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MGMT 201: Financial Accounting > Chapter 5: Statement of Cash Flow > Flashcards

Chapter 5: Statement of Cash Flow Flashcards

1
Q

Free cash flow

A

defines as cash flows from operating activities (sales) less net additions to property, plant, and equipment and intangible assets.

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2
Q

When free cash flow is negative,

A

When this amount is negative, it’s called free cash flow usage

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3
Q

Statement of cash flows

A

which categorizes the inflows and outflows of cash into operating, investing, and financing activities.

explains the net change in a company’s cash position during an accounting period.

by summarizing its cash inflows and outflows and highlighting the activities that resulted in the net change in its cash position during the period.

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4
Q

Cash

A
  • Cash normally includes both cash and cash equivalents
  • cash includes amounts the company has on hand, together with balances in demand deposits (chequing and savings accounts) with banks and other financial institutions.
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5
Q

Short-term, highly liquid investments

A

They must be convertible into known amounts of cash and be maturing within the next three months, meaning that there is little risk of a change in their value, due to changes in interest rates or other economic factors.

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6
Q

Cash equivalents

A

Examples include: Investments in money market funds, short-term deposits, and Government of Canada treasury bills

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7
Q

Bank borrowings and repayments are normally considered to be cash inflows and outflows from _____ activities.

A

financing

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8
Q

Certain borrowings to be considered as cash equivalents

A

For example, if a company has used a bank overdraft facility or has drawn on a line of credit from its bank, then the amount of the borrowing can be considered “negative cash” and included in the determination of the company’s cash and cash equivalents.

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9
Q

The use of accrual accounting means that

A

the revenues and expenses on the statement of income do not correspond to the company’s cash flows—inflows and outflows of cash—and therefore do not provide all of the information that creditors need.

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10
Q

How a statement of cash flow helps creditors

A

Assess the company’s ability to generate cash flows from its core operations.

Evaluate the cash flows the company has been able to obtain from investors (through the issuance of new shares) and creditors (through new borrowings).

Assess the extent to which the company has invested cash to replace or add revenue-generating assets such as property, plant, and equipment.

Determine the amount of cash that the company has used to repay debt.

Evaluate the amount of cash dividends distributed to shareholders, together with the sources of that cash.

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11
Q

Using the statement of cash flow for predictions / predictive

A

Estimate the value of the company, because a number of commonly used business valuation techniques are based on estimated future cash flows.

Assess the company’s ability to repay debt in the future.

Evaluate the potential for the company to be able to pay dividends in the future.

Estimate the company’s future cash requirements and assess these needs relative to the company’s existing cash and short-term investment balances, together with the company’s access to funding that has already been secured (that is, existing operating lines of credit).

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12
Q

Operating acitivities

A

These are the lifeblood of any company and should generate a positive cash flow (an inflow of cash).

After all, the operating activities include all of the inflows and outflows related to the sale of goods and services—the activities that the company provides in its normal operations.

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13
Q

A positive cash flow from operating activities

A

indicates that a company’s core business operations are generating more cash than it is using. This net inflow of cash may then be used for other activities, such as purchasing new capital assets, repaying debts, or paying dividends to shareholders.

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14
Q

A negative cash flow from operations

A

indicates that a company’s regular operating activities required more cash than they generated. This may suggest that investments or capital assets may have to be sold and/or external sources of financing have to be found in order to offset this cash outflow and enable the company to continue to operate.

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15
Q

Assessing a company’s cash flows from investing activities enables users to:

A

examine a company’s decisions regarding the purchase or sale of property, plant, and equipment.

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16
Q

Financing activities

A

to assess the decisions made by management and/or the board of directors in relation to the company’s debt and equity.

They will determine whether the company incurred more debt or repaid principal during the period.

They will also assess whether new shares were issued and whether any dividends were declared and paid.

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17
Q

How Does the Statement of Cash Flows Differ from the Statement of Income? (The statement of cash flows differs from the statement of income because it:)

A

-the statement of income measures a company’s performance for a period (usually a month, quarter, or year) on an accrual basis (accrual is accounting for revenue when it has been earned, rather than received)

reflects the cash basis rather than the accrual basis of accounting
focuses on more than just operating activities (it includes investing and financing activities)

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18
Q

The statement of cash flows differs from the statement of income because it:

A

The statement of income does not reflect many of the transactions a company has with its creditors (such as borrowing funds or repaying principal) or shareholders (such as the proceeds of issuing shares or the payment of dividends)

information related to a company’s cash payments for the purchase of property, plant, and equipment or the cash receipts from their sale is not included on a company’s statement of income.

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19
Q

What Are the Categories of Cash Flows Presented in the Statement of Cash Flows

A

Operating activities, investing activities, and financing activities.

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20
Q

Typical Operating Activities: inflows

A

Cash sales to customers
Collections of amounts owed by customers
Collections of interest and dividends

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21
Q

Typical Operating Activities: Outflows

A 
Purchases of inventory
Payments of amounts owed to suppliers
Payments of expenses such as wages, rent, and interest
Payments of taxes owed to the government
Payments of interest
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22
Q

Typical Investing Activities: Inflows

A

Proceeds from the sale of property, plant, and equipment

Proceeds from the sale of shares of other companies

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23
Q

Typical Investing Activities: Outflows

A

Purchases of property, plant, and equipment

Purchases of shares of other companies

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24
Q

Typical Financing Activities: Inflows

A

Borrowing money

Issuing shares

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25
Q

Typical Financing Activities: Outflows

A

Repaying loan principal

Paying dividends

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26
Q

all companies present cash flows from operating activities first.

A

CRAZY

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27
Q

Cash flows from operating activities are key because they:

A

result from what the company is in the business of doing
are the source for future debt repayments
are the source for future dividends payments

(If a company is able to generate positive cash flows from operating activities, you know that it will likely succeed and will continue to operate in the future.)

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28
Q

When preparing the statement of cash flows, companies have to make a decision regarding which method they will use for determining cash flows from operating activities. Accounting standard setters have identified two acceptable methods:

A

Indirect Method
Direct Method

(It is important to note that the total cash flows from operating activities are exactly the same regardless of the method; the only difference is in how the amount is determined)

29
Q

The indirect method (aka reconciliation)

A

This is because when using the indirect method to determine cash flows from operating activities, the starting point is net income.

Since net income is determined using the accrual basis of accounting, a reconciliation is required to adjust it to a cash basis.

This reconciliation is a strength of the indirect method, in that it makes the linkage between net income and cash flows from operating activities very clear.

30
Q

The direct Method

A

the direct method directly presents a company’s operating cash flows by major category of cash receipts and payments. These categories commonly include:

receipts from customers
payments to suppliers
payments to employees
payments of interest
payments of income taxes
31
Q

Companies are encouraged to use the direct method for determining cash flows from operating activities under IFRS and ASPE

A

preference for the direct method because it is considered more informative than the indirect method

32
Q

Direct vs indirect

A

The direct method allows users to focus on cash flows, while the indirect method allows users to see the differences between net income and cash flows from operations.

33
Q

What Are the Options for Classifying Cash Flows Related to Interest and Dividends Paid and Received?

A

Companies using IFRS have choices to make in terms of how they classify payments and receipts of interest and dividends.

34
Q

Interest paid and interest and dividends received can be classified as

A

Operating activities

35
Q

the interest paid can be classified as

A

Financing activity

36
Q

while interest and dividends received can be classified as

A

Investing activity

37
Q

Is is possible for a company to have investing and financing activities that do not appear on the statement of cash flows?

A

The company purchased property, plant, and equipment by assuming debt or issuing shares rather than paying cash.

The company acquired the shares of another company by assuming debt or issuing shares rather than paying cash.

The company repaid debt by issuing shares rather than paying cash.

38
Q

How Is a Statement of Cash Flows Prepared Using the Indirect Method for Operating Activities?

A

Next several slides…

39
Q

Advantages of the indirect method are:

A

It is simpler to prepare.
It uses information available in most accounting systems.
It provides a linkage between net income and cash flows from operating activities.

40
Q

Step 1: Determine the net change in cash during the period.

A

This can be determined by subtracting the balance of cash and cash equivalents at the beginning of the accounting period from the balance of cash and cash equivalents at the end of the accounting period.

41
Q

Step 2.

Read any additional information provided and cross-reference it to the related statement of financial position accounts.

A

Without this step, many students forget to use these pieces of additional information, so give it a try and see if it helps you.

42
Q

The most common non-cash item is __________, while the most common non-operating activity adjustments involve __________

A

depreciation and amortization expense

gains and losses from the sale of property, plant, and equipment.

43
Q

Step 3.
Using the statement of income, record net income and adjust it for any non-cash items included on the statement (such as depreciation and amortization expense) and/or items that do not involve operating activities (such as gains and losses from the sale of property, plant, and equipment or investments).

A

It can be helpful to cross out the statement of income once you have determined net income, the amount of any non-cash items, and the amount of any gains or losses from investing activities. This ensures that you will not be tempted to go back and try to use any additional information from the statement of income.

44
Q

Step 4.
Determine the net change in each current asset and current liability account (except for the Cash and the Dividends Payable accounts) and record the impact that these changes had on cash.

A

In this step, net income is adjusted to remove the effects of accrual accounting. This is done by calculating the change in each of the company’s current asset and current liability accounts, with the exception of the Cash account (because the change in this account, which was determined in Step 1, is what the statement of cash flows is explaining) and the Dividends Payable account (because the payment of dividends is a financing activity rather than an operating activity).

45
Q

Step 5.

A

Determine and record the cash proceeds received from selling property, plant, and equipment and the cost of property, plant, and equipment purchased with cash during the period.

46
Q

Step 6.
Determine and record the cash proceeds from the sale of shares of other companies (the sale of investments) and the cost of any investments in other companies purchased with cash during the period.

A

When preparing the statement of cash flows for companies that have invested in other companies, any proceeds received from the sale of these shares during the period are treated as cash inflows from investing activities, while the cost of any shares purchased during the period is treated as an outflow of cash from investing activities.

47
Q

Remember that, although most current liabilities relate to operating activities, some, such as dividends payable, relate to financing activities. Other examples are short-term bank loans or notes payable that have been used to obtain financing through borrowing and dividends payable.

A

Helpful Hint

48
Q

Step 7.

A

Determine the amount of cash dividends paid during the period

49
Q

Step 8.

A

Determine and record the amount of cash received from borrowings (new loans or increases to existing loans) made during the year and the amount of cash principal repaid on loans during the period.

50
Q

Step 9.

A

Determine the cash received from shares issued during the period.

51
Q

Step 10.

A

Calculate the sum of the cash flows from operating, investing, and financing activities and agree it to the net change in cash for the period as determined in Step 1.

We can now complete MML’s statement of cash flows by simply entering a subtotal for each of the three sections, and then combining these into an overall net change in cash for the period.

52
Q

Finally, to assist users in their analysis of cash flows, standard setters require a few additional pieces of cash flow-related information to be disclosed.

A

interest paid and received during the period
dividends paid and received during the period
income taxes paid during the period

53
Q

END OF INDIRECT METHOD SLIDES

A

END OF INDIRECT METHOD SLIDES

54
Q

How Is a Statement of Cash Flows Prepared Using the Direct Method for Operating Activities?

A

Rather than reconciling net income from the accrual basis of accounting to the cash basis, the direct method directly presents a company’s operating cash flows by major category of cash receipts and payments. These categories commonly include:

receipts from customers
payments to suppliers
payments to employees
payments of interest
payments of income taxes
55
Q

Common cash flow challenges include:

A
  • significant increases in sales volumes
  • lengthy cash-to-cash cycles
  • undercapitalization (or inadequate financing)
56
Q

Significant increases in sales volumes

A

These increased sales require companies to purchase or produce more and more inventory, as well as to expand their storage and operating capacity.

57
Q

Cash-to-cash cycle

A

The period of time between when cash is disbursed for the purchase of inventory and when cash is received from selling the inventory and collecting the accounts receivable

(The longer the cash-to-cash cycle, the greater the company’s cash requirements, and this issue is magnified in periods of high sales growth )

58
Q

Undercapitalized

A

-they are not sufficiently financed.

It is common for companies to begin operations without a large enough pool of cash.

59
Q

Companies can resolve the common cash flow challenges by taking the following measures.

A
  1. Alleviate cash flow problems by reducing the rate of growth.
  2. Alleviate cash flow problems by shortening the cash-to-cash cycle.
  3. Alleviate cash flow problems by increasing the amount of capitalization. (either debt finance or equity finance)
60
Q

Cash flow pattern

A

the direction (positive or negative) of its cash flows in the three categories: operating, investing, and financing

61
Q

the majority of public companies fit into pattern

A

(+ / − / +) or (+ / − / −)

Operating / investing / financing

62
Q

Cash flows to total liabilities =

A

Cash flows from operating activities / Total liabilities

63
Q

The concept of free cash flow (non-IFRS financial measure)

A

is to measure the amount of cash that a company generates from its operations that is in excess of the cash required to maintain the company’s productive capacity.

64
Q

Net free cash flow =

A

Cash flows from operating activities - net capital expenditures - dividends on preferred shares

65
Q

Most companies use the _______ in reporting cash flows from operating activities.

A

indirect method

66
Q

Under the indirect method, net income would be reported under which section on the statement of cash flows?

A

operating activities section

67
Q

While both the indirect and direct methods are acceptable choices to determine cash flows from operating activities, the use of the
________ is encouraged by the organizations setting accounting standards.

A

Direct method

68
Q

The purpose of adding an increase in accounts payable to net income is to:

A

calculate cash provided by operations.

MGMT 201: Financial Accounting (12 decks)

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