Chapter 6

The Statement of Cash Flows

SOLUTIONS 1. The two primary purposes of the statement of cash flows are to provide information about the firms operating cash receipts and cash payments and to provide information about the cash flows associated with the firms investing and financing activities. Cash equivalents are short-term, highly liquid investments such as treasury bills, commercial paper, and money mar et funds. These investments are readily convertible to nown amounts of cash. The three cash flow categories included in the statement of cash flows are" #perating. #perating activities are those activities that enter into the calculation of net income. $et cash provided by operating activities is the %bottom line& of the cash flow statement. 'nvesting. The primary investing activities are the purchase and sale of land, buildings, equipment, and investments involving securities of other entities. (inancing. (inancing activities involve the receipt of cash from and the repayment of cash to owners and lenders. * growing company might report negative cash from operating and investing activities as a sign of the cash that is being spent in business e+pansion. * growing company would also e+perience positive cash from financing activities in order to fund this growth. * mature company in a stable industry would probably have positive cash from operations, a small negative cash from investing activities in order to finance asset replacements, and negative cash from financing activities as loans are repaid and large dividends are paid to shareholders. Two significant non-cash activities that you might e+pect to find disclosed in the notes to the financial statements are assets acquired through a mortgage or in e+change for stoc or a conversion of a debt obligation into an equity position such as conversion of bonds into stoc . Conceptually, the statement of cash flows is the easiest financial statement to prepare because the preparation of a statement of cash flows is no more complicated than a simple three-way sorting of transactions into operating, investing, and financing transactions. The following transactions affect both net income and cash flows" /ale of merchandise 0services1 for cash 2ayment to suppliers for merchandise inventory that has been sold 2ayment to employees for salaries and wages 2ayment of income ta+es The following transactions change net income but have no effect on cash flows from operations" 3ecording of depreciation e+pense 3ecognition of gains or losses on the sale of assets 3ecognition of a restructuring charge

2. !.

).

,.

-.

..

Chapter - 4 1

5.

The si+ steps in the process for preparing a statement of cash flows using income statement and balance sheet data are" 1. Compute the change in the cash balance. 2. Convert the income statement from an accrual-basis to a cash-basis summary of operations. !. *naly6e the long-term assets to identify the cash flow effects of investing activities. ). *naly6e the long-term debt and stoc holders equity accounts to determine the cash flow effects of any financing transactions. ,. 2repare the formal statement of cash flows. -. 7isclose any significant investing or financing transactions that did not involve cash. 7epreciation is added bac to net income in computing cash from operating activities using the indirect method because depreciation does not involve an outflow of cash. /ince depreciation e+pense is initially subtracted to arrive at net income, adding it bac effectively eliminates depreciation from the computation of cash from operations. :ains are subtracted and losses are added to compute cash flow from operations when using the indirect method in order to avoid double counting. (or e+ample, the cash flow effect of an equipment sale is shown in the investing activities section of the cash flow statement. To avoid double counting, any gain or loss on the sale of the equipment should be e+cluded from the operating activities section. 'n order to e+clude a gain from the operating activities section, it must be subtracted from net income. * loss must be added bac to net income in the operating activities section. 'n general, one should analy6e the current assets and current liabilities in computing cash from operating activities. To analy6e cash from investing activities, one should loo at the long-term asset accounts. To analy6e cash from financing activities, one should loo at the long-term debt and the equity accounts. To find cash collected from customers 0using the direct method1" ;eginning accounts receivable = /ales during the year > Total amount to be collected 4 ?nding accounts receivable 0amount not yet collected1 > Cash collected from customers <229,999 2.9,999 <)89,999 01-9,9991 <!!9,999

8.

19.

11.

12.

1!.

The direct method is favored by many users of financial statements because it is easy to understand. ?ven a financial statement novice can decipher operating cash flow information when it is presented using the direct method. #n the other hand, the indirect method is favored and used by most companies because it is relatively easy to construct from e+isting balance sheet and income statement data. 'n addition, the indirect method highlights the reasons for the difference between net income and cash from operations. 7epreciation is not a source of cash. @igher depreciation e+pense means lower net income. @owever, since the depreciation e+pense is added bac in computing cash from operating activities, there is no net effect on operating cash flow. To repeat, depreciation is not a source of cash. $ote" 7epreciation ta+ deductions do reduce the amount of cash paid for income ta+es. 'f the balance in a prepaid asset account increases during the year, this means that the cash paid for that item 0to replenish the account1 was more than the e+pense, or consumption, associated with that item.

1).

1,.

Chapter - 4 2

1-.

'f the account Anearned 3evenue increases during a period, this represents an additional inflow of cash for services that have not yet been performed Bith the direct method, this is shown as additional cash collected from customers. Bith indirect method, the increase in the liability Anearned 3evenue is shown as an addition to operating cash flow. 'ncreases in current assets result in a subtraction from net income to arrive at cash flow from operations when using the indirect method because an increase represents cash that otherwise would have been available for buying equipment or paying dividends that is tied up in the form of that current asset. * decrease is added in the computation of cash flow from operations because a decrease means cash has been freed for other purposes. Bith respect to the account 2roperty, 2lant C ?quipment and the related *ccumulated 7epreciation account, the three most common events that can occur are purchases, sales, and depreciation. * purchase is shown as a cash outflow from investing activities. * sale is a cash inflow from investing activities. 7epreciation e+pense is included in the computation of net income but, because it is a non-cash e+pense, is eliminated by adding it bac in computing cash from operating activities. The 3etained ?arnings account increases because of net income, which is included in the computation of cash from operating activities. The 3etained ?arnings account decreases because of net losses which are also part of the computation of cash from operating activities. The 3etained ?arnings account also decreases because of cash dividends which are reported as part of financing activities. * forecasted statement of cash flows allows management to see the relationship between forecasted operating cash flow and the cash needed for investing activities. 'f there is an e+pected shortfall in available cash, a company can either use the forecasted information in obtaining additional financing or the company can scale bac its e+pansion plans in order to reduce the drain on cash. Denders can ma e use of a forecasted statement of cash flows to see whether it seems li ely that a company can continue to meet its e+isting debt obligations. *n investor can use the proEected cash flow statement to evaluate the li elihood that a company will be able to continue ma ing dividend payments.

1..

15.

18.

29.

21.

EXERCISES ? --1 Transactions *ffecting Cash (lows Transaction a. *morti6ation of intangible asset b. Conversion of preferred stoc to common stoc c. /ales on account d. 2urchase of inventory on account e. 7eclaration of a dividend f. 2ayment of accounts payable g. Collection of accounts receivable h. 7epreciation on factory building i. /ale of building at a loss E. 3etirement of debt through issuance of common stoc ?ffect on Cash 'ncrease 7ecrease $o ?ffect F F F F F F F F

F F

Chapter - 4 !

? --2 Types of *ctivities *ffecting Cash (low a. b. c. d. e. f. g. h. i. 2ayment of federal income ta+es 7ividend payments to shareholders 3epayment of short4term obligations Doans made to another company 2ayments made to acquire a business /alaries paid to employees 'nterest paid to lenders 7ividends received from investments Cash paid to acquire treasury stoc 1 ! ! 2 2 1 1 1 ! #perating (inancing (inancing 'nvesting 'nvesting #perating #perating #perating (inancing

? --! 2urpose and (ormat of the /tatement of Cash (lows 1. The two primary purposes of the cash flow statement are to provide information about the firms cash receipts and cash payments and to provide information about the investing and financing activities of the firm. This statement is useful to present and potential investors and creditors because it helps them assess" a. the firms ability to generate future cash flows. b. the firms ability to meet its obligations and pay dividends and its need for outside financing. c. the reasons for the differences between income and cash receipts and payments. d. both the cash and non-cash aspects of the firms investing and financing activities. The following methods are used to report cash flows from operations" a. The direct method, which involves reporting the maEor types of operating receipts and cash payments, such as receipts from the sale of goods and services and payments to suppliers of inventory. Cash flows from operating activities are the difference between the total operating receipts and the total operating payments. b. The indirect method, which involves presenting a reconciliation between net income and net cash flows from operations. ?ssentially, the accrual-based income statement is reconciled to a cash-basis statement. The following categories of activities must be disclosed on the statement of cash flows" a. #perating activities, which include all transactions that are not considered either investing or financing activities. Therefore, operating activities consist primarily of delivering or producing goods for sale and providing services. Cash flows from operating activities are really the cash effect of the transactions that enter into the determination of net income. b. 'nvesting activities, which include cash inflows and outflows from lending money and collecting on loans and from acquiring and selling securities and productive assets such as property, plant, and equipment. c. (inancing activities, which include obtaining resources from owners and providing them a return on their investment and obtaining borrowed resources from creditors and repaying those borrowings. Common e+amples include issuance of notes, bonds, mortgages, and other shortor long-term borrowings and the issuance of common and preferred stoc . The (*/; requires that information about the non-cash investing and financing activities be disclosed outside the formal statement of cash flows. These transactions should be clearly identified as not involving cash receipts or payments. *n e+ample of such a transaction is when a firm issues common stoc in e+change for plant and equipment.

2.

!.

).

Chapter - 4 )

? --) *ccounts Ased for Cash (low *nalysis a. b. c. d. e. f. g. h. 'ncome /tatement /ales Cost of :oods /old 7epreciation ?+pense *morti6ation ?+pense 3ent ?+pense 'nterest ?+pense 'nsurance ?+pense 'ncome Ta+ ?+pense ;alance /heet *ccounts 3eceivable 'nventory, *ccounts 2ayable *ccumulated 7epreciation *ccumulated *morti6ation or associated asset account 2repaid 3ent or 3ent 2ayable 'nterest 2ayable 2repaid 'nsurance 'ncome Ta+es 2ayable, 2repaid 'ncome ta+

? --, Classifying Cash (low *ctivities a. b. c. d. e. f. g. (inancing activity, increase cash 'nvesting activity, increase cash (inancing activity, decrease cash #perating activity, decrease cash 'nvesting activity, decrease cash 'nvesting and financing, non-cash transaction (inancing activity, decrease cash

? --- (ormat of the /tatement of Cash (lows 1. Bilco+ 'nc. /tatement of Cash (lows (or the Gear ?nded 7ecember !1, 299Cash flows from operating activities" 3eceipts from customers 2ayments for inventory 2ayments for operating e+penses 2ayments for interest 2ayments for ta+es $et cash used in operating activities Cash flows from investing activities" 2roceeds from sale of equipment 2urchase of equipment $et cash used in investing activities Cash flows from financing activities" 2roceeds from loan /ale of stoc 2ayment of dividends $et cash provided by financing activities $et Cash 'ncrease for the 2eriod <2.-,999 0211,2991 0-2,)991 0)9,5991 0!.,5991 <0.-,2991 < --,999 02.-,9991 0219,9991 <2)9,999 159,999 0,2,5991 !-.,299 <51,999

Chapter - 4 ,

2.

The cash inflow and outflow summary report initially prepared by Bilco+ 'nc. obscures the fact that Bilco+s operations consumed <.-,299 in cash during 299-. Cash from operating activities is a ey indicator of company performance. (rom the formal statement of cash flows, we can see that Bilco+ needed to obtain <)29,999 in financing in order to meet its cash needs for the year. The three-category statement of cash flows is much more informative than is the summary inflowHoutflow statement prepared by Bilco+.

? --. Anderstanding the /tatement of Cash (lows Doo ing at the cash flow statement, we see that the maEority of the cash generated from operating and financing activities was invested in IC* Company. 'f this investment was made with the intention of acquiring 0or merging with1 IC* Company, then the financial statements of IC* Company must be e+amined to assess the impact of this investment on the overall profitability of 2otsie Company. Be also notice that 2otsie Company retired bonds of <)99,999, issued <,99,999 of common stoc , and issued <599,999 of long-term debt. (urther, the dividends paid totaled <299,999. ?ven though there was a net increase in cash of <-,,999, this is far less than the cash provided by operations of <1-,,999. (urther, the amount of investing and financing activities that too place indicates that the company may be going through a maEor reorgani6ation. ? --5 7etermining Cash 2ayments for 'nventory 2urchases ?nding inventory = Cost of goods sold during the year > Total amount of inventory needed during the year 4 ;eginning inventory 0inventory already on hand1 > 'nventory purchased during the year = ;eginning balance in accounts payable > Total amount owed for inventory purchases 4 ?nding balance in accounts payable 0amount not yet paid1 > Cash paid for inventory purchases ? --8 7etermining Cash 2ayments for 'nventory 2urchases ?nding inventory = Cost of goods sold during the year > Total amount of inventory needed during the year 4 ;eginning inventory 0inventory already on hand1 > 'nventory purchased during the year = ;eginning balance in accounts payable > Total amount owed for inventory purchases 4 ?nding balance in accounts payable 0amount not yet paid1 > Cash paid for inventory purchases < -9,999 !,9,999 <)19,999 0)9,9991 <!.9,999 2,,999 <!8,,999 029,9991 <!.,,999 < 2-,,999 899,999 <1,1-,,999 02!2,,991 < 8!2,,99 129,999 <1,9,2,,99 0199,9991 < 8,2,,99

Chapter - 4 -

? --19 7etermining Cash (lows from #perations 2ayne Company Cash (lows from #perating *ctivities $et cash flows from operating activities $et income 7epreciation e+pense 'ncrease in accounts receivable 'ncrease in prepaid insurance 7ecrease in supplies 7ecrease in accounts payable $et cash provided by operating activities ? --11 7etermining Cash (lows from #perations *mule Corporation Cash (lows from #perating *ctivities $et cash flows from operating activities $et income 7epreciation e+pense Dess" :ain on sale of land Dess" 'ncrease in accounts receivable 2lus" 7ecrease in inventory 2lus" 'ncrease in accounts payable $et cash provided by operating activities ? --12 Cash (low 'mpact of :ains and Dosses 1. 'f 2ecan uses the direct method of reporting cash from operating activities, nothing with respect to the computer sale will be reported in the operating activities section. The <,9,999 cash proceeds from the computer sale will be reported as a cash inflow from investing activities. The <,9,999 cash proceeds from the computer sale will be reported as a cash inflow from investing activities. 'n addition, if 2ecan uses the indirect method of reporting cash from operating activities, the impact of the <29,999 loss must be removed from net income. 'n order to do so, the <29,999 loss is added bac in computing cash from operating activities. < -.,,999 1!8,,99 02,,,991 02-,1991 15,899 1!,,99 < .8,,!99 <2.,,999 8,999 0),,9991 01,)991 2,999 05,9991 <2!1,-99

2.

Chapter - 4 .

? --1! Complete /tatement of Cash (lows" 'ndirect Jethod Da(orge Company /tatement of Cash (lows 0'ndirect Jethod1 (or the Gear ?nded 7ecember !1, 299Cash flows from operating activities" $et 'ncome *dEustments" 7epreciation < -9 7ecrease in accounts receivable ,9 'ncrease in inventory 0!91 'ncrease in prepaid general e+penses 051 'ncrease in accounts payable 2, 'ncrease in interest payable 2 7ecrease in income ta+es payable 01.1 $et cash provided by operating activities Cash flows from investing activities" /ale of plant assets 2urchase of plant assets $et cash used in investing activities Cash flows from financing activities" 'ssuance of bonds payable 'ssuance of stoc 2ayment of cash dividends $et cash provided by financing activities $et increase in cash and cash equivalents Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year C#J2AT*T'#$/"
1

<

.9

52 < 1,2

< 299 0!)811 01)81 < )92 !5! 0.,1 ! < < 122

;eginning plant assets Dess" 2lant assets sold *dd" ?nding plant assets 7ifference 0plant assets purchased1

< 1,999 !!9 < -.9 1,918 < !)8 < .. 11. < )9 < !99 !!5 < !5

;eginning bonds payable ?nding bonds payable 'ncrease 0bonds payable issued1 ;eginning paid-in capital ?nding paid-in capital 'ncrease 0stoc issued1

Chapter - 4 5

The following matri+ can be used in computing cash from operating activities" 'ncome /tatement 1,!99 05591 0-91 02)91 01,1 0!,1 .9 *dEustments *. ;. C. 7. ?. (. :. ,9 0!91 2, -9 051 2 01.1 Cash (lows from #perations 1,!,9 055,1 9 02)51 01!1 0,21 1,2

/ales Cost of :oods /old 7epreciation ?+pense :eneral ?+penses 'nterest ?+pense 'ncome Ta+ ?+pense *. ;. C. 7. ?. (. :.

7ecrease in accounts receivable 'ncrease in inventory 'ncrease in accounts payable *mount of reported depreciation e+pense 'ncrease in prepaid general e+penses 'ncrease in interest payable 7ecrease in income ta+es payable

? --1) Complete /tatement of Cash (lows" 7irect Jethod Da(orge Company /tatement of Cash (lows 07irect Jethod1 (or the Gear ?nded 7ecember !1, 299Cash flows from operating activities" Cash receipts from customers Cash payments for" 2urchases of inventory :eneral e+penses 'nterest e+pense 'ncome ta+ e+pense 01,1851 $et cash provided by operating activities Cash flows from investing activities" /ale of plant assets 2urchase of plant assets $et cash used in investing activities Cash flows from financing activities" 'ssuance of bonds payable 'ssuance of common stoc 2ayment of cash dividends $et cash provided by financing activities $et increase in cash and cash equivalents Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year C#J2AT*T'#$/" 1 /ales = ;eginning accounts receivable 4 ?nding accounts receivable <1,!,91 <055,12 02)51! 01!1) 0,21, < 1,2 <299 0!)81 01)81 < )9 !5 0.,1 < < ! 122

<1,!99 2,9 02991

Chapter - 4 8

>

Cash receipts from customers

< 1,!,9

Chapter - 4 19

Cost of goods sold 4 ;eginning inventory = ?nding inventory > 'nventory purchases = ;eginning accounts payable 4 ?nding accounts payable > Cash payments for inventory purchases :eneral e+penses 4 ;eginning prepaid general e+penses = ?nding prepaid general e+penses > Cash payments for general e+penses 'nterest e+pense = ;eginning interest payable 4 ?nding interest payable > Cash payments for interest e+pense 'ncome ta+ e+pense = ;eginning income ta+es payable 4 ?nding income ta+es payable > Cash payments for income ta+ e+pense

< 559 08,1 12, < 819 ,9 0.,1 < 55, < 2)9 0191 15 < 2)5 < 1, 5 0191 < 1! < !, 19. 0891 < ,2

The following matri+ can be used in computing cash from operating activities" 'ncome /tatement 1,!99 05591 0-91 02)91 01,1 0!,1 .9 *dEustments *. ;. C. 7. ?. (. :. ,9 0!91 2, -9 051 2 01.1 Cash (lows from #perations 1,!,9 055,1 9 02)51 01!1 0,21 1,2

/ales Cost of :oods /old 7epreciation ?+pense :eneral ?+penses 'nterest ?+pense 'ncome Ta+ ?+pense *. ;. C. 7. ?. (. :.

7ecrease in accounts receivable 'ncrease in inventory 'ncrease in accounts payable *mount of reported depreciation e+pense 'ncrease in prepaid general e+penses 'ncrease in interest payable 7ecrease in income ta+es payable

? --1, Cash (low from 'nvesting and (inancing *ctivities 1. ;eginning long-term debt balance = $ew long-term debt incurred during the year 0computed1 > ?nding long-term debt balance ;eginning common stoc balance = $ew common stoc issued during the year 0computed1 > ?nding common stoc balance < .,,999 .,,999 <1,9,999 <129,999 !9,999 <1,9,999

Chapter - 4 11

Cash inflow from financing activities is computed as follows" $ew long-term debt Common stoc issued Cash dividends paid Total 2. ;eginning equipment balance 4 ?quipment sold during the year > ?nding equipment B'T@#AT purchase of new equipment = $ew equipment purchased during the year 0computed1 > ?nding equipment balance Cash outflow from investing activities was <1.),999 for new equipment. $o additional land was purchased during the year. ? --1- (orecasted 'ncome /tatement and /tatement of Cash (lows 1. (orecasted 'ncome /tatement 299299. /ales Cost of :oods /old :ross 2rofit 7epreciation ?+pense #ther #perating ?+penses #perating 2rofit 'nterest ?+pense 'ncome before Ta+es 'ncome Ta+es $et 'ncome 2. Cash flows from operating activities" $et 'ncome *dEustments" 7epreciation 'ncrease in other current assets 'ncrease in accounts payable $et cash provided by operating activities Cash flows from investing activities" 2urchase of property, plant, and equipment $et cash used in investing activities Cash flows from financing activities" 3epayment of ban loans payable 'ssuance of common stoc 2ayment of cash dividends $et cash provided by financing activities $et increase in cash and cash equivalents Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year
Chapter - 4 12

<.,,999 !9,999 0!9,9991 <.,,999 <1,9,999 49 <1,9,999 1.),999 <!2),999

2,999 .99 1,!99 129 1,919 1.9 89 59 !9 ,9

2,299 ..9 1,)!9 1-9 1,111 1,8 ., 5) !2 ,2

given !,K of sales, li e last year 29K of 22?, li e last year ,9.,K of sales, li e last year 1,K of ban loan, li e last year !..,K of pre-ta+, li e last year

< ,2 <1-9 0,91 29

1!9 <152

<0!-911 0!-91 <019912 259! 091) 159 < 2 29 < 22

C#J2AT*T'#$/"
1

;eginning property, plant, and equipment Dess" 'mpact of depreciation e+pense ?nding property, plant, and equipment 7ifference 0assets purchased1

<-99 1-9 <))9 599 < !-9 <-99 ,99 < 199 <!29 ,2 091 <!.2 -,2 < 259

;eginning ban loans payable ?nding ban loans payable 7ecrease 0ban loans repaid1 ;eginning stoc holders equity 2lus" 'ncrease from forecasted net income Dess" 7ecrease from forecasted cash dividends Total stoc holders equity with no new stoc ?nding stoc holders equity 'ncrease 0common stoc issued1 't is assumed that cash dividends are <9.

? --1. (orecasted ;alance /heet, 'ncome /tatement, and /tatement of Cash (lows 1. ;alance /heet Cash #ther Current *ssets 2roperty, 2lant, and ?quipment, net Total *ssets *ccounts 2ayable ;an Doans 2ayable Total /toc holders ?quity Total Diabilities and ?quities 2. 'ncome /tatement /ales Cost of :oods /old :ross 2rofit 7epreciation ?+pense #ther #perating ?+penses #perating 2rofit 'nterest ?+pense 'ncome before Ta+es 'ncome Ta+es $et 'ncome 29929 ,99 1,-99 2,129 299 1,)99 ,29 2,129 (orecasted 299. !9 .,9 1,-99 2,!59 !99 1,599 259 2,!59 ,9K natural increase ,9K natural increase more efficient, item 0b1 ,9K natural increase new loan of <)99, item 0c1 to balance

2,999 1,,99 ,99 59 1-9 2-9 1)9 129 )9 59

Chapter - 4 1!

!,999 2,2,9 .,9 59 2)9 )!9 159 2,9 5! 1-.

given, item 0a1 .,K of sales, li e last year ,K of 22?, li e last year 5K of sales, li e last year 19K of ban loan, li e last year !!.!K of pre-ta+, li e last year

!.

Cash flows from operating activities" $et 'ncome *dEustments" 7epreciation 'ncrease in other current assets 'ncrease in accounts payable 0.91 $et cash provided by operating activities Cash flows from investing activities" 2urchase of property, plant, and equipment $et cash used in investing activities Cash flows from financing activities" $ew ban loans payable 3epurchase of common stoc 2ayment of cash dividends $et cash provided by financing activities 0.1 $et increase in cash and cash equivalents Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year

<1-. < 59 02,91 199 < 8. < 05911 0591 < )992 0)9.1! 091)

< 19 29 < !9

C#J2AT*T'#$/"
1

;eginning property, plant, and equipment Dess" 'mpact of depreciation e+pense ?nding property, plant, and equipment 7ifference 0assets purchased1

< 1,-99 59 < 1,,29 1,-99 < 59 < 1,)99 1,599 < )99 < ,29 1-. 091 < -5. 259 < 0)9.1

;eginning ban loans payable ?nding ban loans payable 'ncrease 0new ban loans1 ;eginning stoc holders equity 2lus" 'ncrease from forecasted net income Dess" 7ecrease from forecasted cash dividends Total stoc holders equity with no new stoc ?nding stoc holders equity 7ecrease 0common stoc repurchased1 't is assumed that cash dividends are <9.

Chapter - 4 1)

PROBLEMS 2 --15 Types of Changes in Cash 1. 'tem a. $et income for the year, <!,999 b. 2urchase of a new building through the issuance of a mortgage for the entire amount c. 'ssuance of capital stoc in e+change for land valued at <29,999 d. Collection of accounts receivable, <12,999 e. 2ayment of interest on bond debt, <8,999 f. 2ayment of cash dividends, <12,999 g. 'ssuance of additional common stoc , <!99,999 h. 7epreciation for year, <-,999 i. 2urchase of equipment for cash, <12,999 E. /ale of long-term investments, <2,,999 . /ale of merchandise on account, <!,,999 l. 7eposit of cash in a savings account, <,,999 #perating F F F F F F F F F F F F 'nvesting (inancing $one

$ote" (or item 0l1, the savings account would probably be considered to be a cash equivalent. *s a result, this transaction merely results in changing cash from one form into anotherL there is no net financial statement effect. 2. *$*DG/'/" *s seen in items 0b1 and 0c1, some very significant transactions can be e+cluded from the cash flow statement. The (*/;s position ma es some sense because it restricts the cash flow statement to Eust those transactions involving cash. * compromise position might be to e+clude the significant non-cash transactions from the formal cash flow statement, but to require that they be briefly mentioned at the bottom of the statement of cash flows and then more fully e+plained in the financial statement notes. 'n this way, financial statement users would be less li ely to overloo these important non-cash transactions.

2 --18 7etermining Cash (low from #perations 1. The Da er ;as etball Company 2artial /tatement of Cash (lowsM'ndirect Jethod (or the Gear ?nded Nune !9, 299Cash from operating activities $et income <,9,999 *dEustments to reconcile net income to net cash provided by operating activities" 7epreciation e+pense <12,999 Doss on sale of investment securities 1,999 3estructuring charge 19,,999 Doss on sale of land 29,999 :ain on early e+tinguishment of debt 0.9,9991 'ncrease in accounts receivable 05,9991 -9,999 $et cash provided by operating activities <119,999 $ote" ;ecause the investment securities are $#T part of the Da ers active trading portfolio, the purchases and sales of the investment securities are investing activities. *s such, the loss is e+cluded from the calculation of cash from operating activities.
Chapter - 4 1,

2.

*$*DG/'/" Bithout the <.9,999 gain from the early e+tinguishment of debt, The Da er ;as etball Company would have reported a net loss of <29,999 0<,9,999 4 <.9,9991 for the year. Clearly, the company accelerated the e+tinguishment of the debt in order to avoid the embarrassment of reporting a net loss. @owever, because the company was preparing to e+tinguish the debt anyway, management can hardly be faulted for ta ing advantage of the timing to erase the potential net loss.

2 --29 7etermining Cash (low from #perations 1. /tevo Company 2artial /tatement of Cash (lowsM7irect Jethod (or the Gear ?nded 7ecember !1, 299-

Cash from operating activities Cash received from customers /ales 7ecrease in accounts receivable )29,999 Cash received from rent 3ental income 'ncrease in rent receivable Cash paid to suppliers Cost of goods sold 7ecrease in inventories 7ecrease in accounts payable Cash paid for supplies /upplies used 'ncrease in supplies Cash paid for other accrued e+penses #ther accrued e+penses 'ncrease in other accrued liabilities $et cash provided by operations 2.

< )99,999 29,999 < -,,-9 01-91

<

-,)99

< 2.5,599 0),9991 ),999 < !,.-9 -)9

02.5,5991 0),)991 0,8,2991 < 5),999 < 1-,999 0),9991 < 12,999 1,-99 < 1!,-99

< -1,-99 02,)991

The property, plant, and equipment was sold for <1!,-99, computed as follows" @istorical cost of property, plant, and equipment sold Dess" *ccumulated depreciation ;oo value of property, plant, and equipment sold 2lus" :ain on sale 2roceeds from sale of property, plant, and equipment

!.

2roperty, plant, and equipment in the amount of <8-,999 was purchased during the year, computed as follows" ;eginning property, plant, and equipment 022C?1 balance <)99,999 4 @istorical cost of 22C? sold during the year 4 1-,999 > ?nding 22C? B'T@#AT purchase of new 22C? <!5),999 = $ew 22C? purchased during the year 0computed1 8-,999 > ?nding 22C? balance <)59,999 * cash dividend of <2.,5)9 was paid during the year, computed as follows" ;eginning retained earnings balance 2lus" $et income for the year > ?nding retained earnings B'T@#AT payment of dividends 4 Cash dividends paid during the year 0computed1 <.2,999 ,-,999 <125,999 2.,5)9

).

Chapter - 4 1-

,.

> ?nding retained earnings balance <199,1-9 *$*DG/'/" /tevo Company does not loo li e a young, start-up company. ;oth accounts receivable and inventory decreased during the yearL these accounts are typically increasing for growing companies. 'n addition, cash dividends paid were almost half of net income. 7ividends would probably be a much lower percentage of net income for a young company.

2 --21 *nalysis of Cash (low 7ata 1. $et income = 7epreciation 4 'ncrease in other current assetsH = 7ecrease in other current assets = 'ncrease in current liabilitiesH 4 7ecrease in current liabilities $et cash from operating activities 2. Cash #ther current assets Current liabilities 299<.,,999 ),9,999 !!,,999 299<-,,999 ,9,999 0,9,9991 8,,999 <1-9,999 299, <129,999 )99,999 289,999 299$et income = 7epreciation 4 'ncrease in other current assetsH = 7ecrease in other current assets = 'ncrease in current liabilitiesH 4 7ecrease in current liabilities $et cash from operating activities !. Cash #ther current assets Current liabilities 299< .,,999 ),9,999 !!,,999 <-,,999 ,9,999 0,9,9991 ),,999 <119,999 299, <129,999 !,9,999 2)9,999 299$et income = 7epreciation 4 'ncrease in other current assetsH = 7ecrease in other current assets = 'ncrease in current liabilitiesH 4 7ecrease in current liabilities $et cash from operating activities ). <-,,999 ,9,999 0199,9991 8,,999 <119,999 299, <,.,999 )5,999 0!9,9991 019,9991 <-,,999 299) <-9,999 !.9,999 2,9,999 299, <,.,999 )5,999 0!9,9991 )9,999 <11,,999 299) < -9,999 !.9,999 2,9,999 299, <,.,999 )5,999 29,999 019,9991 <11,,999

*$*DG/'/" *s the e+amples above illustrate, cash from operations can be manipulated easily by delaying payments or purchases past the end of the period. @owever, the e+amples also illustrate that total cash flow cannot be manipulatedMtotal cash flow for the years 299- and 299, is <22,,999 in all three e+amples. The manipulations Eust have the effect of shifting cash flow from one period to another.

Chapter - 4 1.

2 --22 7efinitions of Cash (low 1. $et income = 7epreciation O Change in receivables O Change in inventory O Change in payables $et cash from operating activities 2. !. %Cash flow& 0net income = depreciation1 is <1-9 each year. *$*DG/'/" Bhen wor ing capital 0current assets 4 current liabilities1 is relatively constant, the net cash from operations is about the same as the cash flow measure. This is the case in 299- and in 299! in the e+ample. (irms that are not growing would e+pect to have a stable level of wor ing capital. (or such firms, net income = depreciation is a reasonable appro+imation for cash flow from operations. 'f wor ing capital is increasing, then part of the cash generated by operations must be used to finance the additional wor ing capital. This will cause cash flow from operations to be less than net income = depreciation. This is the case in 299) in the e+ample. Bor ing capital is often increasing in high-growth firms and also in firms that are having trouble collecting receivables or moving inventory. 'f wor ing capital is decreasing, e+tra cash is freed up in addition to the cash generated by operations. This will cause cash flow from operations to be greater than net income = depreciation. This is the case in 299, in the e+ample. Bor ing capital can be decreased by any combination of the following actions" increase receivable collection efforts, reduce inventory levels, allow payable levels to increase. 2 --2! @ow to :enerate Cash ?+amination of the operating activities section of a statement of cash flows reveals several other possible sources of cash. 'n general, it is often possible to free up cash by reducing wor ing capital as follows" 3educe receivables. This can be done by increasing collection efforts. This strategy is particularly effective for businesses that have previously been la+ and have allowed receivables to balloon. #f course, care must be ta en not to alienate customers. 3educe inventories. Bhen cash is short, many companies find that by more carefully monitoring inventory levels they can reduce the need to eep inventory on hand. 3educe prepaid e+penses. 7elay cash payment of payables. Care must be ta en not to anger suppliers, and the advisability of losing cash discounts must be considered, but this is probably the most common strategy used by businesses with short-term cash shortages. 299<199 -9 0291 0!91 )9 <1,9 299, <199 -9 9 -9 ,9 <2.9 299) <199 -9 0)91 9 0!91 < 89 299! < 199 -9 0!91 19 29 <1-9

Jany businesses are less profitable than they could be because they have too large an investment in wor ing capital. #ften it requires a cash shortage to ma e this fact apparent.

Chapter - 4 15

2 --2) Comparison of 'ndirect and 7irect Jethods 1. 3i er Company 2artial /tatement of Cash (lows 07irect Jethod1 (or the Gear ?nded 7ecember !1, 299Cash flows from operating activities" Cash receipts from customers Cash payments for" 'nventory #perating e+penses 'nterest 'ncome ta+es $et cash flow provided by operating activities C#J2AT*T'#$/"
1

<59!,.,91 <)58,)892 85,599! 22,,99) !.,8!9,

-)5,.29 <1,,,9!9

/ales 4 'ncrease in accounts receivable > Cash receipts from customers Cost of goods sold 4 7ecrease in inventory = 7ecrease in accounts payable 059K1 > Cash payments for inventory #perating e+penses = 7ecrease in accounts payable 029K1 4 7ecrease in prepaid operating e+penses > Cash payments for operating e+penses 'nterest e+pense 4 'ncrease in interest payable > Cash payments for interest 'ncome ta+ e+pense 4 'ncrease in income ta+es payable > Cash payments for income ta+es

<512,!,9 5,-99 <59!,.,9 <,99,999 012,)!91 1,829 <)58,)89 <199,999 )59 01,-591 < 85,599 < 2!,999 ,99 < 22,,99 < )9,)!9 2,,99 < !.,8!9

2.

*$*DG/'/" Gour partner is correct in one senseMnegative operating cash flow is a bad sign in an old, established company. /uch companies should be generating enough cash from operations to be able to finance investing activities and have e+tra cash to pay cash dividends, repay loans, and so forth. Doo again at the cash flow statementMthis is e+actly the situation that 3i er Company is in. Gour partner has made the mista e of confusing overall change in the cash balance with operating cash flow. The change in the cash balance is not a very important number, but the operating cash flow is very important.

Chapter - 4 18

2 --2, 2reparation of an 'ncome /tatement Asing ;alance /heet and Cash (low 7ata 1. Troi Company 'ncome /tatement (or the Gear ?nded 7ecember !1, 299/ales <-82,!991 Cost of goods sold !9.,9992 :ross profit <!5,,!99 #perating e+penses" :eneral e+penses Bages e+pense *morti6ation e+pense 7epreciation e+pense #ther revenue and e+penses" 'nterest e+pense Doss on retirement of bonds payable :ain on sale of property, plant, and equipment. 'ncome before income ta+es 8!,199 'ncome ta+ e+pense $et income -5,599 C#J2AT*T'#$/"
1

<191,!99! 1,1,.99) ),999, 2.,-99< 08,5991. 0!,99915 ,,2998

25),-99 <199,.99

0.,-991 < 2),!9919 <

Cash collected from customers = 'ncrease in accounts receivable > /ales Cash payments for inventory = 'ncrease in accounts payable = 7ecrease in inventory > Cost of goods sold Cash payments for general e+penses 4 'ncrease in prepaid general e+penses > :eneral e+penses Cash payments for wages = 'ncrease in wages payable > Bages e+pense ;eginning goodwill 4 ?nding goodwill > *morti6ation e+pense

<-5,,!99 .,999 <-82,!99 <!99,999 !,999 ),999 <!9.,999 <192,999 .99 <191,!99 <1,9,999 1,.99 <1,1,.99 <)9,999 !-,999 < ),999

Chapter - 4 29

;eginning accumulated depreciation 4 *ccumulated depreciation associated with asset sale > Total 4 ?nding accumulated depreciation > 7epreciation e+pense

< 125,899 ,!,999 <.,,899 19!,,99 <2.,-99

Chapter - 4 21

Cash payments for interest e+pense 4 7ecrease in interest payable > 'nterest e+pense 7ecrease in bonds payable 4 Cash used to retire bonds payable > Doss on retirement ;oo value of property, plant, and equipment sold 4 /ales price > :ain on sale Cash payments for income ta+ e+pense = 'ncrease in income ta+ payable > 'ncome ta+ e+pense

<11,999 1,299 < 8,599 <29,999 2!,999 < 0!,9991 <22,999 2.,299 < ,,299 <2!,899 )99 <2),!99

19

2.

*$*DG/'/" 't can be deduced that the <1),999 in dividends payable have already been deducted from the retained earnings balance. ;eginning retained earnings balance <5),999 2lus" $et income for the year -5,599 > ?nding retained earnings B'T@#AT payment of dividends < 1,2,599 4 Cash dividends during the year 0computed1 ,-,999 > ?nding retained earnings balance <8-,599 Total dividends subtracted from retained earnings were <,-,999, only <)2,999 of which were paid in cash 0see the cash flow statement1. #nce a dividend is declared by the board of directors, it is considered to be a legal obligation and the amount is subtracted from retained earnings.

2 --2- 'nterpretation of Cash (low 'nformation 1. The statement of cash flows provides information about 7enslowes current liquidity, a measure to assist 7enslowe in setting a dividend payment for the year and in evaluating the effects of the companys investing and financing strategies during the year. 't also provides a basis for anticipating the companys future cash flows 0especially those from operations1 to determine whether additional financing 0debt, equity, or liquidation of e+isting assets1 will be required to continue operations, meet obligations as they come due, and pay dividends. The principal e+planation for why 7enslowe earned a profit for the year yet couldnt pay its current debts is revealed in the statement. Jost of the net income of <199,999 for the year was attributable to the <89,999 gain on sale of the plant. This is deducted from net income because the transaction affects net income but does not affect cash flows from operations 0the sale of a long-term asset such as property, plant, and equipment is an investing activity1. * loo at the financing section tells us that of the <129,999 received from the sale of the plant, <59,999 was spent paying off long-term debt 0most li ely related to the plant1, so the net cash generated by the sale is <)9,999 0<129,999 4 <59,9991. 'n addition, the company spent <),,999 on the plant during the year 0the plant may have required capital improvements before it could be sold to the buyer1. Thus, from a cash standpoint, the company came out of poc et by <,,999 0<),,999 4 <)9,9991 as a result of the entire %cycle& of improving the plant, selling it, and paying off the related debt. 'n addition, the company paid <!,,999 in dividends during the year. 3eceivables and inventories increased by <29,999 and <!9,999, respectively. Thus, e+penditures totaling <5,,999 were made using cash that potentially could have been available to pay current debts. The company should e+amine and refine its policies for spending cash if it wishes to ma e cash available to meet current debts.

2.

Chapter - 4 22

!.

*$*DG/'/"

7enslowe *ssociates (#3?C*/T?7 /tatement of Cash (lows (or the Gear ?nded 7ecember !1, 299. < 19,9991 )9,999 029,99912 0!9,99912 029,99912 <029,9991 0),,9991! 0),,9991 0!,,9991) 199,999, -,,999 < 9

Cash flows from operating activities $et income *dEustments" 2rovision for depreciation and amorti6ation Changes in assets and liabilities" 0'ncrease1 in receivables 0'ncrease1 in inventory 07ecrease1 in payables $et cash used by operating activities Cash flows from investing activities *ddition to plant and equipment $et cash used by investing activities Cash flows from financing activities 7ividends paid $ew financing 0loans or stoc issuance1 $et cash provided by financing activities Change in cash

*ssumptions" 1. The gain on the sale of the plant was a one-time thing. The best guess of ne+t years net income is <19,999 which is this years net income without the gain 0<199,999 this years net income 4 <89,999 gain1. 2. Bithout information to the contrary, it seems reasonable to e+pect current assets and current liabilities to continue to increase or decrease as in the past. *lternatively, it may be assumed that, instead of decreasing, accounts payable will be unchanged or even increase. !. 'n order to stay in business, 7enslowe will have to continue to update and improve its plant and equipment. *ccordingly, it is assumed that e+penditures for new plant and equipment in 299. will be the same as in 299-. 't is also assumed that no additional asset disposals will occur. ). Companies are very reluctant to reduce the amount of cash dividends. *lso, given 7enslowes operating cash flow problems, it seems unli ely that dividends will be increased. Thus, it is assumed that dividends in 299. will be the same as in 299-. ,. This <199,999 is a plug figureMthis is the amount of new financing needed if the total change in cash for the year is to be <9. This simple e+ercise illustrates the power of a forecasted statement of cash flows. * few basic assumptions lead one to the conclusion that, unless something changes dramatically, 7enslowe will be forced to obtain a significant amount of e+ternal financing in 299.. *rmed with this forecasted information, the president of 7enslowe *ssociates can now consider what changes to operating policy and dividend policy need to be implemented in 299..

Chapter - 4 2!

2 --2. Asing a /tatement of Cash (lows 1. The balance in the 3etained ?arnings account as of 7ecember !1, 299- is <!9,999, computed as follows" ;eginning retained earnings balance <2,,999 2lus" $et income for the year -,999 Dess" Cash dividends paid during the year 01,9991 > ?nding retained earnings balance <!9,999 The balance in the ?quipment 0net1 account as of 7ecember !1, 299- is <2),999, computed as follows" ;eginning equipment balance <)-,999 4 7epreciation e+pense for the year 4),999 4 ?quipment sold during the year 415,999 > ?nding equipment B'T@#AT purchase of new equipment <2),999 = $ew equipment purchased during the year 9 > ?nding equipment balance <2),999 The <15,999 net amount of the equipment sold during the year is the boo value of the equipment, computed as follows" Cash proceeds from sale of equipment <1,,999 Dess" ;oo value 0computed1 15,999 :ain or 0loss1 on sale < 0!,9991 !. /ales for the period were <19-,999, computed as follows" ;eginning accounts receivable balance 2lus" /ales for the year 0computed1 Dess" Cash collections during the year > ?nding accounts receivable balance 0<15,999 = <-,9991 Cost of goods sold for the period was <-2,999, computed as follows" ;eginning balance in accounts payable = 'nventory purchased during the year 0computed1 4 Cash paid for inventory purchases > ?nding balance in accounts payable 0<2.,999 4 <5,9991 ;eginning inventory = 'nventory purchased during the year 0from above1 4 ?nding inventory 0<2-,999 4 <2,9991 > Cost of goods sold during the year ,. The net increase in T#T*D assets for 299- was <9, computed as follows" Cash *ccounts receivable 'nventory ?quipment 0see part P2Q1 Dand Total change <2.,999 -9,999 0-5,9991 <18,999 <2-,999 -9,999 02),9991 <-2,999 =<,,999 = -,999 4 2,999 422,999 =1!,999 < 9 <15,999 19-,999 0199,9991 <2),999

2.

).

Chapter - 4 2)

-.

*$*DG/'/" This is $#T a point that should be emphasi6ed. 'n a normal company, cash from investing activities is usually negative, reflecting the fact that cash is being used to upgrade, replace, or e+pand property, plant, and equipment. The ey number in the cash flow statement is the cash from operating activitiesMthe members of the board of directors should spend their time figuring out how to e+plain to the stoc holders why this number is so low.

2 --25 Bor ing ;ac wards from Cash (low 7ata 1. Nohn Company 'ncome /tatement /ales Cost of goods sold #ther e+penses 7epreciation e+pense :ain on sale of equipment $et income 1 Cash collected from customers = 'ncrease in accounts receivable > /ales
2

<

<

19,,-991 0-.,29912 02),9991 08,-991 2,)99 .,299 <55,599 1-,599 < 19,,-99 <)5,999 2),999 4),599 <-.,299

Cash payments for inventory = 'ncrease in accounts payable 4 'ncrease in inventory > Cost of goods sold Nohn Company ;alance /heet

2.

Cash *ccounts receivable 1-,599 'nventory ),599 ?quipment Dess" *ccumulated depreciation 0<8,-99 4 <2,)991 Total assets -.,299 *ccounts payable 2),999 Dong-term debt )5,999 2aid-in capital 2),999 3etained earnings 0<.,299 4 <!-,9991 025,5991 Total liabilities and equities

< .,299

<

),,-99! 0.,2991

!5,)99 < <

<-.,299

$ote" This is Nohn Companys first year of operations so the beginning balances of all the balance sheet accounts were <9.
!

;eginning equipment balance 4 ?quipment sold during the year

Chapter - 4 2,

< 9 412,999

= $ew equipment purchased during the year > ?nding equipment balance !.

,.,-99 <),,-99

*$*DG/'/" 't is somewhat unusual that Nohn is already selling equipment in the first year of operations. @owever, even more unusual is the fact that Nohn paid <!-,999 in dividends, five times the amount of income for the year. 'n a real company, it is unli ely that the creditors would allow the company to pay out so much cash to stoc holders so soon.

Chapter - 4 2-

2 --28 (orecasted ;alance /heet and 'ncome /tatement 1. ;alance /heet Cash #ther Current *ssets 2roperty, 2lant, and ?quipment, net Total *ssets *ccounts 2ayable ;an Doans 2ayable 2aid-in Capital 3etained ?arnings Total Diabilities and ?quities 'ncome /tatement /ales Cost of :oods /old :ross 2rofit 7epreciation ?+pense #ther #perating ?+penses #perating 2rofit 'nterest ?+pense 'ncome before Ta+es 'ncome Ta+es $et 'ncome 299)9 !,9 1,999 1,!89 199 1,999 199 189 1,!89 (orecasted 299. )5 29K natural increase )29 29K natural increase 599 <1,999 4 <299L no replacements 1,2-5 129 1,999 41). 28, 1,2-5 29K natural increase no new loans, item 0c1 to balance <189 = <129 4 <1,

1,999 !,9 -,9 299 2,9 299 129 59 29 -9

1,299 )29 .59 299 !99 259 129 1-9 )9 129

given, item 0a1 !,K of sales, li e last year Rsame as last yearL no replacements 2,K of sales, li e last year 12K of ban loan, li e last year 2,K of pre-ta+, li e last year

R#ne could also argue that depreciation e+pense will be lower in 299. because the net amount of property, plant, and equipment will decline. Cash flows from operating activities" $et 'ncome *dEustments" 7epreciation 'ncrease in other current assets 'ncrease in accounts payable $et cash provided by operating activities Cash flows from investing activities" 2urchase of property, plant, and equipment $et cash used in investing activities < <129 <299 0.91 29 < 0911 091

1,9 2.9

Chapter - 4 2.

Cash flows from financing activities" $ew ban loans payable 3epurchase of common stoc 2ayment of cash dividends $et cash provided by financing activities $et increase in cash and cash equivalents Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year C#J2AT*T'#$/"
1

<

9 02).12 01,1 02-21 < )9 < 5 )5

;eginning property, plant, and equipment Dess" 'mpact of depreciation e+pense ?nding property, plant, and equipment 7ifference 0assets purchased1

<1,999 299 < 599 599 < 9 < 199 01).1 < 02).1

;eginning paid-in capital ?nding paid-in capital 7ecrease 0common stoc repurchased1

2.

*$*DG/'/" 2ayment of cash dividends involves distributing an equal amount of cash for each share owned. 3epurchase of shares of stoc channels the cash to shareholders who are the least optimistic about the prospects of the company. ;ecause they are the least optimistic, they are the shareholders who offer their shares for sale when the company announces a stoc repurchase.

APPLICATIONS AND EXTENSIONS SOLUTIONS

Deciphering Actual Financial State ent! Deciphering 6"# $McD%nal&'!( 1. The single biggest cause of the increase in cash from operating activities in 299! was the <,...8 increase in net incomeMfrom <58!., million to <1,).1.) million. 2. !. 'n 299!, the cash generated by Jc7onalds operations was <!,2-5.5 million. This was more than sufficient to pay the <1,!-8.- million required for Jc7onalds investing activities. 'n 299!, Jc7onalds distributed cash to its stoc holders in the following two ways" S Cash dividends amounting to <,9!., million. S 3epurchases of shares of common stoc totaling <!81.9 million. 'f interest paid and income ta+es paid were not considered to be part of operating activities, Jc7onalds would have reported <),!9).2 million in cash from operating activities in 299!, computed as follows" 3eported cash from operating activities <!,2-5.5 million Cash paid for interest )2-.8 million Cash paid for income ta+es -95., million Total <),!9).2 million Jc7onalds defines cash equivalents as %short-term, highly liquid investments.&

).

,.

Chapter - 4 25

Deciphering 6") $C%ca"C%la( 1. The amount represents the operating cash flow generated by Coca-Cola that is in e+cess of what the company needed to pay for new property, plant, and equipment and other investing activities. (or the years 2991 through 299!, this e+cess was" <2.822 billion in 2991, <!.-.. billion in 2992, and <).,29 billion in 299!. 'n fact, Coca-Colas operations generated surplus cash even after paying for its financing activities in each of these three years. 2. Coca-Cola subtracts gains and adds losses on sales of assets in the computation of net cash provided by operating activities to avoid double counting these gains and losses. The gains and losses are included in the proceeds from the disposal of property, plant, and equipment and other investments which are reported in the investing activities section. The gains and losses are also included in the computation of net income. 'f the gains were not subtracted and the losses added in computing cash from operating activities, then they would be included in cash from operating activities 0by being included in net income1 and they would also be included in investing activities. /ubtracting gains and adding losses avoids double counting. 299! 3?C?'T?7 (3#J /@*3?@#D7?3/" 'ssuances of stoc 2*'7 T# /@*3?@#D7?3/" 2urchases of stoc for treasury 7ividends $?T C*/@ 2*'7 T# /@*3?@#D7?3/ 85 01,))91 02,1--1 0!,,951 2992 19. 0-811 01,85.1 02,,.11 2991 1-) 02..1 01,.811 01,89)1

!.

(rom 2991 through 299!, the Company paid its shareholders much more than it received from its shareholders. ). The A./. dollar got stronger during 2991 and then got wea er during 2992 and 299!. Gou can tell this by loo ing at the line titled %?ffect of e+change rate changes on cash and cash equivalents.& This amount represents the change in the A./. dollar value of the foreign currency cash 0yen, mar s, rupiah, baht, francs, etc.1 held by Coca-Cola. $otice that in 2991 this amount results in a subtraction from cash. This means that these foreign currencies, as a whole, got wea er 0that is, lost value1 relative to the A./. dollar in 2991. *nother way to say this is that the A./. dollar got stronger. Conversely, notice that in 2992 and 299! this amount results in an addition to cash, which means that these foreign currencies, as a whole, got stronger 0that is, gained value1 relative to the A./. dollar. *nother way to say this is that the A./. dollar got wea er.

Deciphering 6"* $Micr%!%+t( 1. Tirtually all companies display the years in their financial statements with the most recent year in the far left column. Jicrosoft does it e+actly the opposite. BhyU *ny answer would be speculation. Jicrosoft Eust does it different. 2. Tirtually all companies list the activities in the following order 4 #perating, 'nvesting, (inancing. Jicrosoft lists the categories 4 #perating, (inancing, 'nvesting. BhyU *gain, any answer would be speculation. Jicrosoft Eust does it different. a1 Jicrosofts primary financing activity is the repurchase of shares of its own stoc . b1 Jicrosofts primary investing activities are the purchase and sale of investments. Jicrosoft uses much of its e+cess cash to invest in other companies.

!.

Chapter - 4 28

c1 The addition of Vunearned revenue amounts to the net income figure represents cash that was received in the current period but will not be recorded as revenue on the income statement until future periods. The subtraction of Vrecognition of unearned revenue amounts represents revenue that was recogni6ed on the income statement in this period even though the cash was received in a prior period. Deciphering 6", $Archer Daniel! Mi&lan&( 1. 7uring 299!, *7J increased its long-term borrowing by <,1. million and borrowed <252 million under lines of credit agreements. These two events account for the maEority of the increase in cash flow from financing activities from 2992 to 299!. 2. 7uring 299!, *7J acquired <,2. million in assets from various businesses, and it invested <89 million in affiliates. These two events account for the maEority of the increase in cash flow used in investing activities from 2992 to 299!. * dramatic increase in borrowings and no new stoc issuance do not necessarily mean there will be a correspondingly dramatic increase in the companys debt ratio. 'nvested capital can come from two sourcesMfrom new stoc issues and from retained earnings. Comparison of net income to cash dividends during the period shows that *7JWs retained earnings increased by over <28, million in 299!. 'ncidentally, *7Js debt ratio did increase from ,-.1 percent in 2992 to ,5.8 percent in 299!Mwhether this increase is considered %dramatic& is debatable.

!.

Deciphering 6"- $L%c.hee& Martin( 1. a. $et income plus depreciation b. Cash flow from operating activities c. Cash flow from operating activities = Cash paid for interest = Cash paid for ta+es d. Cash flow from operating activities 4 Capital e+penditures 4 7ividends 2. 299! <1,,!! 1,598 2,)85 2992 <8-2,255 2,828 2991 <)-5 1,52, !,!-8

5-1

1,)2.

1,91)

'n order to maintain its long-run potential, a company must consistently replace property, plant, and equipment, and must maintain a stable cash dividend level for investors. The cash flow number computed in 0d1 of part 011-cash flow from operating activities4capital e+penditures4dividendsMis a measure of how much %free cash flow& Doc heed Jartin generates after maintaining its long-run potential. /omeone considering a leveraged buyout 0D;#1 is interested in the cash flow from the operations of the business before payment of financing costs. This is the cash flow before payments for interest and ta+es are subtracted. /o, someone considering an D;# would be particularly interested in the %cash flow& numbers calculated in 0c1 of part 011MCash flow from operating activities = Cash paid for interest = Cash paid for ta+es.

!.

Chapter - 4 !9

Internati%nal Financial State ent!/ 0la1%S ith2line 1. :la+o/mithIline uses the following 8 categories in preparing its cash flow statement" operating activities dividends from Eoint ventures and associated underta ings returns on investment and servicing of finance ta+ation paid capital e+penditure and financial investment acquisitions and disposals equity dividends paid management of liquid resources financing 2. :la+o/mithIline has e+cluded the following items from the computation of cash from operating activities. These items would be included in that computation if the cash flow statement were prepared according to A./. standards. 7ividends from Eoint ventures and associated underta ings interest received interest paid ta+ation paid Doo ing at the list of items in 021 that :la+o/mithIline e+cludes from the computation of cash from operating activities but which a A./. company would include, it appears that the ;ritish number is a better measure of operating cash flow. The items e+cluded under the ;ritish format are not operating items at all, but relate primarily to the payment of interest and ta+es. These are usually thought of as non-operating items. /o, it loo s li e the ;ritish have developed a better measure for operating cash flow than that used by the *mericans. The total change in cash is the same no matter how you sort the individual items that caused the change. /ort them into three categories as is done in the A./., into nine categories as done by :la+o/mithIline, or into 11) categoriesMthe net change in cash for :la+o/mithIline in 299! will still be 02.1.

!.

).

Bu!ine!! Me %/ C%n3incing the Ol&"ti er! %+ the Nee& +%r Ca!h Fl%4 Data J?J# To" 2resident, @arry Jonst Company (rom" Chief *ccountant ' can understand your reluctance to sign the statement of cash flows that ' presented to you at your office. 'n contrast to the long history of the balance sheet and the income statement, the statement of cash flows has only been a required part of the standard set of financial statements since 185.. 't is still a relatively new statement, and many financial analysts and loan officers are not familiar with how to use it properly. Bith that said, let me add that those who have used the statement of cash flows have found it to be a useful supplement to the income statement. This is the reason that our new loan officer has requested that we provide the statement. The cash flow data are particularly useful to ban ers as they evaluate whether our operations will generate sufficient cash flow to enable us to ma e our debt service payments. ' have carefully e+amined our statement of cash flows and am convinced that it provides accurate and relevant information about our operations. ' have attached a copy of the statement to this memo. $ote that

Chapter - 4 !1

the three categories in the statementMoperating, investing, and financingMgive a nice summary of what we have done in our business in the past year. ' as that you ta e another loo at the statement.

Chapter - 4 !2

Re!earch/ 5hat I! in a REAL Ca!h Fl%4 State ent6 The (ebruary 1, 299), financial statements for @ome 7epot will be used to discuss possible findings for the research proEect involving five actual cash flow statements. 1. 2. !. ). @ome 7epot uses the indirect method. #nly about one out of 29 large A./. companies uses the direct method. (or the year ended (ebruary 1, 299), @ome 7epot has the classic pattern" positive cash from operations and negative cash from investing activities. @ome 7epots 299) cash from operations of <-.,), billion is greater than its net income of <).!9) billion. (or most companies, cash from operations is greater than net income. The three largest adEustments for @ome 7epot are" 7epreciation and amorti6ation 'ncrease in accounts payable 'ncrease in merchandise inventories <1,9.-,999,999 .89,999,999 0-8!,999,9991

(or many companies, the depreciation and amorti6ation adEustment is the largest. @ome 7epot is growing fast, as is evidenced in its large increases in accounts payable and inventory. ,. @ome 7epots 299) %free cash flow& is computed as follows" Cash flow from operations 4 Capital e+penditures 4 Cash dividends > (ree cash flow -. @ome 7epots 299) %net income plus depreciation& is computed as follows" $et income = 7epreciation and amorti6ation > $et income plus depreciation <),!9),999,999 1,9.-,999,999 <,,!59,999,999 < -,,),,999,999 0!,,95,999,9991 0,8,,999,9991 <2,))2,999,999

(or @ome 7epot, this is a poor estimate of cash flow from operations. /ince @ome 7epot is growing rapidly, changes in the balances of the current operating asset and current operating liability accounts are si6able. The %net income plus depreciation& definition of cash flow ignores changes in current operating assets and current operating liabilities. .. @ome 7epots 299) %operating cash flow& is computed as follows" Cash flow from operations = Cash paid for interest = Cash paid for ta+es > #perating cash flow Total assets <!),)!.,999,999 9.1, > <,,1-,,,,9,999 /o, for @ome 7epot, %operating cash flow& is in e+cess of 1,K of total assets. < -,,),,999,999 .9,999,999 2,9!.,999,999 <5,-,2,999,999

Chapter - 4 !!

5.

'n its financial summary, @ome 7epot includes a section called %/tatement of Cash (lows 7ata.& @owever, only three items are listed" depreciation and amorti6ation, capital e+penditures, and cash dividends per share.

Ethic! Dile a/ I! the Price Right6 This is an ethical dilemma without a neat and tidy solution. 't seems clear that you cannot give the presentation to the investment ban ers. Gour analysis strongly suggests that the earnings numbers have been manipulated, so you cannot in good conscience present the proposal to the investment ban ers without voicing your concerns. Gou should notify the board of directors immediately, so that they can have sufficient time to find someone else to ma e the presentation. Gou should offer to brief the new presenter on the results of your analysis. ;efore rendering a harsh Eudgment against the board for engaging in earnings manipulation, reali6e that earnings numbers in an '2# serve much the same purpose as advertising does in the selling of cars. ?veryone nows that the numbers have been puffed up and beautified as much as possible. The investment ban ers, if they are e+perienced, will loo at all of the financial statement numbers with healthy s epticism. The De7ate/ N% One Can Un&er!tan& the In&irect Meth%&88 /ome of the arguments that might be used are listed below. 7irect Jethod *nyone can understand items such as %cash collected from customers& or %cash paid for inventory purchases.& The direct method gives e+actly the type of information that financial statement users e+pect when they view the statement of cash flowsMline by line details of how cash was generated and consumed. The indirect method ma es the statement of cash flows seem too comple+. 'n fact, conceptually the statement of cash flows is the simplest of the financial statements. The direct method gives simple, straightforward information. 'ndirect Jethod The indirect method is very important because it highlights the adEustments that are made to transform raw cash flow data into net income. These adEustments are the essence of accrual accounting. /ophisticated financial statement users have long e+perience with the indirect method. They dont want the direct method. The mar et has spo enL firms have a choice between the two methods and they have overwhelmingly chosen the indirect method. Cu ulati3e Sprea&!heet Pr%9ect 1. ;ecause of spreadsheet rounding, not all of the displayed totals reconcile e+actly. :AND;MAN Chapter -, 2art 1 /ales growth rate $ew 22? $ew long-term debt Cash dividends 3equired current ratio )9K < 59 < 9 < 9 2.9

Chapter - 4 !)

Gear 299;*D*$C? /@??T *ssets Cash 3eceivables 'nventory Total Current *ssets 2roperty, 2lant, C ?quipment *ccumulated 7epreciation Total *ssets Diabilities *ccounts 2ayable /hort-term Doans 2ayable Total Current Diabilities Dong-term 7ebt Total Diabilities /toc holders ?quity 2aid in Capital 3etained ?arnings 0as of 12H!11 Total Diab. and ?quities 3etained ?arnings 0as of 1H11 = $et 'ncome 4 7ividends 3etained ?arnings 0as of 12H!11 '$C#J? /T*T?J?$T /ales Cost of :oods /old :ross 2rofit 7epreciation ?+pense #ther #perating ?+penses #perating 'ncome 'nterest ?+pense 'ncome ;efore Ta+es 'ncome Ta+ ?+pense $et 'ncome .99 ,18 151 , 1,, 21 8 12 ) 5 19 2. 1,! 189 188 8 !59 .) 19 5) 29. 281 ,9 !8 !59 !1 5 9 !8

(orecasted 299. 1) !5 21) 2-2.8 1,28 19) 28 1!! 29. !)9 1!,! ,28 !8 1) 9 ,! natural )9K increase figure to ma e current ratio equal to 2.9 no new long-term debt natural )9K increase natural )9K increase natural )9K increase new 22? of <59 last year plus this years depreciation e+pense

balancing figure computed from net income and <9 dividends

859 .2. 2,! . 21. 28 8 29 . 1)

increase of )9K same percentage of sales as in prior year increase in proportion to increase in 22? same percentage of sales as in prior year same as last yearL no new long-term debt same percentage of pre-ta+ income as last year

Chapter - 4 !,

/T*T?J?$T #( C*/@ (D#B/ #perating *ctivities $et 'ncome 7epreciation Change in *H3 Change in 'nventory Change in *H2 Cash from operating activities 'nvesting *ctivities 2urchase of new 22? (inancing *ctivities $ew short-term loans payable $ew long-term debt $ew paid-in capital Cash dividends Cash from financing activities $et change in cash 2. a. :AND;MAN Chapter -, 2art 2a

1) . 411 4-1 !9 422 459 18 9 59 19) /ales growth rate $ew 22? $ew long-term debt Cash dividends 3equired current ratio Gear 299(orecasted 299. 1! !) 181 2!5 2.8 1,99 8! 2118 29. !22,K <59 <9 <9 2.9

;*D*$C? /@??T *ssets Cash 3eceivables 'nventory Total Current *ssets 2roperty, 2lant, C ?quipment *ccumulated 7epreciation Total *ssets Diabilities *ccounts 2ayable /hort-term Doans 2ayable Total Current Diabilities Dong-term 7ebt Total Diabilities

19 2. 1,! 189 188 8 !59 .) 19 5) 29. 281

Chapter - 4 !-

/toc holders ?quity 2aid in Capital 3etained ?arnings 0as of 12H!11 Total Diab. and ?quities 3etained ?arnings 0as of 1H11 = $et 'ncome 4 7ividends 3etained ?arnings 0as of 12H!11 '$C#J? /T*T?J?$T /ales Cost of :oods /old :ross 2rofit 7epreciation ?+pense #ther #perating ?+penses #perating 'ncome 'nterest ?+pense 'ncome ;efore Ta+es 'ncome Ta+ ?+pense $et 'ncome /T*T?J?$T #( C*/@ (D#B/ #perating *ctivities $et 'ncome 7epreciation Change in *H3 Change in 'nventory Change in *H2 Cash from operating activities 'nvesting *ctivities 2urchase of new 22? (inancing *ctivities $ew short-term loans payable $ew long-term debt $ew paid-in capital Cash dividends Cash from financing activities $et change in cash

,9 !8 !59 !1 5 9 !8

12, ,9 ,99 !8 11 9 ,9

.99 ,18 151 , 1,, 21 8 12 ) 5

5., -)8 22. 18) 2, 8 1, 11

11 . 4. 4!5 18 45 459 19 ., 9 81 !

Chapter - 4 !.

b. :AND;MAN Chapter -, 2art 2b

/ales growth rate $ew 22? $ew long-term debt Cash dividends 3equired current ratio Gear 299(orecasted 299. 1, )1 2!9 25, 2.8 1,)5 111 !2 1)! 29. !,9 1)) ,) ,)5 !8 1, 9 ,)

,9K <59 <9 <9 2.9

;*D*$C? /@??T *ssets Cash 3eceivables 'nventory Total Current *ssets 2roperty, 2lant, C ?quipment *ccumulated 7epreciation Total *ssets Diabilities *ccounts 2ayable /hort-term Doans 2ayable Total Current Diabilities Dong-term 7ebt Total Diabilities /toc holders ?quity 2aid in Capital 3etained ?arnings 0as of 12H!11 Total Diab. and ?quities 3etained ?arnings 0as of 1H11 = $et 'ncome 4 7ividends 3etained ?arnings 0as of 12H!11 '$C#J? /T*T?J?$T /ales Cost of :oods /old :ross 2rofit 7epreciation ?+pense #ther #perating ?+penses #perating 'ncome 'nterest ?+pense 'ncome ;efore Ta+es 'ncome Ta+ ?+pense $et 'ncome

19 2. 1,! 189 188 8 !59 .) 19 5) 29. 281 ,9 !8 !59 !1 5 9 !8

.99 ,18 151 , 1,, 21 8 12 ) 5

1,9,9 ..8 2.2 . 2!! !2 8 2! 5 1,

Chapter - 4 !5

/T*T?J?$T #( C*/@ (D#B/ #perating *ctivities $et 'ncome 7epreciation Change in *H3 Change in 'nventory Change in *H2 Cash from operating activities 'nvesting *ctivities 2urchase of new 22? (inancing *ctivities $ew short-term loans payable $ew long-term debt $ew paid-in capital Cash dividends Cash from financing activities $et change in cash !. :rowth 3ate 2,K )9K ,9K

1, . 41) 4.. !. 4!1 459 22 9 8) 9 11, (orecasted Cash from #perating *ctivities 4<5 422 4!1

The faster that @andyman grows, the worse becomes its cash from operating activities. This is because the growth requires increases in accounts receivable and inventory and the increases in these current assets reduce the amount of cash generated by operating activities. Internet Search/ http/<<444=c%.e=c% 1. The name %Coca-Cola& was created by (ran J. 3obinson, partner and boo eeper for 7r. Nohn 2emberton, the inventor of the drin itself. Jr. 3obinson also penned the words in the unique script that is still Coca-Colas trademar . 2. !. Noseph Bhitehead and ;enEamin Thomas paid <1 in 1588 for the e+clusive rights to bottle CocaCola. 'n addition to Coca-Cola, other Coca-Cola soft drin brand names in /outh *frica are" ;iboMa ids drin in such flavors as apple, pineapple, raspberry, lemon, and orange JiloMa chocolate malt drin /parletta IidsMflavors include 2ine$ut and /parberry. 'n the press release announcing its quarterly earnings for the first quarter in 299) 0released *pril 21, 299)1, Coca-Cola said that cash from operations for the quarter nearly doubled to <1.2 billion and that it e+pects strong cash flows to continue in the future. 7uring the years 2991 through 299!, Coca-Cola spent over <2.) billion to repurchase shares of its own stoc M<2.. million in 2991, <-81 million in 2992, and <1,))9 million in 299!.

).

,.

Chapter - 4 !8

;%u Be the Anal>!t8 EBITDA? Operating Ca!h Fl%4? an& In3e!ting Ca!h Fl%4 The data for this solution were gathered on Nune ), 299). #f course, solutions will differ depending on when this e+ercise is completed. 1. (or the year ended 7ecember !1, 299! 0or thereabouts1, here are the ?;'T7* and operating cash flow numbers for the si+ companies. *ll numbers are in millions. $ame 0tic er symbol1 Jc7onalds 0JC71 /afeway 0/BG1 7u2ont 0771 /ears 0/1 :eneral Jotors 0:J1 @ome 7epot 0@71 ?;'T7* <!,5)1,))) 2,9-) .,!., 25,92, .,851 #perating Cash (low <!,2-8 1,-19 2,,58 2,,2) .,-99 -,,),

2. 'n many cases, ?;'T7* is a reasonable estimate of operating cash flow. @owever, there are many cases 0such as /ears and :eneral Jotors in 011 above1 where the appro+imation is very bad indeed. The use of ?;'T7* gained favor before 1855 when the reporting of the statement of cash flows was required. (inancial statement users still use this traditional estimate of operating cash flow when they could instead be using the operating cash flow number from the statement of cash flows itself. !. (or the year ended 7ecember !1, 299! 0or thereabouts1, here are the operating cash flow and investing cash flow numbers for the si+ companies. *ll numbers are in millions, and the investing cash flow numbers represent cash outflows. $ame 0tic er symbol1 Jc7onalds 0JC71 /afeway 0/BG1 7u2ont 0771 /ears 0/1 :eneral Jotors 0:J1 @ome 7epot 0@71 #perating Cash (low <!,2-8 1,-19 2,,58 2,,2) .,-99 -,,), 'nvesting Cash (low <1,!.9 .8, !,!., 8),,,)82 !,88-

). (or 299!, Jc7onalds, /afeway, /ears, and @ome 7epot were all cash cows with cash flow generated by operating activities e+ceeding the amount of cash flow needed for investing activities. The cash flow numbers reflect the fact that 2992 and 299! were tough years for 7u2ont because the company consistently was a cash cow up until those years. The :eneral Jotors cash flow statement is substantially complicated by the combination, in one set of financial statements, of the automotive manufacturing operations and the financial services of :J*C. Te!t ;%ur Intuiti%n The FASB specifies that a companys cash flows are to be summarized under three headings: operating activities investing activities and financing activities! Can you thin" of any alternatives to this three#way classification scheme$ The international financial statement e+ercise at the end of this chapter illustrates the format of a cash flow statement used in the Anited Iingdom 0:la+o/mithIline plc1. That cash flow statement has nine

Chapter - 4 )9

categoriesMthe si+ e+tras include one for cash paid for income ta+es 0domestic and foreign1 and one for interest and dividends received and paid. Bith such a large fraction of business being done overseas, another way to categori6e cash flow is by the currency of the cashMcash flows in A./. dollars, in Napanese yen, and so forth. This type of categori6ation would help users evaluate a companys e+posure to foreign currency ris . 'n addition, cash flows can also be categori6ed by line of business. (or e+ample, the revenue of 2epsiCo is split between snac foods and soft drin s. 't would be useful to see how each of these business segments generates and uses cash. %hy is depreciation ignored when the direct method is used but added to cash from operations when the indirect method is used$ 3emember that depreciation is a non-cash item, so the obEective is to eliminate it in the computation of cash from operations. Bhen the direct method is used, the computation starts from 6ero, with amounts being added for cash collected and subtracted for cash paid. 'n this framewor , depreciation is ignored, since it doesnt involve cash. Bhen the indirect method is used, the computation starts with net income. 7epreciation has already been subtracted in the computation of net income. Therefore, to eliminate the effect of depreciation, it must be added bac to net income in the computation of cash from operations. Bu!ine!! C%nte1t 6=#/ Di!agree ent! 4ithin the FASB 1. *rguments in favor of classifying interest paid as cash outflow from operating activities" 0a1 @istorically, interest paid has been considered an operating cash flow. 0b1 'nterest paid is considered an e+pense in computing net incomeL whereas dividends paid are not. There is strong support among accountants for maintaining a strong functional relationship between net income and cash flow from operating e+penses. 0c1 *lthough both interest and dividends paid can be thought of as costs of obtaining financing, they obviously differ in many respects. 'nterest paid is ta+-deductibleL dividends paid are not. 2ayment of interest is a contractual obligationL payment of dividends is not. 'n formulating /tatement $o. 8,, the (*/; ac nowledged the merit of classifying interest paid as a cash outflow from financing activities. @owever, the ;oards conclusion is summari6ed as follows" %The ;oard therefore was not convinced that changing the prevalent practice in classifying interest X paid would not necessarily result in a more meaningful presentation of cash flows. This /tatement does, however, require that the amount of interest paid during a period X be disclosed, which will permit users of financial statements who wish to consider interest paid as a financing cash outflow to do so.& 2. The following items might be useful in deciding whether to require the direct method" 0a1 The degree to which companies use the direct method in their statements of cash flow. ?vidence thus far indicates that firms overwhelmingly are choosing the indirect method over the direct method. 'f this were to continue, it could be ta en as evidence that the demand from users for the incremental information provided by the direct method is not sufficient to induce firms to provide that information. 0b1 Costs of implementing the direct method. *fter some years of use, it should be possible to better quantify the costs borne by firms in gathering the data necessary to use the direct method.

Chapter - 4 )1

0c1 Ase by financial analysts. * study of reports produced by financial analysts can reveal the e+tent to which the community of sophisticated users are interested in the information provided by the direct method. 'f there is no evidence that analysts are doing e+tra research to appro+imate the direct method cash flow disclosures for firms that do not provide them, this again can be ta en as an indication that mar et demand for the direct method may not be great enough to Eustify requiring it. Data Mining 6=#/ Di++erence! 7et4een Inc% e an& Ca!h +r% Operati%n! 1. (or many companies, cash from operations is greater than net income because depreciation e+pense is subtracted in computing net income but is a non-cash e+pense. ;oth :eneral ?lectric and ';J report large amounts of depreciation e+pense, so they both have a large difference between net income and cash from operations. 2. *s shown in ?+hibit --) in the te+t, the negative operating cash flow that is typical of a start-up company must be made up for through increased cash inflow from financing activities such as borrowing or issuance of stoc . *ma6on.com must have been borrowing money or issuing stoc during these start-up years. (irst of all, financial institutions report very little depreciation e+pense and, as discussed in 011, depreciation is frequently the item that causes the biggest e+cess of cash flow over net income. 'n addition, the operations of financial institutions include management of large investment portfolios. (or financial institutions, buying and selling securities is considered an operating activity. Thus, in a period when a financial institution spends cash to increase its investment portfolio significantly, the financial institution may very well report negative cash from operating activities.

!.

Data Mining 6=)/ A erican an& Briti!h Operating Ca!h Fl%4 1. ?++on Cash from operations 0A./. definition1 /ales Cash from operations H /ales 2. *ltria 19,5151,5!2 1!.2K Jobil 25,)85 2!.,9,) 12.9K 7iageo 1,528,))9 18.!K ;2 *moco 1-,-89 2!-,9), ..1K

The ;ritish definition of %cash from operations& e+cludes from the computation of cash from operating activities items that are not operating items at all, but relate primarily to the payment of interest and ta+es. These are usually thought of as non-operating items. /o, it loo s li e the ;ritish have developed a better measure for operating cash flow than that used by the *mericans.

5e7 Search/ http/<<444=+a!7=%rg *s of Nuly 1, 299!, the seven members of the (inancial *ccounting /tandards ;oard were" 3obert @er6, Chairman :eorge N. ;atavic :. Jichael Crooch :ary /. /chieneman Iatherine /chipper Deslie (. /eidman ?dward B. Trott

Chapter - 4 )2

;efore Eoining the (*/;, 7r. Iatherine /chipper was a professor of accounting at 7u e Aniversity.

Chapter - 4 )!