You are on page 1of 8

CHAPTER 13 STATEMENT OF CASH FLOWS

SUGGESTED ANSWERS TO DISCUSSION QUESTIONS


1. The primary purpose of a statement of cash flows is to provide information about the cash receipts and cash payments of a business. A related purpose is to provide information about the investing and financing activities of the business. 2. The income statement provides the better measurement of profitability, especially when the business is financially sound and short-run survival is not the critical issue. The statement of cash flows is designed for measuring solvency, not profitability. An income statement, on the other hand, is specifically designed to measure profitability but gives little indication of solvency. 3. Two supplementary schedules usually accompany a statement of cash flows prepared by the direct method. One discloses the noncash aspects of financing and investing activities, such as the purchase of land in exchange for a note payable or the conversion of preferred stock into common shares. The other schedule itemizes the differences between net income and net cash flow from operations. 4. Examples of cash receipts and of cash payments in the three major classifications of a cash flow statement are shown below (two receipts and two payments required): a. Operating activities: Receipts: (1) Cash received from customers. (2) Dividends and interest received. Payments: (1) Cash paid to suppliers and employees. (2) Interest paid. (3) Income taxes paid. b. Investing activities: Receipts: (1) Sales of investments. (2) Collecting loans. (3) Sales of plant assets. Payments: (1) Purchases of investments. (2) Lending cash. (3) Purchases of plant assets. c. Financing activities: Receipts: (1) Short-term or long-term borrowing. (2) Issuance of capital stock. (3) Sales of treasury stock. Payments: (1) Repayment of debt. (2) Purchase of treasury stock or retirement of outstanding shares. (3) Payment of dividends.

5. Net cash flow from operating activities generally reflects the cash effects of transactions entering into the determination of net income. Because interest revenue and interest expense enter into the determination of net income, these items are classified as operating activities. 6. Cash equivalents are investments that are so short-term and so highly liquid that there is no significant distinction between them and cash held on hand or in bank accounts. Examples of cash equivalents include (1) money market funds, (2) commercial paper, and (3) Treasury bills. 7. A money market fund is viewed as a cash equivalent. For purposes of preparing a statement of cash flows, transfers of cash into or out of cash equivalents are not viewed as cash payments or receipts. Therefore, the transfer of cash into a money market fund will not appear in a statement of cash flows.

The McGraw-Hill Companies, Inc., 2003

8. In the long run, it is most important for a business to have positive cash flows from operating activities. To a large extent, the ability of a business to generate positive cash flows from financing activities is dependent upon its ability to generate cash from operations. Investors are reluctant to invest money in a business that does not have an operating cash flow sufficient to assure interest and dividend payments. Also, a business cannot sustain a positive cash flow from investing activities over the long run. A company can only sell productive assets for a limited period of time. In fact, a successful and growing company will often show a negative cash flow from investing activities, as the company is increasing its investment in plant assets. 9. Among the classifications shown in the cash flow statement, a successful and growing company is least likely to report a positive cash flow from investing activities. A growing company is usually increasing its investment in plant assets, which generally leads to a negative cash flow from investing activities. If the company is successful and growing, however, the cash flows from operating activities and from financing activities usually are positive. 10. No; a statement of cash flows summarizes the effects of cash transactions, but ledger accounts are maintained by the accrual basis of accounting. Therefore, the balances of ledger accounts must be adjusted to the cash basis in order to determine the items and amounts appearing in a statement of cash flows. 11. Cash collected from customers may be computed as follows: Net sales ................................................................................................................................... $870,000 Less: Increase in accounts receivable ($162,000 $90,000) ................................................... 72,000 Cash collected from customers................................................................................................. $798,000 The logic behind this computation is that sales resulting in an increase in accounts receivable have not been collected in cash and, therefore, do not represent cash receipts in the current period. 12. The caption Cash paid to suppliers and employees includes two basic elements: (1) cash paid (to suppliers) for purchases of merchandise, and (2) cash paid for operating expenses (expenses other than interest and taxes), including salaries to employees. 13. Net income may differ from the net cash flows from operating activities as a result of such factors as: (1) Depreciation and other noncash expenses that enter into the determination of net income. (2) Short-term timing differences between the cash basis and accrual basis of accounting. These include changes in the amounts of accounts receivable, inventories, prepaid expenses, accounts payable, and accrued liabilities. (3) Nonoperating gains and losses that, although included in the measurement of net income, are attributable to investing or financing activities rather than to operating activities. 14. The direct method identifies the major operating sources and uses of cash, using such captions as Cash received from customers. The indirect method, on the other hand, reconciles net income to the net cash flows from operating activities by showing a series of adjustments to the net income figure. Both methods result in exactly the same net cash flows from operating activities. 15. Payments of accounts payable are viewed as operating activities and are included in the caption Cash paid to suppliers and employees. 16. One purpose of a statement of cash flows is to provide information about all the investing and financing activities of a business. Although the acquisition of land by issuing capital stock does not involve a receipt or payment of cash, the transaction involves both investing and financing activities. Therefore, these activities are disclosed in a supplementary schedule that accompanies the statement of cash flows.

The McGraw-Hill Companies, Inc., 2003

17. The credit to the Land account indicates a sale of land and, therefore, a cash receipt. However, this $170,000 credit represents only the cost (book value) of the land that was sold. This amount must be adjusted by any gain or loss recognized on the sale in order to reflect the amount of cash received. 18. Credits to paid-in capital accounts usually indicate the issuance of additional shares of capital stock. Assuming that these shares were issued for cash, the transaction would be presented in the financing activities section of a statement of cash flows as follows: Proceeds from issuance of capital stock............................................................................. 19. The amount of cash dividends paid during the current year may be determined as follows: Dividends declared during the year........................................................................................ $ 3,800,000 Add: Decrease during the year in the liability for dividends payable 700,000 ($1,500,000 $800,000)...................................................................................................... Dividends paid during the year .............................................................................................. $4,500,000 20. Free cash flow is that portion of the net cash flow from operating activities that is available for discretionary purposes after the basic obligations of the business have been met. From a short-term creditors point of view, free cash flow is a buffer, indicating that the business brings in more cash than it must have to meet recurring commitments. Long-term creditors view free cash flow as evidence of the companys ability to meet interest payments and to accumulate funds for the eventual retirement of long-term debt. From the stockholders viewpoint, free cash flow indicates a likelihood of future dividend increases or, perhaps, expansion of the business, which will increase future profitability. Management views free cash flow positively because it is available for discretionary purposes rather than already committed to basic operations. In summary, everyone associated with the business views free cash flow favorablyand the more, the better. 21. A cash budget is a forecast of expected future cash flows. It usually shows the expected cash flows of each department within the organization, month by month, for the coming year. Budgets are useful to management in many ways. The very act of preparing a budget forces management to plan and coordinate the activities of all departments. During the year, it advises managers of the resources available to them and the results they are expected to achieve. It also serves as a basis for evaluating actual performance, and provides advance warning of impending cash shortages. 22. Peak pricing means charging higher prices in periods in which customer demand exceeds the companys capacity, and lower prices in off-peak periods. This serves the dual purposes of increasing revenue during peak periods, and allowing the business to serve more customers by shifting excess demand to off-peak periods. Common examples include restaurants, which charge higher prices at dinner time, and movie theaters, which offer low matinee prices during the daytime. 23. An effective product mix is one that generates more sales, both by attracting more customers and inspiring customers to purchase more products. 24. Speeding up the collection of accounts receivable does not increase the total amount collected. Rather, it merely shifts collections to an earlier time period. The only period(s) in which cash receipts actually increase are those in which collections under both the older and newer credit periods overlap. $88,500,000

The McGraw-Hill Companies, Inc., 2003

SOLUTIONS TO EXERCISES
Ex. 132 Note: All dollar figures are in thousands. a. Cash from operations ........................................................................................... Expenditures for property and equipment......................................................... Dividends paid....................................................................................................... Free cash flow........................................................................................................ $14,398 (9,155) (1,849) $ 3,394

b. The major sources and uses of cash from financing activities during 2000 were: Source: Long-term borrowings ........................................................................... Use: Repayments of long-term borrowings ........................................................ $13,020 $11,922

Financing activities resulted in a decline in cash of $1,815,000 in 2000, which consisted of the following: Increases in cash from financing activities ......................................................... $13,071 Decreases in cash from financing activities ........................................................ (14,886) Net decrease........................................................................................................... $(1,815) c. Cash and cash equivalents decreased by $1,711 thousand during 2000, moving the cash balance from $5,104 thousand to $3,393 thousand. Rowe appears to be in a strong position to continue paying dividends at least at the 2000 level. Free cash flows (part a), which assumes the payment of the 2000 dividends, is strong, as is cash provided by operating activities.

Ex. 138

a. (1) Expenditures for R&D are an operating activity. In the short term, reducing these expenditures will increase the net cash flow from operating activities. (2) In the long run, reducing expenditures for R&D may reduce cash flows from operations by reducing the number of new products the company brings to market. b. Selling to customers using bank credit cards taps a new market of potential customers. This should increase sales and cash receipts in both the short and long term. c. (1) Reducing inventory will lessen expenditures for inventory purchases during the time that inventory levels decline. This will improve the net cash flow from operating activities in the near term. (2) Once inventory has stabilized at the new and lower level, monthly expenditures will become approximately equal to the inventory used. Thus, this strategy will not affect cash flows once inventory has stabilized. d. (1) Deferring taxes can postpone taxes each year. For a growing business, this can reduce annual cash outlays year after year. Thus, it can increase net cash flows over both the short and long terms. (2) At some point in the future, the early deferrals will require payment, causing the cash paid to stabilize, much like (2) above. e. Dividends are a financing activity, not an operating activity. Therefore, discontinuing dividends has no direct effect upon the net cash flow from operating activities. Over

The McGraw-Hill Companies, Inc., 2003

the long term, however, the business may increase its cash flows by investing the cash that it retains.

Ex. 1311 a. The increase in cash and cash equivalents was due primarily to: 1. Operating cash flows, $77,735,000 Maturing of investments, $240,195,000 Sale of investments, $216,765,000 2. ($9,150) = ($22,595) + $973 + $12,472 $94,189 = $80,744 + $973 + $12,472 $ 77,735 14,878 9,150 $53,707 4. From a cash flow perspective, the company appears to be better off in 1998 than in 1997. The primary reason is the increased cash provided by operations ($77,735 thousand in 1998 compared with $68,176 thousand in 1997). Cash flows from investing and financing activities are similar for the two years, so the overall cash position at the end of 1998 is stronger than in 1997 ($80,744 thousand compared with $60,433 thousand). b. The major changes in cash flows in 1999, when compared with 1998, were: 1. 2. 3. 4. $4,800,000 lower cash provided by operations. $7,836,000 less cash used in investing activities $15,587,000 more cash used in financing activities $7,760,000 higher ending cash balance 3. Free cash flows (in thousands): Net cash flow from operating activities......................................... Cash invested in plant assets (capital expenditures).................... Cash paid for dividends .................................................................

The cash position is stronger at the end of 1999. The cash balance is higher and significant debt has been retired. The only negative is the decline in the amount of cash provided by operations in 1999 compared with 1998. 15 Minutes, Easy

PROBLEM 131 VANDERGRIFF, INC.

a. Operating activity b. Financing activity c. Operating activity d. Financing activity e. Operating activity f. Operating activity

The McGraw-Hill Companies, Inc., 2003

g. Not included in the statement of cash flows. A money market fund is viewed as a cash equivalent. Therefore, transfers between bank accounts and money market funds are not viewed as cash receipts or cash payments. h. Investing activity i. Not included in a statement of cash flows prepared by the direct method. Depreciation is a noncash expense; recording depreciation does not require any cash outlay within the accounting period. Operating activity

j.

k. Financing activity l. Operating activity

m. Operating activity n. Investing activity o. Not included in the statement of cash flows. Transfers between cash equivalents and other forms of cash are not regarded as cash receipts or cash payments.

The McGraw-Hill Companies, Inc., 2003

30 Minutes, Medium

PROBLEM 132 REIZENSTEIN COMPANY

REIZENSTEIN COMPANY Statement of Cash Flows For the Year Ended December 31, 2002 Cash flows from operating activities: Cash received from customers (1) $ 3 Interest and dividends received Cash provided by operating activities Cash paid to suppliers and employees (2) $ (2 Interest paid ( Income taxes paid Cash disbursed for operating activities Net cash flow from operating activities Cash flows from investing activities: Loans made to borrowers Collections on loans Cash paid to acquire plant assets Proceeds from sales of plant assets (3) Net cash used in investing activities: Cash flows from financing activities: Proceeds from issuing bonds payable Dividends paid Net cash provided by financing activities Net increase (decrease) in cash and cash equivalents Cash and cash equivalents, beginning of year Cash and cash equivalents, end of year

0 0 0 0 0 0 1 0 0 0 0 0 $ 31 0 0 0 0 0 5 5 0 0 0 0 ) 1 8 0 0 0 0 ) (9 5 0 0 0 ) $ (2 8 2 5 0 0 0 ) 2 7 5 0 0 0

$ (5 2 (3 1 5

0 6 0 8

0 0 0 0

0 0 0 0

0 0 0 0

0 ) 0 0 ) 0 (2 7 6 0 0 0 0 )

$ 25 0 0 0 0 0 (1 2 0 0 0 0 ) 23 8 0 0 0 0 $ (1 0 5 0 0 0 ) 5 1 7 0 0 0 $ 4 1 2 0 0 0

Supporting computations: (1) Cash received from customers: Cash sales Collections on accounts receivable Cash received from customers

8 0 0 0 0 0 22 0 0 0 0 0 $ 30 0 0 0 0 0

(2) Cash paid to suppliers and employees: Payments on accounts payable to merchandise suppliers Cash payments for operating expenses Cash paid to suppliers and employees

$ 15 0 0 0 0 0 10 5 0 0 0 0 $ 25 5 0 0 0 0

(3) Proceeds from sales of plant assets: Book value of plant assets sold Less: Loss on sales of plant assets Proceeds from sales of plant assets

$ $

6 6 0 0 0 0 8 0 0 0 0 5 8 0 0 0 0

The McGraw-Hill Companies, Inc., 2003

15 Minutes, Easy

CASE 132 PERSONAL BUDGETING

a. Ending cash balances: Week 2: $20 [$(20) + $100 $30 $20 $10] Week 3: $60 ($20 + $100 $30 $20 $10) Week 4: $100 ($60 + $100 $30 $20 $10) b. In Week 1 you have two problems. The first is that you do not have enough cash to pay your rent on Wednesday. But you will by Friday, so your payment may be a couple of days late. (But whats going to happen next month? Is there some handwriting on the wall?) Your second problem is that if you spend in your normal pattern, you will overdraw your bank account by $20 (which may trigger a service charge of another $10 or more). This problem can be solved by your foregoing any expenditures on entertainment this weekannoying, but hardly a cash crisis. You have a bigger problem coming up in February. You will have more difficulty paying Februarys rent than you did Januarys. The sad fact is that you cannot afford rent of $200 per month. You are earning $400 per month and spending $240 on things other than rent. Thus, you can afford only about $160 per month for rent unless you reduce other expenses. To solve this problem, you might find a roommate to share the rent, move into less expensive housing, or somehow increase your monthly cash receipts. (It does not appear practical to trim $40 per month from your other expenses.)

The McGraw-Hill Companies, Inc., 2003

You might also like