Chapter 5 Flashcards
pro forma cash flow state
a prediction of what the future statement of cash flow statement will look like in future years if the OIF plans are implemented
statement of cash flow
explains the change during the period in cash and cash equivalents
cash equivalent
short term, HIGHLY liquid investments that can easily be converted to cash
Operating Activities
include those transactions that are associated with the revenues and expenses that enter into the determination of net income
- Cash receipts from selling goods or from providing services.
- Receipts from Interest, dividends, and similar items.
- Payments to purchase inventory and to pay wages, taxes, and similar expenses.
categories of cash flows
operating activities
investing activities
finance activities
“bottom line” of cash flow statement
net cash from operating activites
guiding principal of the Operating Activities section
It contains cash flow effects of revenues and expenses included on the income statement
Investing Activities
the purchase and sale of land, buildings, equipment and other assets not generally held for sale. It also includes the purchase and sale if financial instruments not intended for trading purposes as well as the making and collections of loans
They are Indirectly related to the central ongoing operation of a business
Financing Activities
include transactions and events whereby cash is obtained from or repaid to owners (equity financing) and creditors (debt financing)
- Cash proceeds from issuing stocks or bonds.
- Payments to reacquire stock (treasury stock) or to retire bonds.
- Payment of dividends.
Non Investing and Financing Activities
Equipment purchased with a note payable
Land acquired by issuing stock
Significant transactions should be disclosed separately.
These transactions do not appear in the statement of cash flows.
Direct Method
The direct method is a reexamination of each income statement item with the objective of reporting how much cash was received or disbursed in association with the item.
To prepare the operating section, each income statement item must be adjusted for the effects of accruals.
Indirect Method
begins with net income as reported on the income statement and adjusts the accrual amount for any items that do NOT affect cash flow.
Adjustments for the Indirect Method
- Adjustments for changes in current operating assets and liabilities that indicate noncash sources of revenues and expenses.
- Gains and losses associated with investing or financing activities.
-Revenues and expenses that do not involve cash inflow or outflow.
Cash paid for interest and income taxes
Direct Method: part of the Operating Activities section
Indirect Method: separate disclosure
cash flow to net income ratio
cash from operations/ net income
cash flow adequacy ratio
cash from operations/ expenditures for fixed asset additions and new business aquisitions
cash times interest earned ratio
cash before taxes and interest/ cash paid for interes
Under what circumstances does cash flow from operations offer a clearer picture of a companys performance than does the net income?
- When a company reports large noncash expenses: write-offs, depreciation and provisions of future obligations
- A company is growing rapidly
- A company needs to report favorable earnings. The cash flow from operations provides a reality check of actualreported earning
What criteria must be met for an item to be considered a cash equivalent in preparing a statement of cash flows?
- Readily converted ti cash
2. Near its maturity that there is insignificant risk of changes in value due to changes in interest rate
What are the three categories in a statement of cash flows? What types of items are included in each?
- Operating Activities: Includes current liabilities and current assets;
- Investing Activities: Includes purchase or sale of land, buildings, equipment etc.
- Financing Activites: equity and debt financing; cash is optained and repaid to owners; retire bonds; payment of dividends; treasury stock
What is the normal pattern of cash flows for operating, investing and financing activities?
Operating +
Investing -
Financing +/-
Either the direct method or the indirect method may be used to report cash flows from operating activities. What is the difference in approach for the two methods?
The direct method reports ALL operating receipts and cash payments. The difference is then the net cash flow from operations. And the indirect method begins with the NI and includes the adjustments for any non-cash items and converts the accrual amounts to a cash basis.
Why do many users prefer the direct method? Why do majority of preparers prefer the indirect?
Users prefer the direct method because it is straightforward and easy to understand. Accountants prefer the indirect method because it is easier to prepare.
How is depreciation expense handled when the direct method is used? The indirect method?
It is added back to net income with the indirect method. With the direct method it is ommitted
