Chapter 11: Reporting and Interpreting Cash Flows from Investing Activities Flashcards
The effects of Investing activites on cash outflows/inflows
Reporting Cash Flows from Investing Activities
Importance: This section of the statement of cash flows focuses on analyzing accounts related to property, plant, and equipment, intangible assets, and investments in other companies’ securities.
Method: Cash flows from investing activities are presented using the “direct method,” detailing gross receipts and payments for each activity.
Typical Activities:
Cash Expenditures: Includes acquisitions of tangible assets (buildings, equipment), intangible assets (trademarks, patents), and short- or long-term investments (shares, bonds, government securities) paid for with cash or cash equivalents.
Cash Proceeds: Involves cash received from selling productive assets, intangible assets, or short- or long-term investments, regardless of whether the sale resulted in a gain or loss.
Analyzing Changes in Assets:
Example: For National Beverage (referencing Exhibit 11.3), changes in property, plant, and equipment (net) are noted (I for investing activities). To understand these changes, accountants must delve into company records for details.
Importance: Understanding the reasons behind changes in investing activities helps stakeholders assess the company’s capital investments, divestments, and overall investment strategy.
Important
Note: Investing and financing activities are always presented using the “direct method,” outlining specific gross receipts and payments for each activity.
Changes in Property, Plant, and Equipment (PPE) - Net
Key Points:
Changes in PPE: Net change in PPE is influenced by three main factors: purchase of new assets, disposal of old assets, and periodic depreciation.
Impact of Transactions:
Purchase: Increases PPE balance.
Disposal: Decreases PPE balance by carrying amount (original cost - accumulated depreciation) of the assets sold.
Depreciation: Increases accumulated depreciation, reducing PPE balance.
Reporting Cash Flows for Property, Plant, and Equipment (PPE)
Key Points:
Separate Reporting: Cash purchases and sales of PPE are listed separately on the statement of cash flows.
Presentation: Shown in the schedule of investing activities (Exhibit 11.7) as cash outflows ($25,302) due to purchases and sales.
Importance: Clear presentation allows stakeholders to understand the company’s investment in new assets and divestment from old assets, aiding in assessing the company’s capital expenditure strategy.
Capital Expenditures Ratio
Analytical Question: To what extent did the company finance property, plant, and equipment purchases with cash from operating activities?
Formula: Capital expenditures ratio = Cash flow from operating activities / Cash paid for property, plant, and equipment
Interpretation:
General Significance: Reflects the portion of property, plant, and equipment purchases financed from operating activities, indicating the ability to expand without external financing or selling long-lived assets.
High Ratio: Implies reduced dependence on outside financing, enabling strategic acquisitions, avoiding additional debt costs, and reducing bankruptcy risks associated with leverage.
Cautions about Capital Expenditure Ratios
Cautions:
Industry Variations: Investment needs in property, plant, and equipment vary widely across industries; compare a firm’s ratio with its prior years or industry peers.
High Ratio Caution: Can indicate failure to upgrade productive capacity, limiting future competitiveness.
Importance of Capital Expenditures Ratio
Importance: Measures the company’s ability to finance investments internally, providing insights into strategic decisions and financial stability.
Strategic Implications:
Opportunities: High ratio creates opportunities for strategic acquisitions, avoids additional debt, and reduces bankruptcy risks.
Competitiveness: Ensuring productive capacity upgrades maintains future competitiveness.
Comparison: Compare a firm’s ratio with its historical data or industry peers to contextualize the company’s investment strategy and financial health.
Free Cash Flow
Calculation: Free cash flow = Cash flows from operating activities - Dividends - Net capital expenditures
Significance:
Positive Sign: Indicates the availability of surplus cash for long-term investments, acquisitions, and capital expenditures without external financing.
Financial Flexibility: Considered a sign of financial flexibility, allowing the company to pursue strategic opportunities.
Managerial Caution: Managers might use free cash flow for unprofitable investments or managerial perks, potentially disadvantaging shareholders.
Shareholder Benefit: Proper utilization, like additional dividends or share repurchases, benefits shareholders more than unwise investments or managerial perks.
