cash flow

p.214

financial performance: reflects the operations of an entity over time (aka revenue and expenses)

financial viability: the entity's ability to meet its debts as they come due, which depends in major part on how cash in the business is managed and how it flows through the business

p.214

things such amounts on deposit in bank accounts, US govenment obligations, time deposits, overnight securities, and other short term highly liquid securities with original maturities of three months of less

p.215 

what kinds of things can the statement of cash flow help you assess about the entity?

• it's ability to generate positive cash in the future
• it's ability to pay its debts as they come due
• it's ability to pay dividends
• it's ability to obtain financing
• entity's overall business and financial condition from the affects of investing and financing activities
• understand the differences in net income and cash flow

p.215

1. operating

2. investing

3. financing

p.215

it is classified to the category constituting the main activity (NOT divided among categories)

p.215

transactions arising in connection with the daily operation of the business in the ordinary course

(aka activities that generate items of revenue and expense)

What kind of activity (operating, investing, financing) are each of the following: 

1. making sales to customers

2. paying suppliers and employees

3. research and development costs

4. taxes?

all are operating costs

p.215-216

What kind of activity (operating, investing, financing) are the following:

1. reciept of dividends

2. payment of interest ?

GAAP classifies both of these as operating cash flows, even though they could have been put elsewhere.

Could have been investing or financing activities, but FASB has demed them too closely connected with revenues and expenses.

p.216

transactions arising in connection with the purchase and sale of items for purposes of generating returns not directly related to the daily operations of the business in the ordinary course

p.216

what kind of activity (operating, investing, financing) are the below:

1. purchase and sale of marketable securities

2. investments in other entities

3. loans made to other entities ?

these are all investing activities

p.216

what kind of activity (operating, investing, financing) are the below:

1. purchase and sale of fixed assets, such as property, plant, and equipment

FASB declares these as investments. Although used in the ordinary course of operating the business, the impact on revenue and expense are sufficiently attenuated.

p.216

transactions in which the entity borrows money (and all transactions in which it repays the borrowings).

p.216

what kind of activity (operating, investing, financing) are the below:

1. borrowings from banks and other lenders

2. the issuance of common stock and other equity securities

3. debt securities ?

these are all financing activities.

p.216

this is a financing activity.  this is because (1) the payment of dividends is not an expense so it is not an operating activity, (2) it is a reutn to shareholders on their investment, which from the entity's point of view is a source of funding and therefore financing activity

p.216

the direct method reports each account in which a change in cash occurred during the period.  all journal entries during the peiord are reviewed and each entry that affected the cash account is allocated to one of the three categories of activies (operating, investing, financing).

p.217

the indirect method's starting point is the net income during the period, and then identifies the types of transactions that would impact net income in a way that differs from the impact of those transactions on cash flows.  financing and investing activies are recorded more directly reported in which a change in cash occurred during the period.

p.217

1. the accural system -- the effects on net income is without regard to when cash in repsect of those activities is paid or received.
2. inventory accounting -- there is a mismatch in any one period between cash expended to create the asset and the COGS recognized as an expense to burden net income.
3. depreciation -- this allocation burdens net income in those period even while no cash is actually spent in resprect of the fixed asset in those period.

p.218-9

the effect of depreciation or amortization expense is to cause net income to be lower than net cash flows.  hence, the amount of those expenses is added to the net income figure on the way toward calculating the net cash flow figure.

p.221

which method was used to prepare and present this statement of cash flow?

cash flow from operating activities

     Collections from customers                             9,600

     Payments to employees                               (3,000)

Net cash provided by operating activities     6,600

cash flow from investing activities                          

None                                                                        0

cash flow from financing activities                 

None                                                                        0

NET INCREASE IN CASH                             6,600

which method was used to prepare and present this statement of cash flow?

cash flow from operating activities

     Net income                                                   5,850

8/31   9/30

1200   2500     (increase) in acct. receivable      (1,300)

1000   1250     (increase) in inventory                 (250)

1000   800       decrease in prepaid insur.              200

750    1700      increase in expense payable          950

50       100       increase in interest payable            50

100    1400      increase in accts. payable            1,300

200       0        (decrease) in deferred income        (200)

net cash provided by operating activities    6,600

cash flow from investing activities                          

None                                                                        0

cash flow from financing activities                 

None                                                                        0

NET INCREASE IN CASH                             6,600

if accts receivable increased, that means more people owe the entity money.  the income will have shown an increase because of the sale, but no cash actually came in, so you would decrease the net income.

p.222

a decrease in inventory means that the entity sold more inventory than it produced/purchased.  when an entity sells inventory, the COGS does not involve the disbursement of cash. so you have to add back to the net income that amount of expense to come up with the net cash flow number.

p.222

an increase in accounts payable means that the entity still has moeny in its pocket.  the effect of an increase in accounts payable is to reduce net income but without involving the disbursement of an equivalent amount of cash. as a result, the net income must be increased by this amount to compute net cash flow.

p.222

Please fill in the blanks with raise/reduce and add/subtract

Reconciling Net Income to Net Cash Flow

                                                                                 Effect on           Reconciliation to

                                                                        Net Income         compute net cash flow

1. depreciation expense                                  _________                     _________
2. other non-cash charges to income                 ________                      _________
3. increase in assets                                       _________                     _________
4. decrease in assets                                      _________                     _________
5. increase in liabilities                                   _________                     _________
6. decreases in liabilities                                 _________                     _________

p.223 Table 9-4

Reconciling Net Income to Net Cash Flow

                                                                                 Effect on           Reconciliation to

                                                                        Net Income         compute net cash flow

1. depreciation expense                                  (reduces)                     add back
2. other non-cash charges to income                (reduces)                     add back
3. increase in assets                                       raises                     (subtract out)
4. decrease in assets                                      (reduces)                     add back
5. increase in liabilities                                   raises                           add back
6. decreases in liabilities                                 (reduces)                (subtract out)

FASB encourages the direct method.  Some reasons FASB may find the direct method more desirable than the indirect method are as follows:

1. more nearly reflects real-world events such as receipt of cash from customers and the payment of cash to suppliers, employees, and others;
2. the classification of cash flows is not available or revealed by the indirect method;
3. evident lack of congruency between the balance sheet line items and the cash flow statement figures (aka "non-articulation")
4. example: a company that recently acquires another company having used different depreciation conventions, which must be adjusted in the indirect but not in the direct method.

p.224-25