Reading 20: understanding cash flow statements

Question 1

Which of the following items is least likely considered a cash flow from financing activity under U.S. GAAP?
Receipt of cash from the sale of bonds.
Payment of cash for dividends.
Payment of interest on debt.

Answer 1

The payment of interest on debt is an operating cash flow under U.S. GAAP. (LOS 20.a)

Question 2

Which of the following would be least likely to cause a change in investing cash flow?
The sale of a division of the company.
The purchase of new machinery.
An increase in depreciation expense.

Answer 2

Depreciation does not represent a cash flow. To the extent that it affects the firm’s taxes, an increase in depreciation changes operating cash flows, but not investing cash flows. (LOS 20.a)

Question 3

Which of the following is least likely a change in cash flow from operations under U.S. GAAP?
A decrease in notes payable.
An increase in interest expense.
An increase in accounts payable.

Answer 3

A change in notes payable is a financing cash flow. (LOS 20.a)

Question 4

Sales of inventory would be classified as:
operating cash flow.
investing cash flow.
financing cash flow.

Answer 4

Sales of inventory would be classified as operating cash flow. (LOS 20.a)

Question 5

Issuing bonds would be classified as:
investing cash flow.
financing cash flow.
no cash flow impact.

Answer 5

Issuing bonds would be classified as financing cash flow. (LOS 20.a)

Question 6

Sale of land would be classified as:
operating cash flow.
investing cash flow.
financing cash flow.

Answer 6

Sale of land would be classified as investing cash flow. (LOS 20.a)

Question 7

The write-off of obsolete equipment would be classified as:
operating cash flow.
investing cash flow.
no cash flow impact.

Answer 7

Write-off of obsolete equipment has no cash flow impact. (LOS 20.a)

Question 8

Under IFRS, interest expense would be classified as:
either operating cash flow or financing cash flow.
operating cash flow only.
financing cash flow only.

Answer 8

Under IFRS, interest expense can be classified as either an operating cash flow or financing cash flow. (LOS 20.a)

Question 9

Under U.S. GAAP, dividends received from investments would be classified as:
operating cash flow.
investing cash flow.
financing cash flow.

Answer 9

Dividends received from investments would be classified as operating cash flow under U.S. GAAP. (LOS 20.a)

Question 10

Torval, Inc., retires debt securities by issuing equity securities. This is considered a:
cash flow from investing.
cash flow from financing.
noncash transaction.

Answer 10

The exchange of debt securities for equity securities is a noncash transaction. (LOS 20.b)

Question 11

Where are dividends paid to shareholders reported in the cash flow statement under U.S. GAAP and IFRS?

Answer 11

Under U.S. GAAP, dividends paid are reported as financing activities. Under IFRS, dividends paid can be reported as either operating or financing activities. (LOS 20.c)

Question 12

From an analyst’s perspective, an advantage of the indirect method for presenting operating cash flow is that the indirect method:
shows operating cash received and paid.
provides more information than the direct method.
shows the difference between net income and operating cash flow.

Answer 12

The indirect method reconciles the difference between net income and CFO. The direct method shows operating cash received and paid and, therefore, provides more information on its face than the indirect method. (LOS 20.d)

Question 13

Which balance sheet items are most likely to be linked to cash flows from financing?
Long-lived assets.
Current assets and liabilities.
Long-term liabilities and equity.

Answer 13

Financing cash flows are linked primarily to changes in long-term liabilities and equity. Changes in current assets and liabilities tend to be linked to operating cash flows. Changes in long-lived assets are typically linked to investing cash flows. (LOS 20.e)

Question 14

Using the following information, what is the firm’s cash flow from operations?

net income: 120
decrease in accounts receivable: 20
depreciation: 25
increase in inventory: 10
increase in accounts payable: 7
decrease in wages payable: 5
increase in deferred tax liabilities: 15
profit from the sale of land: 2

$158
$170
$174

Answer 14

Net income – profits from sale of land + depreciation + decrease in receivables – increase in inventories + increase in accounts payable – decrease in wages payable + increase in deferred tax liabilities = 120 – 2 + 25 + 20 – 10 + 7 – 5 + 15 = $170. Note that the profit on the sale of land should be subtracted from net income because this transaction is classified as investing, not operating. (LOS 20.a, 20.f)

Question 15

Cash flow from operations is:
$70.
$100.
$120.

net income: 45
depreciation: 75
taxes paid: 25
interest paid: 5
dividends paid: 10
cash received from sale of building: 40
issuance of preferred stock: 35
repurchase of common stock: 30
purchase of machinery: 20
issuance of bonds: 50
debt retired through issuance of common stock: 45
paid off long-term borrowings: 15
profit on sale of building: 20

Answer 15

Net income – profit on sale of building + depreciation = 45 – 20 + 75 = $100. Note that taxes and interest are already deducted in calculating net income, and that the profit on the sale of the building should be subtracted from net income. (LOS 20.a, 20.f)

Question 16

Cash flow from investing activities is:
–$30.
$20.
$50.

net income: 45
depreciation: 75
taxes paid: 25
interest paid: 5
dividends paid: 10
cash received from sale of building: 40
issuance of preferred stock: 35
repurchase of common stock: 30
purchase of machinery: 20
issuance of bonds: 50
debt retired through issuance of common stock: 45
paid off long-term borrowings: 15
profit on sale of building: 20

Answer 16

Cash from sale of building – purchase of machinery = 40 – 20 = $20. (LOS 20.a, 20.f)

Question 17

Cash flow from financing activities is:
$30.
$55.
$75.

net income: 45
depreciation: 75
taxes paid: 25
interest paid: 5
dividends paid: 10
cash received from sale of building: 40
issuance of preferred stock: 35
repurchase of common stock: 30
purchase of machinery: 20
issuance of bonds: 50
debt retired through issuance of common stock: 45
paid off long-term borrowings: 15
profit on sale of building: 20

Answer 17

Sale of preferred stock + issuance of bonds – principal payments on bank borrowings – repurchase of common stock – dividends paid = 35 + 50 – 15 – 30 – 10 = $30. Note that we did not include $45 of debt retired through issuance of common stock since this was a noncash transaction. Knowing how to handle noncash transactions is important. (LOS 20.a, 20.f)

Question 18

Cash flow from operations is:

$115.
$275.
$375.

sales: 1500
increase in inventory: 100
depreciation: 150
increase in accounts receivable: 50
decrease in accounts payable: 70
after-tax profit margin: 25%
gain on sale of machinery: 30

Answer 18

Net income = $1,500 × 0.25 = $375, and cash flow from operations = net income – gain on sale of machinery + depreciation – increase in accounts receivable – increase in inventory – decrease in accounts payable = 375 – 30 + 150 – 50 – 100 – 70 = $275. (LOS 20.a, 20.f)

Question 19

Net income for Monique, Inc., for the year ended December 31, 20X7 was $78,000. Its accounts receivable balance at December 31, 20X7 was $121,000, and this balance was $69,000 at December 31, 20X6. The accounts payable balance at December 31, 20X7 was $72,000 and was $43,000 at December 31, 20X6. Depreciation for 20X7 was $12,000, and there was an unrealized gain of $15,000 included in 20X7 income from the change in value of trading securities. Which of the following amounts represents Monique’s cash flow from operations for 20X7?
$52,000.
$67,000.
$82,000.

Answer 19

subtract unrealized gain and change in accounts receivable, add rest for $52k

Question 20

Continental Corporation reported sales revenue of $150,000 for the current year. If accounts receivable decreased $10,000 during the year and accounts payable increased $4,000 during the year, cash collections were:
$154,000.
$160,000.
$164,000.

Answer 20

$150,000 sales + $10,000 decrease in accounts receivable = $160,000 cash collections. The change in accounts payable does not affect cash collections. Accounts payable result from a firm’s purchases from its suppliers. (Module 20.3, LOS 20.f, 20.g)

Question 21

In preparing a common-size cash flow statement, each cash flow is expressed as a percentage of:
total assets.
total revenues.
the change in cash.

Answer 21

The cash flow statement can be converted to common-size format by expressing each line item as a percentage of revenue. (Module 20.3, LOS 20.h)

Question 22

To calculate free cash flow to the firm based on operating cash flow, an analyst should add interest expense net of tax and subtract:
noncash charges.
fixed capital investment.
working capital investment.

Answer 22

FCFF can be calculated from CFO by adding interest expense net of tax and subtracting fixed capital investment. (Module 20.4, LOS 20.i)

Question 23

The reinvestment ratio measures a firm’s ability to use its operating cash flow to:
pay dividends.
invest in working capital.
acquire long-lived assets.

Answer 23

The reinvestment ratio is CFO / cash paid for long-term assets. (Module 20.4, LOS 20.i)