Chapter 12 Flashcards
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
- The entity’s ability to generate future cash flows
- The entity’s ability to pay dividends and meet obligations
- The reasons for the difference between net income and net cash provided by operating activities
- 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
- Direct issuance of common stock to purchase assets
- Conversion of bonds into common stock
- Direct issuance of debt to purchase assets
- 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:
- Introductory
- Growth
- Maturity
- 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:
- Comparative balance sheets - indicates the amount of changes in assets, liabilities, and stockholders’ equities from beginning to end of period
- Current income statement - helps determine the amount of cash provided or used by operations during the period
- 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
- Determine net cash provided/used by operating activities by converting net income from an accrual basis to a cash basis
- Analyze changes in noncurrent asset and liability accounts and record as investing and financing activities, or disclose as noncash transactions
- 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:
- It is easier and less costly to prepare
- 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
*MEASURE 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
