Cash Flow Intro.(19.1)

Question 1

What information does the statement of cash flows provide?

Answer 1

The cash flow statement provides information beyond that available from the income statement, which is based on accrual, rather than cash, accounting. The cash flow statement provides the following:

Information about a company's cash receipts and cash payments during an accounting period.
Information about a company's operating, investing, and financing activities.
An understanding of the impact of accrual accounting events on cash flows.

Question 2

The cash flow statement provides information to assess the firm’s _____, _____, and _____ _____

Answer 2

The cash flow statement provides information to assess the firm’s liquidity, solvency, and financial flexibility.
An analyst can use the statement of cash flows to determine whether:

Regular operations generate enough cash to sustain the business.
Enough cash is generated to pay off existing debts as they mature.
The firm is likely to need additional financing.
Unexpected obligations can be met.
The firm can take advantage of new business opportunities as they arise.

Question 3

Describe cash flows from operating activities (CFO)

Answer 3

Cash flow from operating activities (CFO), sometimes referred to as “cash flow from operations” or “operating cash flow,” consists of the inflows and outflows of cash resulting from transactions that affect a firm’s net income.

Question 4

Describe cash flows from investing activities (CFI)

Answer 4

Cash flow from investing activities (CFI) consists of the inflows and outflows of cash resulting from the acquisition or disposal of long-term assets and certain investments.

*Note that the acquisition of debt and equity investments (other than trading securities) and loans made to others are reported as investing activities; however, the income from these investments (interest and dividends received) is reported as an operating activity.

*note that dividends paid to the firm’s shareholders are financing activities (under GAAP)

Question 5

Describe cash flows from financing activities (CFF)

Answer 5

Cash flow from financing activities (CFF) consists of the inflows and outflows of cash resulting from transactions affecting a firm’s capital structure.

Question 6

Describe how non-cash investing and financing activities are reported.

Answer 6

Noncash investing and financing activities are not reported in the cash flow statement since they do not result in inflows or outflows of cash.

Noncash transactions must be disclosed in either a footnote or supplemental schedule to the cash flow statement.

Question 7

Contrast cash flow statements prepared under International Financial Reporting Standards (IFRS) and US generally accepted accounting principles (US GAAP).

Answer 7

International Financial Reporting Standards (IFRS) allow more flexibility in the classification of cash flows.

Question 8

There are two methods of presenting the cash flow statement: what are they

Answer 8

There are two methods of presenting the cash flow statement: the direct method (more info.) and the indirect method. Both methods are permitted under U.S. GAAP and IFRS.

Question 9

what is the more desirable method to present cash flow statement? which one do firms usually use?

Answer 9

The use of the direct method is encouraged by both standard setters.
Most firms use the indirect method.

The difference between the two methods relates to the presentation of cash flow from operating activities. The presentation of cash flows from investing activities and financing activities is exactly the same under both methods.

Question 10

Describe the direct method

Answer 10

The direct method begins with cash inflows from customers and then deducts cash outflows for purchases, operating expenses, interest, and taxes.

Under the direct method, each line item of the accrual-based income statement is converted into cash receipts or cash payments.

Recall that under the accrual method of accounting, the timing of revenue and expense recognition may differ from the timing of the related cash flows.
Simply stated, the direct method converts an accrual-basis income statement into a cash-basis income statement.

Direct method gives more info. because unlike the indirect method which starts with net income, under the direct method, the starting point is total revenue.

Question 11

Describe the indirect method

Answer 11

Under the indirect method, net income is converted to operating cash flow by making adjustments for transactions that affect net income but are not cash transactions.

These adjustments include eliminating noncash expenses (e.g., depreciation and amortization), nonoperating items (e.g., gains and losses), and changes in balance sheet accounts resulting from accrual accounting events.

under the indirect method, the starting point is net income,

Question 12

Describe how the cash flow statement is linked to the income statement and the balance sheet.

Answer 12

The cash flow statement reconciles the beginning and ending balances of cash over an accounting period. The change in cash is a result of the firm’s operating, investing, and financing activities as follows:

Operating cash flow \+	Investing cash flow \+	Financing cash flow =	Change in cash balance \+	Beginning cash balance =	Ending cash balance