation closely matches revenue recognition.
Answer Explanation:
Correct Answer: B) Reducing accounts payable and liquidating inventory enhance short-term CFO but may signal potential operational or supply chain issues.
Reducing accounts payable and liquidating inventory increase CFO temporarily but are not sustainable actions. This strategy may indicate underlying issues, such as slow sales or an attempt to improve liquidity artificially.
Option A incorrectly interprets temporary adjustments as strategic improvements.
Option C mischaracterizes working capital adjustments as a sign of operational strength.
Option D conflates cash flow with earnings quality without considering the unsustainable nature of these actions.
In 2022, Tesla Inc. reported CFO of $14 billion, CFI of -$7 billion, and CFF of -$8 billion. Given Tesla’s ongoing expansion, what concerns should an analyst focus on regarding Tesla’s cash flow structure and long-term financial health?
A) Tesla’s negative CFI and CFF suggest the company is in financial distress and unable to generate sufficient funds internally.
B) Tesla’s positive CFO reflects strong operational performance, and negative CFI indicates continued investment in growth, which aligns with its business strategy.
C) Tesla’s cash outflows in CFI and CFF highlight aggressive spending, suggesting a possible need for future external financing to maintain operations.
D) Tesla’s cash flow structure is typical for mature companies and poses no immediate concern for analysts.
Answer Explanation:
Correct Answer: B) Tesla’s positive CFO reflects strong operational performance, and negative CFI indicates continued investment in growth, which aligns with its business strategy.
Tesla’s cash flow structure indicates a healthy operating cash flow, which funds its aggressive investments in expansion and technology. The negative CFF represents debt repayment and stock buybacks, common in firms balancing growth with capital management.
Option A misinterprets negative CFI and CFF as distress rather than strategic investments.
Option C suggests financial strain without recognizing the underlying operational strength.
Option D overlooks Tesla’s growth phase characteristics, treating it as a mature firm.
In 2023, Alphabet Inc. had CFO of $91 billion, CFI of -$30 billion, and CFF of -$15 billion. Alphabet decided to use $25 billion of its CFO to buy back shares. How does this decision affect its financial flexibility and future growth potential?
A) Share buybacks enhance Alphabet’s financial flexibility by reducing equity, leading to lower future dividend obligations.
B) The allocation of cash to buybacks instead of reinvestment in the business suggests Alphabet may struggle to identify profitable growth opportunities.
C) Alphabet’s decision to use CFO for buybacks instead of debt repayment indicates misaligned capital management priorities.
D) The buybacks improve Alphabet’s earnings per share, supporting the stock price and providing benefits to shareholders.
Answer Explanation:
Correct Answer: B) The allocation of cash to buybacks instead of reinvestment in the business suggests Alphabet may struggle to identify profitable growth opportunities.
While share buybacks can support stock prices, allocating significant CFO to buybacks rather than growth investments may signal limited reinvestment opportunities, potentially stifling long-term growth.
Option A misunderstands buybacks’ impact on financial flexibility.
Option C assumes debt repayment is the only prudent use of CFO.
Option D focuses on shareholder returns without addressing growth concerns.
Netflix Inc. reported CFO of $2 billion, CFI of -$1.5 billion, and CFF of $1 billion, primarily from issuing new debt in 2022. What does this cash flow structure suggest about Netflix’s ability to self-fund its operations and strategic initiatives?
A) Netflix’s reliance on external financing indicates it cannot sustain its operations without ongoing debt issuance.
B) The combination of positive CFO and negative CFI demonstrates Netflix’s self-sufficient operating performance supporting strategic investments.
C) Netflix’s financial structure is common for high-growth companies and does not indicate any cash flow concerns.
D) The company’s positive CFO and rising debt levels suggest an aggressive approach to managing liquidity, increasing future financial risk.
Answer Explanation:
Correct Answer: D) The company’s positive CFO and rising debt levels suggest an aggressive approach to managing liquidity, increasing future financial risk.
While positive CFO reflects strong operations, consistent reliance on debt for financing indicates aggressive liquidity management, which could heighten financial risk, especially if market conditions tighten.
Option A overstates Netflix’s dependency on external financing, ignoring positive CFO.
Option B oversimplifies the sustainability of strategic investments solely based on current CFO.
Option C downplays the implications of increasing debt levels.
In 2020, Caterpillar Inc. reported operating cash flows as a percentage of revenue decreasing significantly compared to the previous year. Despite this, the company continued with aggressive investments in new machinery and equipment, leading to a highly negative cash flow from investing activities. Which of the following scenarios could best explain Caterpillar’s declining cash flow from operations relative to its revenues?
A) Increasing accounts receivable due to delayed customer payments.
B) A significant reduction in depreciation expenses following changes in accounting policy.
C) A rise in net income driven by one-time gains from asset sales.
D) Increased issuance of bonds leading to higher interest payments.
Answer Explanation:
Correct Answer: A) Increasing accounts receivable due to delayed customer payments.
Caterpillar’s decrease in operating cash flow relative to revenue can be attributed to an increase in accounts receivable, which suggests that revenue has not yet been collected in cash, thus reducing cash flow from operations.
Option B is incorrect because while changes in depreciation affect non-cash charges, they do not directly reduce cash flow.
Option C is incorrect as net income increases from asset sales affect the investing section rather than cash flows from operations.
Option D is incorrect because higher interest payments, while an operating outflow under U.S. GAAP, would not directly affect the comparison of operating cash flow to revenue.
Tesla Inc. has been experiencing rapid growth, which is evident from its common-size cash flow statement. Despite substantial revenue growth, Tesla’s operating cash flow has been consistently below net income, and the company has continued heavy investment in Gigafactories globally. What is the most plausible financial risk associated with Tesla’s cash flow trends?
A) Inability to maintain dividend payments to shareholders.
B) Risk of liquidity constraints due to high working capital investment.
C) Excessive debt accumulation resulting from frequent bond issuances.
D) Potential overstatement of net income due to aggressive revenue recognition practices.
Answer Explanation:
Correct Answer: B) Risk of liquidity constraints due to high working capital investment.
Tesla’s heavy investment in working capital, such as inventory and receivables, is a key reason why operating cash flow is lagging behind net income. This could lead to liquidity issues, especially as capital expenditure demands continue to grow.
Option A is incorrect because Tesla does not pay regular dividends, making this scenario irrelevant.
Option C is incorrect as the question specifically relates to operating cash flow issues, not debt accumulation.
Option D is incorrect because, while aggressive revenue recognition could impact net income, the focus here is on cash flow, not earnings manipulation.
Amazon.com Inc.’s common-size cash flow statement reveals a trend of decreasing cash flow from operations as a percentage of revenue over the past three years, driven primarily by increased investments in fulfillment centers and technology. However, the company has also aggressively extended its accounts payable periods. What could be the main implication of this strategy on Amazon’s financial flexibility?
A) Improved short-term liquidity but potential strain on supplier relationships.
B) Increased earnings due to lower cost of goods sold.
C) Enhanced ability to raise equity financing due to higher retained earnings.
D) Reduced long-term debt due to improved operating cash flows.
Answer Explanation:
Correct Answer: A) Improved short-term liquidity but potential strain on supplier relationships.
By extending its accounts payable periods, Amazon improves short-term liquidity by holding onto cash longer. However, this could strain relationships with suppliers if payments are delayed excessively.
Option B is incorrect because extending payables does not impact the cost of goods sold in the income statement.
Option C is incorrect as this strategy does not directly influence equity financing capabilities.
Option D is incorrect because improved liquidity does not necessarily translate into a direct reduction in long-term debt.
Apple Inc.’s common-size cash flow statement indicates that cash flows from operating activities as a percentage of revenue have remained stable, but investing cash outflows have sharply increased due to large-scale buybacks of technology patents. Assuming no changes in financing activities, what is the most likely consequence of this strategy on Apple’s balance sheet?
A) A significant increase in goodwill due to the acquisition of intangible assets.
B) A potential depletion of cash reserves, leading to increased reliance on short-term borrowings.
C) Enhanced profitability due to reduced tax liabilities associated with patent acquisitions.
D) Improved asset turnover ratios reflecting more efficient use of acquired technology.
Answer Explanation:
Correct Answer: B) A potential depletion of cash reserves, leading to increased reliance on short-term borrowings.
Apple’s aggressive investment in patents likely leads to a substantial reduction in cash reserves, potentially forcing the company to turn to short-term borrowing to maintain liquidity.
Option A is incorrect as goodwill does not arise from the acquisition of patents; it results from business acquisitions.
Option C is incorrect because while patent acquisitions can affect tax liabilities, this impact does not directly relate to the cash flow trends described.
Option D is incorrect since the acquisition of technology does not directly improve asset turnover ratios without corresponding revenue growth.
Alphabet Inc., the parent company of Google, has shown an increasing trend in cash outflows related to stock buybacks in its common-size cash flow statement. Simultaneously, its operating cash flow has consistently exceeded net income. What does this trend suggest about Alphabet’s financial management strategy?
A) Alphabet is focused on increasing shareholder value through stock price appreciation.
B) The company is reducing its reliance on external financing through aggressive debt repayments.
C) Alphabet is likely manipulating its earnings to maintain a favorable cash flow position.
D) The firm is failing to generate sufficient cash from its core operations, necessitating asset sales.
Answer Explanation:
Correct Answer: A) Alphabet is focused on increasing shareholder value through stock price appreciation.
Alphabet’s increased stock buybacks suggest a strategy aimed at returning capital to shareholders and enhancing stock price, which aligns with a focus on increasing shareholder value.
Option B is incorrect because the trend relates to equity buybacks, not debt repayment.
Option C is incorrect as there is no indication of earnings manipulation; operating cash flow exceeding net income generally reflects high-quality earnings.
Option D is incorrect since Alphabet is generating more than sufficient cash from operations, as indicated by its high operating cash flow relative to net income.
In 2022, General Electric (GE) reported net income of $3 billion, noncash charges of $2 billion, interest expense of $1 billion with a tax rate of 25%, net capital expenditures of $1.5 billion, and an increase in working capital of $500 million. Calculate the Free Cash Flow to the Firm (FCFF) for GE.
A) $4.75 billion
B) $5.25 billion
C) $5.50 billion
D) $6.00 billion
Answer Explanation:
Correct Answer: B) $5.25 billion
Calculation:
FCFF = NI + NCC + [Int × (1 − tax rate)] − FCINV − WCINV
= $3 billion + $2 billion + [$1 billion × (1 − 0.25)] − $1.5 billion − $0.5 billion
= $3 + $2 + $0.75 − $1.5 − $0.5 = $5.25 billion
Option A is incorrect due to miscalculating the interest adjustment.
Option C is incorrect because it does not subtract working capital investment.
Option D is incorrect due to an overestimation of noncash charges.
Microsoft Corporation, which follows IFRS, reported a CFO of $10 billion, net capital expenditures of $3 billion, and net debt repayments of $1 billion in 2023. If Microsoft classified dividends paid as operating activities amounting to $500 million, what is the Free Cash Flow to Equity (FCFE)?
A) $5.5 billion
B) $6.0 billion
C) $6.5 billion
D) $7.0 billion
Answer Explanation:
Correct Answer: A) $5.5 billion
Calculation:
FCFE = CFO − FCINV + net borrowing
= $10 billion − $3 billion − $1 billion
Since dividends are classified as operating activities, they were already included in CFO and do not need adjustment. Therefore:
FCFE = $6 billion - $0.5 billion = $5.5 billion
Option B does not adjust for dividends paid as operating activities.
Option C incorrectly adds dividends paid to FCFE.
Option D is incorrect because it ignores the effect of net borrowing.
Tesla Inc. recorded CFO of $15 billion, capital expenditures of $7 billion, and net borrowing of $3 billion for 2024. Assume no dividends were paid. If Tesla plans to shift significant resources towards fixed capital investments in the following year, which measure is best for investors to assess Tesla’s ability to fund these investments from its operations?
A) Free Cash Flow to the Firm (FCFF)
B) Free Cash Flow to Equity (FCFE)
C) Net Income
D) Cash Flow from Investing Activities (CFI)
Answer Explanation:
Correct Answer: B) Free Cash Flow to Equity (FCFE)
FCFE directly measures the cash available to shareholders after accounting for capital investments and net borrowing, making it ideal for assessing Tesla’s capacity to fund further investments.
Option A measures cash available to both equity and debt holders but doesn’t specifically address cash left for equity holders after financing decisions.
Option C is inadequate as it doesn’t account for cash flows.
Option D does not provide a direct measure of available cash flow after financing and operations.
Amazon.com Inc. had net income of $11 billion, noncash charges of $6 billion, interest expense of $1.5 billion (tax rate of 20%), and net capital expenditures of $5 billion in 2022. The company also increased its working capital by $2 billion. Calculate Amazon’s Free Cash Flow to the Firm (FCFF) using net income.
A) $9.2 billion
B) $10.5 billion
C) $11.2 billion
D) $12.0 billion
Answer Explanation:
Correct Answer: C) $11.2 billion
Calculation:
FCFF = NI + NCC + [Int × (1 − tax rate)] − FCINV − WCINV
= $11 billion + $6 billion + [$1.5 billion × (1 − 0.20)] − $5 billion − $2 billion
= $11 + $6 + $1.2 − $5 − $2 = $11.2 billion
Option A underestimates the tax shield on interest.
Option B does not correctly adjust for net capital expenditures.
Option D mistakenly adds capital expenditures instead of subtracting.
In 2023, Alphabet Inc. (Google) reported CFO of $25 billion, fixed capital investments of $10 billion, and repaid $2 billion in debt while issuing new debt of $5 billion. Calculate Alphabet’s Free Cash Flow to Equity (FCFE).
A) $13 billion
B) $15 billion
C) $17 billion
D) $18 billion
Answer Explanation:
Correct Answer: C) $17 billion
Calculation:
FCFE = CFO − FCINV + net borrowing
= $25 billion − $10 billion + ($5 billion − $2 billion)
= $25 − $10 + $3 = $17 billion
Option A incorrectly assumes no net borrowing adjustment.
Option B incorrectly calculates net borrowing.
Option D overestimates net borrowing by including debt repayments twice.
