Test Flashcards
1
Q
What are the three main portions of a Statement of Cash Flows?
A
Operating activities, investing activities, and financing activities.
2
Q
What is the purpose of the Operating Activities section in the SCF?
A
It reflects cash inflows and outflows from selling goods and services, indicating the company’s ability to generate cash from core activities.
3
Q
What transactions are included in the Investing Activities section of the SCF?
A
Cash transactions for acquiring or disposing of long-term assets, such as property, plant, and equipment (PP&E), as well as investments in securities.
4
Q
What does the Financing Activities section of the SCF represent?
A
It shows cash movements related to the company’s capital structure, including inflows from issuing stock or debt and outflows for repaying loans and paying dividends.
5
Q
What adjustments are made to Net Income using the indirect method?
A
Adjustments include adding back noncash expenses and losses, subtracting noncash gains, and reconciling changes in current operating assets and liabilities.
6
Q
What are the key components of Net Cash Flows Analysis?
A
Operating Cash Flows, Investing Cash Flows, and Financing Cash Flows.
7
Q
What is the significance of Operating Cash Flow to Current Liabilities Ratio?
A
It assesses liquidity by comparing cash flow from operating activities to average current liabilities. A ratio above 1 indicates strong ability to cover short-term obligations.
8
Q
What does Free Cash Flow represent?
A
Free cash flow is operating cash flows minus capital expenditures, indicating the cash available after necessary investments.
9
Q
How does the product life cycle impact cash flow patterns?
A
Each stage (Introduction, Growth, Maturity, Decline) presents distinct cash flow characteristics, influencing operational and financial dynamics.
10
Q
What supplemental disclosures are made at the bottom of the SCF?
A
Disclosures include cash paid for interest and taxes, descriptions of noncash investing and financing transactions, and policies related to cash equivalents.
11
Q
What does a high Free Cash Flow indicate?
A
It suggests financial health, growth potential, and the ability to return value to shareholders.
12
Q
Why is quality of earnings important in cash flow analysis?
A
It helps assess if earnings align with operating cash flows, reducing reliance on accounting adjustments and improving financial health assessment.
13
Q
What is Free Cash Flow (FCF)?
A
A financial metric used in firm valuation. Calculated as NOPAT minus the change in NOA.
14
Q
How is Free Cash Flow (FCF) defined in business analysis?
A
EBIT, adjusted for noncash revenues and expenses, minus taxes, minus investments in working capital and CAPEX.
15
Q
What is the Operating Cash Flow to Capital Expenditures Ratio?
A
A measure of a firm’s ability to fund PP&E using internally generated cash; a ratio above 1.0 indicates financial strength.
16
Q
Why are Operating Working Capital Adjustments important?
A
They allow firms to grow without affecting net income, such as through inventory purchases or extending credit.
17
Q
What are the three primary activities in the Statement of Cash Flows?
A
Operating activities, Investing activities, and Financing activities.
18
Q
Why is analyzing Cash Flow and Earnings Quality important?
A
To determine if net income is supported by actual cash flows and ensure financial stability.
19
Q
A
20
Q
What is the Statement of Cash Flows?
A
It is a financial statement that summarizes the cash inflows and outflows from a company’s operating, investing, and financing activities. It explains the change in cash between balance sheet dates and links the income statement and balance sheet.
21
Q
What are the three main sections of the Statement of Cash Flows?
A
Operating activities, Investing activities, and Financing activities.
22
Q
What do Operating Activities represent?
A
They represent cash generated (or used) from a company’s core business operations, including cash receipts from customers and cash payments for expenses such as salaries, inventory, and taxes.
23
Q
What do Investing Activities include?
A
They include cash flows related to the purchase and sale of long-term assets like property, plant, and equipment (PP&E), intangible assets, and investments (excluding cash equivalents).
24
Q
What do Financing Activities include?
A
They involve cash flows from transactions with creditors and shareholders, such as borrowing and repaying debt, issuing or repurchasing stock, and paying dividends.
25
How is Free Cash Flow (FCF) defined by the business press/analyst approach?
FCF is defined as earnings before interest and taxes (EBIT), adjusted for noncash revenues and expenses, minus taxes, minus investments in working capital, and minus capital expenditures (CAPEX).
26
How is Free Cash Flow (FCF) defined using the full-information approach?
It is defined as Net Operating Profit After Tax (NOPAT) minus the change in Net Operating Assets (NOA).
27
Why might the business press definition of FCF overstate free cash flow?
Because it may include nonoperating income and exclude certain noncash investing activities, thereby not fully reflecting the true cash available to shareholders.
28
What is the Operating Cash Flow to Capital Expenditures Ratio and why is it important?
It is calculated as Cash Flow from Operating Activities divided by Capital Expenditures. A ratio above 1.0 indicates that the company generates sufficient cash to fund its capital investments, reflecting financial strength and long-term solvency.
29
Why are noncash items such as depreciation and amortization added back when computing operating cash flow?
Because these expenses reduce net income but do not represent actual cash outflows. Adding them back converts net income to cash basis.
30
How do gains and losses on asset sales affect operating cash flow calculations?
Gains on sales (related to investing activities) are subtracted, and losses are added back to net income, since the actual cash flow effect is reported in the investing section.
31
How do changes in current operating assets and liabilities affect operating cash flows?
Increases in current assets (like accounts receivable or inventory) are deducted, as they represent cash not received or cash used; decreases are added back. Conversely, increases in current liabilities (like accounts payable) are added, as they indicate delayed cash outlays, and decreases are deducted.
32
What is working capital management in the context of cash flow?
It involves managing current assets (receivables, inventory, prepaid expenses) and current liabilities (payables, accruals) to optimize the cash flow available for operations.
33
What are cash equivalents and what are common examples?
Cash equivalents are short-term, highly liquid investments that can quickly be converted into known amounts of cash. Examples include treasury bills, commercial paper, and money market funds.
34
What is the primary purpose of the Statement of Cash Flows?
To provide stakeholders with information on how a company generates and uses cash, which is essential for assessing liquidity, financial flexibility, and overall financial health.
35
In the Java House case illustration, what adjustments were made to convert net income to net cash from operating activities?
Adjustments included adding back noncash expenses (depreciation of $10,000 and stock-based compensation of $2,000), subtracting a gain on sale of land ($8,000), and adjusting for changes in current operating assets (accounts receivable increased by $5,000, inventory decreased by $6,000, prepaid insurance increased by $13,000) and liabilities (accounts payable decreased by $9,000, income tax payable increased by $2,000) to arrive at a net operating cash flow of $17,000.
36
What does an increase in accounts receivable indicate in the Statement of Cash Flows?
It indicates that sales were made on credit, meaning cash has not yet been collected. This increase is deducted from net income as it represents a cash outflow.
37
What does a decrease in inventory indicate in the Statement of Cash Flows?
It suggests that less cash was used to purchase inventory during the period; the decrease is added back to net income as a cash inflow.
38
How do changes in prepaid expenses affect operating cash flow?
An increase in prepaid expenses is deducted from net income since it represents cash paid for future expenses, while a decrease is added back, reflecting that cash was not used in the current period.
39
How does an increase in accounts payable affect operating cash flow?
It is added to net income because it indicates that the company delayed cash payments to suppliers, resulting in a cash inflow.
40
What role do deferred income taxes play in the operating cash flow calculation?
Deferred income taxes represent a noncash benefit (or cost) that is adjusted in the operating section and will be settled in future periods.
41
What types of transactions are reported under Investing Activities?
Transactions such as purchasing or selling PP&E, acquiring or disposing of investments, and lending money or receiving loan repayments.
42
How are noncash investing and financing transactions disclosed?
They are disclosed in the supplementary notes to the Statement of Cash Flows since they do not involve cash but are important for understanding financing and investing activities.
43
What types of transactions are reported under Financing Activities?
Transactions such as borrowing or repaying debt, issuing or repurchasing stock, and paying dividends.
44
How do changes in long-term liabilities and stockholders’ equity reflect financing activities?
They show how a company raises or returns capital—for example, increasing debt or equity raises cash, while repaying debt or paying dividends uses cash.
45
Why is it important to disclose the effects of foreign currency translation in the Statement of Cash Flows?
Because exchange rate fluctuations can affect the reported cash balances when cash is held in multiple currencies, impacting overall cash flow.
46
What business insight is gained by comparing net income to operating cash flow?
It helps assess earnings quality—determining if net income is supported by actual cash generation, which is vital for evaluating a company’s financial health and sustainability.
47
In a hypothetical company, if Net Income is $40,000, Depreciation is $8,000, and Stock-Based Compensation is $2,000, what is the subtotal after adding back these noncash items?
Subtotal = $40,000 + $8,000 + $2,000 = $50,000
48
If the company recorded a Gain on Sale of an asset of $5,000, how should this be adjusted when converting net income to operating cash flow?
Subtract the $5,000 gain (since gains on asset sales are noncash and belong to investing activities), reducing the subtotal.
49
In the example above, if Accounts Receivable increased by $4,000, what effect does that have on operating cash flow?
An increase in Accounts Receivable means cash hasn’t been collected, so subtract $4,000 from the subtotal.
50
Continuing with the same data, if Inventory decreased by $3,000, what adjustment is made?
A decrease in Inventory adds $3,000 to operating cash flow because less cash was used to purchase inventory.
51
Now, if Prepaid Expenses increased by $6,000, how does that affect cash flow?
An increase in Prepaid Expenses is a cash outflow, so subtract $6,000 from the subtotal.
52
If Accounts Payable decreased by $2,000 and Income Tax Payable increased by $1,000, what are the net effects on operating cash flow?
Subtract $2,000 (for the decrease in Accounts Payable) and add $1,000 (for the increase in Income Tax Payable); overall, a net subtraction of $1,000.
53
Using these adjustments, calculate the net cash provided by operating activities given the following: Starting subtotal = $50,000; subtract Gain on Sale ($5,000) and Accounts Receivable increase ($4,000); add Inventory decrease (+$3,000); subtract Prepaid increase ($6,000); subtract Accounts Payable decrease ($2,000); add Income Tax Payable increase (+$1,000).
Calculation: $50,000 - $5,000 - $4,000 + $3,000 - $6,000 - $2,000 + $1,000 = $37,000 net cash from operating activities.
54
If a company has Operating Cash Flow of $90,000 and Capital Expenditures (CAPEX) of $30,000, what is its Operating Cash Flow to CAPEX Ratio?
Ratio = $90,000 / $30,000 = 3.0, indicating the company generates three times as much cash from operations as it spends on capital investments.
55
In a hypothetical investing activities scenario, if a company purchased investments for $20,000 and equipment for $10,000, but sold an asset for $15,000, what is the net cash flow from investing activities?
Net investing cash flow = -$20,000 (investments) - $10,000 (equipment) + $15,000 (asset sale) = -$15,000.
56
For financing activities, assume a company issued common stock for $25,000, repaid debt for $12,000, and paid dividends of $8,000. What is the net cash flow from financing activities?
Net financing cash flow = $25,000 - $12,000 - $8,000 = $5,000.
57
If the beginning cash balance is $50,000, with Operating Cash Flow of $37,000, Investing Cash Flow of -$15,000, and Financing Cash Flow of $5,000, what is the ending cash balance?
Ending cash balance = $50,000 + $37,000 - $15,000 + $5,000 = $77,000.
58
In noncash transactions, if a company acquires a patent valued at $40,000 by issuing common stock, how is this reported on the Statement of Cash Flows?
It is disclosed as a noncash investing and financing activity in the supplementary notes, without affecting the cash balance directly.
59
If a company records $50,000 in depreciation expense, how does it affect the financial statements?
Income Statement: Depreciation increases expenses, reducing Net Income by $50,000. Balance Sheet: Accumulated Depreciation (contra asset) increases by $50,000, reducing total assets. Cash Flow Statement: Added back to Operating Cash Flow since it's a noncash expense.
60
If inventory increases by $20,000 due to purchases on credit, how do the financial statements reflect this?
Income Statement: No immediate impact (not expensed until sold). Balance Sheet: Inventory (asset) increases by $20,000, and Accounts Payable (liability) increases by $20,000. Cash Flow Statement: No effect since no cash was paid.
61
If a company sells $15,000 worth of inventory that originally cost $9,000, how are the financial statements impacted?
Income Statement: Revenue increases by $15,000, COGS increases by $9,000, and Gross Profit increases by $6,000. Balance Sheet: Inventory decreases by $9,000, and Accounts Receivable or Cash increases by $15,000. Cash Flow Statement: If cash sale, Operating Cash Flow increases by $15,000; if credit sale, no immediate effect.
62
If accounts receivable decreases by $12,000 due to customer payments, what changes occur?
Income Statement: No impact. Balance Sheet: Accounts Receivable decreases by $12,000, and Cash increases by $12,000. Cash Flow Statement: Positive $12,000 effect in Operating Activities (cash inflow).
63
If a company issues $100,000 in new stock, what are the financial statement effects?
Income Statement: No effect. Balance Sheet: Cash increases by $100,000; Common Stock and Additional Paid-in Capital increase by $100,000. Cash Flow Statement: Financing Activities increase by $100,000.
64
If a company takes out a $75,000 loan from a bank, what happens on the financial statements?
Income Statement: No immediate effect. Balance Sheet: Cash increases by $75,000, and Notes Payable (liability) increases by $75,000. Cash Flow Statement: Financing Activities increase by $75,000 (cash inflow).
65
If $20,000 of dividends are declared and paid, how does this transaction affect the financial statements?
Income Statement: No impact. Balance Sheet: Retained Earnings decreases by $20,000, and Cash decreases by $20,000. Cash Flow Statement: Financing Activities decrease by $20,000 (cash outflow).
66
A company prepays $5,000 in rent for next month. How is this recorded?
Income Statement: No immediate impact. Balance Sheet: Cash decreases by $5,000, and Prepaid Rent (asset) increases by $5,000. Cash Flow Statement: Operating Activities decrease by $5,000 (cash outflow).
67
If the company recognizes $4,000 in previously prepaid rent as an expense, what happens?
Income Statement: Rent Expense increases by $4,000, reducing Net Income. Balance Sheet: Prepaid Rent decreases by $4,000. Cash Flow Statement: No immediate cash impact (already paid in the past).
68
A company purchases a $50,000 machine by paying $20,000 cash and financing the remaining $30,000. How do the statements change?
Income Statement: No immediate impact. Balance Sheet: Cash decreases by $20,000, Equipment (asset) increases by $50,000, and Notes Payable increases by $30,000. Cash Flow Statement: Investing Activities decrease by $20,000; Financing Activities show a noncash financing disclosure for the $30,000 loan.
69
A company earns $7,500 in interest revenue but hasn’t received the cash yet. How is this recorded?
Income Statement: Interest Revenue increases by $7,500, increasing Net Income. Balance Sheet: Accounts Receivable increases by $7,500. Cash Flow Statement: No immediate impact since cash has not been received.
70
A company recognizes $10,000 in wages expense but has not yet paid employees. How does this affect financial statements?
Income Statement: Wage Expense increases by $10,000, reducing Net Income. Balance Sheet: Wages Payable (liability) increases by $10,000. Cash Flow Statement: No effect until paid.
71
A company repays $15,000 of long-term debt. What are the financial statement effects?
Income Statement: No effect. Balance Sheet: Cash decreases by $15,000, and Long-Term Debt (liability) decreases by $15,000. Cash Flow Statement: Financing Activities decrease by $15,000.
72
If the company records $25,000 in bad debt expense, how does it affect the statements?
Income Statement: Bad Debt Expense increases by $25,000, reducing Net Income. Balance Sheet: Allowance for Doubtful Accounts (contra asset) increases by $25,000, reducing Net Accounts Receivable. Cash Flow Statement: No immediate cash impact.
73
If a company recognizes $8,000 in unearned revenue as earned, what are the financial statement effects?
Income Statement: Revenue increases by $8,000, increasing Net Income. Balance Sheet: Unearned Revenue (liability) decreases by $8,000, and Retained Earnings increases. Cash Flow Statement: No immediate impact since cash was received in the past.
74
A company writes off $6,000 of accounts receivable as uncollectible. How does this affect financial statements?
Income Statement: No effect if using the allowance method (expense was previously recorded). Balance Sheet: Accounts Receivable and Allowance for Doubtful Accounts both decrease by $6,000. Cash Flow Statement: No effect.
75
If a company records an impairment loss of $12,000 on equipment, how does it affect financial statements?
Income Statement: Impairment Expense increases by $12,000, reducing Net Income. Balance Sheet: Equipment (asset) decreases by $12,000. Cash Flow Statement: The $12,000 is added back in Operating Activities as a noncash expense.
76
A business issues a $50,000 bond at a discount, receiving only $48,000 in cash. How does this affect financial statements?
Income Statement: No immediate effect. Balance Sheet: Cash increases by $48,000, Bonds Payable increases by $50,000, and Discount on Bonds Payable (contra liability) increases by $2,000. Cash Flow Statement: Financing Activities increase by $48,000.
77
If a company recognizes $3,000 in accrued interest expense, what are the effects?
Income Statement: Interest Expense increases by $3,000, reducing Net Income. Balance Sheet: Interest Payable (liability) increases by $3,000. Cash Flow Statement: No immediate impact until paid.
78
If a company records a $4,500 gain on the sale of equipment, what are the financial statement effects?
Income Statement: Gain on Sale of Equipment increases Net Income by $4,500. Balance Sheet: Equipment account decreases by book value, and Cash increases by sale amount. Cash Flow Statement: Operating Activities subtract $4,500 (noncash gain), and Investing Activities include full cash proceeds.
79
A company pays $7,000 in previously accrued wages. What are the financial statement effects?
Income Statement: No effect. Balance Sheet: Cash decreases by $7,000, and Wages Payable (liability) decreases by $7,000. Cash Flow Statement: Operating Activities decrease by $7,000.
80
If a company purchases land for $20,000 in exchange for issuing stock, how is this recorded?
Income Statement: No effect. Balance Sheet: Land (asset) increases by $20,000, and Common Stock & Additional Paid-in Capital increase by $20,000. Cash Flow Statement: No direct impact (disclosed as a noncash transaction).
81
A business signs a lease agreement that requires $5,000 monthly payments but classifies it as a finance lease. What are the initial financial statement effects?
Income Statement: No immediate impact. Balance Sheet: Right-of-Use Asset increases, and Lease Liability (long-term liability) increases by the present value of future payments. Cash Flow Statement: No immediate cash effect.
82
If a company receives a $25,000 customer deposit for a future service, how does it affect financial statements?
Income Statement: No immediate effect (not earned yet). Balance Sheet: Cash increases by $25,000, and Unearned Revenue (liability) increases by $25,000. Cash Flow Statement: Operating Activities increase by $25,000 (cash inflow).
