Chapter 5: Statement of Cash Flows

Question 1

Cash equivalents are…

Answer 1

• Short-term, highly liquid investments.
• Readily convertible into cash.
• So near maturity that market value is unaffected by interest rate changes
  (i.e., original maturities of less than 3 months).
  CLASSIFICATIONS OF THE STATEMENT OF CASH FLOWS

Question 2

Classifications of The Statement of Cash Flows

Answer 2

• Operating activities
  Cash inflows and outflows
  directly related to earnings
  from normal operations
  a. Cash received from revenues
• Investing Activities
  Cash inflows and outflows related to the acquisition or sale of productive facilities and investments in the securities of other companies
  a. Sale of operational assets
  b. Sale of investments
  c. Collections of loans
• Financing Activities
  Cash inflows and outflows related to external sources of financing
  (owners and creditors) for the enterprise.
  a. Issuance of shares, bonds, and notes.

Question 3

Business Cash Outflows

Answer 3

• Cash paid for expenses
• Purchase of operational assets
• Purchase of investments
• Loans to others
• Payment of dividends
• Repurchase of shares
• Repayment of debts

Question 4

Which is used more? Direct or Indirect Method?

Answer 4

Indirect method

Question 5

Direct Method

Answer 5

The Direct Method of presenting the Operating Activities section
of the statement of cash flows reports components of cash flows
from operating activities as gross receipts and gross payments.

Reports the cash effects of each operating activity

Question 6

Indirect Method

Answer 6

The Indirect Method of presenting the Operating Activities
section of the statement of cash flows adjusts profit to compute
cash flows from operating activities.

Starts with
accrual profit
and converts to
cash basis

Question 7

Why do people not implement the direct method eventhough it is encouraged?

Answer 7

Because it is expensive

Question 8

Cash flows from operating activities (Inflows)

Answer 8

Cash received from:
- Customers
- Dividends and interest on investments

Question 9

Cash flows from operating activities (Outflows)

Answer 9

Cash paid for:
- Purchase of goods for resale
and services (electricity, etc.)
- Salaries and wages
- Income taxes
- Interest on liabilities

Question 10

Cash flows from Investing Activities (Inflows)

Answer 10

Cash received from:
- Sale or disposal of property,
plant and equipment
- Sale or maturity of
investments in securities

Question 11

Cash Flows from Investing Activities (Outflows)

Answer 11

Outflows
Cash paid for:
- Purchase of property, plant and
equipment
- Purchase of investments in
securities

Question 12

Cash Flows From Financing Activities (Inflows)

Answer 12

Cash received from:
- Borrowings on notes,
mortgages, bonds, etc. from
creditors
- Issuing shares to
shareholders

Question 13

CASH FLOWS FROM FINANCING ACTIVITIES (Ouflow)

Answer 13

Outflows
Cash paid for:
- Repayment of principal to
creditors (excluding interest, if it
is classified an operating activity)
- Repurchasing shares from
shareholders
- Dividends to shareholders

Question 14

Informations needed to prepare a statement of cash flows

Answer 14

• Comparative Statements of Financial Position.
• Statement of Earnings.
• Additional details concerning selected accounts, transactions
  and events.

Question 15

Interpreting Cash Flows From Operating Activities - A/R Changes

Answer 15

Managers sometimes attempt to
boost declining sales by extending
credit terms or by lowering credit
standards. The resulting increase in
accounts receivable can cause net
earnings to outpace cash flows from
operations.

Question 16

Interpreting Cash Flows From Operating Activities - Inventory Changes

Answer 16

Inventory growth can be a sign that
planned sales growth did not
materialize. A decline in inventory
can be a sign that the company is
anticipating lower sales in the next
quarter.

Question 17

Common rule of thumb

Answer 17

A common rule of thumb followed by financial and credit
analysts is to avoid firms with rising net earnings but
falling cash flow from operations.

Question 18

Quality of earnings ratio

Answer 18

Cash Flow from Operating Activities / Net Earnings

In general, this ratio measures the portion of
net earnings that was generated in cash. All
other things equal, a higher quality of
earnings ratio indicates greater ability to
finance operating and other cash needs from
operating cash inflows.

Question 19

Capital Expenditures Ratio

Answer 19

Cash Flow from Operating Activities / Cash Paid for Capital Expenditures

In general, this ratio reflects the portion of purchases of property,
plant and equipment, intangible assets, and acquisition of other
businesses that were financed from operating activities. A high
ratio indicates less need for outside financing for current and
future expansions.

Question 20

Free Cash Flow

Answer 20

Free Cash Flow - Cash Flow from Operating Activities - Dividends - Capital Expenditures

In general, this measures a firm’s ability to pursue
long-term investment opportunities.

Question 21

What are the 3 things that funds the long term growth of a company?

Answer 21

• Internally generated funds
• The issuance of shares
• Money borrowed on a long-term basis