Cash-Flow Statements » What’s Behind Cash-Flow Statements » Basics » Exercises
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cs.wbn.bas.060 Determining non-operating effects on working capital accounts (P&G)
Use the following excerpts to interpret Procter and Gamble’s (P&G) statements.
2006
Amounts in millions
2005
6,389
4,232
Net earnings
8,684
6,923
Depreciation and amortization
2,627
1,884
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR
OPERATING ACTIVITIES
585
524
Deferred income taxes
(112)
564
Change in accounts receivable
Share-based compensation expense
(524)
(86)
Change in inventories
383
(644)
Change in accounts payable, accrued and other liabilities
230
(101)
(508)
(498)
10
113
11,375
8,679
Change in other operating assets and liabilities
Other
TOTAL OPERATING ACTIVITIES
P&G’s 2006 Annual Report, page 45
Amounts in millions
2006
2005
Inventories
Materials and supplies
Work in process
Finished goods
1,537
623
4,131
1,424
350
3,232
Total inventories
6,291
5,006
P&G’s 2006 Annual Report, page 42
Required
(a) True or False: Based on the excerpt from the cash-flow statement, P&G’s inventories
increased $383 in 2006 due to operating entries.
False: Inventories decreased due to operating entries. The adjustment is associated
with an asset so the sign of the adjustment is the opposite of the change on the balance
sheet. P&G’s inventory adjustment is positive, so the balance-sheet effect is negative.
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(b) True or False: Based on the excerpt of the cash-flow statement, it is reasonable to
assume that inventories changed by $383 from 2005 to 2006 on P&G’s balance
sheets.
False: It is not reasonable to assume the cash flow adjustment is the same as the
change in the related balance sheet account. Generally, this will not be true for large
companies. If P&G acquires another company during the year, most of P&G’s assets
and liabilities will increase because of the acquisition. If the acquired company had
$20 of inventories on the date of the acquisition, P&G would transfer the inventories
to its balance sheet. But this $20 increase is classified as an investing activity, not an
operating activity.
Thus, the change in P&G inventories for the year would be partly attributable to
operating activities (such as selling products) and partly attributable to non-operating
activities (e.g., acquiring other companies). The inventories adjustment in the operating section of P&G’s statement of cash flows would only pertain to the change in
inventories associated with operating activities. By contrast, the change in inventories
on the balance sheet would reflect all activities.
(c) Based on the excerpt of inventories, as reported on P&G’s balance sheet, estimate
the net effect of non-operating entries on total inventories.
P&G’s balance sheet excerpt for fiscal 2005 and fiscal 2006 reports a $1,285 increase in
inventories during fiscal 2006 (from $5,006 to $6,291). However, the operating section
of P&G’s fiscal 2006 statement of cash flows shows a positive $383 “change in inventories” reconciliation adjustment. This means P&G’s inventories decreased by $383
during fiscal 2006 because of operating entries (since the asset-related adjustment is
the negative of the balance sheet effect).
The total change in inventories from the balance sheet is $1,285 and the change associated with operating events is negative $383, so we can determine the change due to
non-operating events to be $1,668:
$1,285 total change = -$383 operating change + $1,668 non-operating change
In fact, most of the increase in inventories related to non-operating events is likely due
to P&G’s acquisition of Gillette, which was recorded during fiscal 2006. The figure on
the next page demonstrates the possibility that changes in assets (such as inventories
and receivables) and liabilities (such as accounts payable) can be partly attributable
to non-operating events (such as business acquisitions). This template can help you
visualize the P&G inventories example. This may help you better understand how to
interpret balance sheets, cash flow reconciliations, and how they are related.
© 1991-2012 NavAcc LLC, G. Peter & Carolyn R. Wilson
income to permanent
owners’ equity
Ending balances
EXERCISE
+
=
+
+
+
3
Other
Assets
Beginning balances
The change in an asset due to operating
Operating
events
events is the negative of the related
The total change in an asset is
reconciliation adjustment.
determined by subtracting the
beginning balance reported on
The change in an asset due to
non-operating events only can be derived.
Non-operating
events
the balance sheet from the
ending balance.
Ending balances
P&G
Inventories
June 30, 2005
$5,006
P&G reports a positive $383 inventories
Operating
events
-$383
reconciliation adjustment for fiscal 2006.
This corresponds to a $383 increase in
inventories because of operating events.
Inventories increased by $1,668 during
Non-operating
events
$1,668
June 30, 2006
$6,291
fiscal 2006 because of non-operating
events: $1,668 = $1,285 - (-$383).
P&G’s balance sheet reports
beginning and ending inventories
of $5,006 and $6,291 for fiscal
2006.
Thus, the total change in P&G’s
inventories for fiscal 2006 is
$1,285 = $6,291 - $5,006.
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© 1991-2012 NavAcc LLC, G. Peter & Carolyn R. Wilson