lOMoARcPSD|18311070 03 ISM Bergeron 7e - Finance for non-financial managers chapter 3 learning exercises Finance (Orta Doğu Teknik Üniversitesi) StuDocu is not sponsored or endorsed by any college or university Downloaded by Zorbek Kazim (gkakha@mail.ru) lOMoARcPSD|18311070 Chapter 3 Statement of Cash Flows REVIEW QUESTIONS 1. Why is it important for managers to analyze changes in the flow of cash between two consecutive accounting periods? Managers should have an appreciation about where cash will be required (investing activities) and where it will come from (operating activities and financing activities). 2. Differentiate between cash inflows and cash outflows. Cash inflows are obtained from different sources (e.g., loans, selling assets). Cash outflows are disbursed or expended for buying or paying something (e.g., paying a mortgage, buying a car). 3. What are internal sources of financing? Internal sources of financing are cash that will be generated by managers (operating activities) in order to buy non-current assets (investing activities). The two main sources of internal financing are profit for the year and depreciation. Working capital can also be a source of cash if managers are able to reduce inventories and trade receivables, and increase their trade and other payables, and borrowings. 4. What are external sources of financing? External sources of financing are cash that will be obtained from investors (financing activities) such as shareholders and long-term lenders in order to purchase noncurrent assets (investing activities). 5. Identify some of the key cash inflows and cash outflows. Cash inflows include profit for the year, the sale of a non-current asset, the sale of investment securities, and obtaining a new loan or new equity. Cash outflows take place when there is a loss from operations, the purchase of a non-current asset, the purchase of investment securities, and the payment of a loan. 6. Why is depreciation/amortization considered a cash inflow? Depreciation/amortization is not a cash expense. It is considered an accounting entry. Since it is not considered a cash expense like salaries or advertising, it is added back to profit for the year. © 2014 by Nelson Education Ltd. Downloaded by Zorbek Kazim (gkakha@mail.ru) lOMoARcPSD|18311070 3-2 Chapter 3 Statement of Cash Flows 7. Why are working capital accounts part of the operating activities shown on the statement of cash flows? Managers are responsible for working capital accounts such as trade receivables and inventories. These accounts are also called operating capital. If managers mismanage the current asset accounts and show increases between two accounting periods in these accounts, the business has to borrow funds (if internal cash is not sufficient) from short-term lenders. These short-term borrowings are commonly called working capital or operating loans. 8. Comment on the key guidelines that can be used to identify whether a change in the accounts shown on a statement of financial position between two consecutive accounting periods is a cash inflow or a cash outflow. A cash inflow takes place when there is a decrease in an asset account or an increase in a liability or equity account. A cash outflow takes place when there is an increase in an asset account or a decrease in a liability or equity account. 9. Identify the basic structure of the statement of cash flows. The statement of cash flows contains four sections: operating activities, financing activities, investing activities, and the change in the cash balance. 10. What is the purpose of the statement of adjustments in non-cash working capital accounts? The statement of adjustments in non-cash working capital accounts shows the cash flows provided (or used) by working capital accounts such as trade receivables, inventories, and trade and other payables. 11. Comment on the important accounts usually shown under the operating activities section in the statement of cash flows. They are profit for the year and depreciation/amortization. However, working capital can also be a source of cash if managers are able to reduce inventories, trade receivables, and increase their trade and other payables, and short-term borrowings. 12. What financial statements are used to prepare the statement of cash flows? They are the statement of income, the statement of changes in equity, and the statement of financial position. The statement of income provides the profit for the year and the depreciation/amortization expense. The statement of changes in equity provides the dividends paid and other infusion of cash provided by the shareholders. Two consecutive statements of financial position provide the increase or decrease of the asset, equity, and liability accounts. © 2014 by Nelson Education Ltd. Downloaded by Zorbek Kazim (gkakha@mail.ru) lOMoARcPSD|18311070 Chapter 3 Statement of Cash Flows 3-3 13. What important accounts are usually shown under the financing activities section in the statement of cash flows? They are the funds provided by shareholders and long-term lenders. However, this section can also show a cash outflow such as the payment of dividends and of a mortgage or bond. 14. Comment on the important accounts usually shown under the investing activities section in the statement of cash flows. They are the purchase of non-current assets (i.e., land, buildings, equipment) and acquisition of another business. The section can also show cash inflow if a business sells one of its non-current assets. 15. How does the statement of cash flows complement the statement of income and the statement of financial position? The statement of income is like a movie in that it shows the amount of revenue earned and expenses incurred between two dates or during a given time period. The statement of financial position, like a snapshot, gives a picture of what a business owns, and what the business owes to creditors and to the owner(s) at a given point in time. These two financial statements have a specific purpose, giving important information about the financial performance and financial condition of a business. However, they do not show the funds flow or cash flows that take place between two consecutive accounting periods; this is precisely what the statement of cash flows does. 16. How can managers use the statement of cash flows to make important business decisions? This statement is a critical decision-making instrument since it tells managers who want to invest cash in plant, property, and equipment (investing activities) if enough funds will be generated from operations, and if there is not enough, how much will have to be raised from external sources (shareholders and long-term lenders). If managers are not able to raise the required amount of funds from these sources, they will have to eliminate some of the projects listed in their capital budget. 17. How does the statement of cash flows prepared for not-for-profit organizations differ from that prepared for profit-motivated businesses? They don’t differ since both types of organizations present in their statement cash flows under three activities: operating, investing and financing. Sometimes, the notfor-profit organizations will combine the sources and uses of cash under one grouping: cash flows from financing and investing activities. Also, the terms used by each organization vary somewhat: the for-profit organization will refer to profit for the year while the not-for-profit organization will call it excess of revenue over © 2014 by Nelson Education Ltd. Downloaded by Zorbek Kazim (gkakha@mail.ru) lOMoARcPSD|18311070 3-4 Chapter 3 Statement of Cash Flows expenses. The not-for-profit organizations will also include accounts specific to the nature of their mandate such as contributions for cash endowments. 18. Give a few examples of accounts shown in the two main sections of the statement of cash flows for a not-for-profit organization. Operating activities list accounts such as excess of revenue over expenses, amortization of capital assets, and net change in non-cash working capital accounts. In the second main section, investing activities list accounts such as the purchase of assets, and financing activities list accounts such as long-term borrowings and contributions from cash endowments. © 2014 by Nelson Education Ltd. Downloaded by Zorbek Kazim (gkakha@mail.ru) lOMoARcPSD|18311070 Chapter 3 Statement of Cash Flows 3-5 LEARNING EXERCISES EXERCISE 1: SOURCES OF CASH FLOWS Identify, under the appropriate heading, whether the following changes are an inflow of cash or an outflow of cash. What amounts and percentages were used by internal and external sources to finance the purchase of the assets? House Trailer Furniture Mortgage RRSP Loan made to a friend Car loan Visa The Bay Cash in the bank Marketable securities Total House Trailer Furniture Mortgage RRSP Loan made to a friend Car loan Visa The Bay Cash in the bank Marketable securities Total This Year 134,600 12,000 5,600 75,000 23,000 ---12,000 1,250 ---3,000 12,000 Last Year 130,000 ---4,000 60,000 20,000 5,000 8,000 600 450 2,000 10,000 In $ Cash Cash Inflows Outflows ---4,600 ---12,000 ---1,600 15,000 ------3,000 5,000 ---4,000 ---650 ------450 ---1,000 ---2,000 24,650 24,650 This Year 134,600 12,000 5,600 75,000 23,000 ---12,000 1,250 ---3,000 12,000 Last Year 130,000 ---4,000 60,000 20,000 5,000 8,000 600 450 2,000 10,000 In % Cash Cash Inflows Outflows ---18.7 ---48.7 ---6.5 60.9 ------12.2 20.3 ---16.2 ---2.6 -----1.8 ---4.0 ---8.1 100.0 100.0 Note: Salary in excess of expenses is not a statement of cash flows account. © 2014 by Nelson Education Ltd. Downloaded by Zorbek Kazim (gkakha@mail.ru) lOMoARcPSD|18311070 3-6 Chapter 3 Statement of Cash Flows EXERCISE 2: IDENTIFYING CASH INFLOWS AND CASH OUTFLOWS From Vicky Subbarao’s statements of financial position shown below, identify whether each account is an outflow of cash or an inflow of cash. In % This Year Last Year Assets House Cottage Land Car Computers Savings bonds RRSP Cash Total assets 145,000 65,000 ---12,000 7,500 5,000 20,000 2,000 256,500 136,000 ---40,000 6,000 3,000 4,000 16,000 4,000 209,000 ------40,000 ------------2,000 Equity 105,000 92,000 13,000 Liabilities Mortgage Bank of Montreal Bank loan Visa Sears 112,000 21,000 14,000 1,500 3,000 99,000 11,000 3,000 2,000 2,000 13,000 10,000 11,000 ---1,000 ---------500 ---- Total liabilities 151,500 117,000 Total equity and liabilities Total cash inflows and outflows 256,500 209,000 90,000 90,000 © 2014 by Nelson Education Ltd. Downloaded by Zorbek Kazim (gkakha@mail.ru) Cash Inflows Cash Outflows 9,000 65,000 6,000 4,500 1,000 4,000 ---- lOMoARcPSD|18311070 Chapter 3 Statement of Cash Flows 3-7 EXERCISE 3: MATCHING ACCOUNTS TO BUSINESS ACTIVITIES Indicate under which activity (operating, financing, investing) the following accounts belong in the statement of cash flows: Activity Trade receivables Land Mortgage payable Profit for the year Trade and other payables Depreciation/amortization Inventories Prepaid expenses Share capital (common) Buildings Accrued expenses Current taxes payable Equipment Long-term borrowings Purchase of a company Dividends Share capital (preferred) EXERCISE operating investing financing operating operating operating operating operating financing investing operating operating investing financing investing financing financing 4: WORKING CAPITAL ACCOUNTS For the following accounts, identify the working capital accounts and prepare the adjustments in non-cash working capital accounts statement. (in $) Cash inflows Trade and other payables Short-term borrowings Total inflows 50,000 48,000 98,000 Cash outflows Trade receivables Inventories Prepaid expenses Revolving loan Accrued expenses Total outflows Adjustments in non-cash working capital accounts (20,000) (60,000) (10,000) (10,000) (10,000) (110,000) ( 12,000) © 2014 by Nelson Education Ltd. Downloaded by Zorbek Kazim (gkakha@mail.ru) lOMoARcPSD|18311070 3-8 Chapter 3 Statement of Cash Flows EXERCISE 5: THE ADJUSTMENTS IN NON-CASH WORKING CAPITAL ACCOUNTS AND THE STATEMENT OF CASH FLOWS With the following financial statements, prepare • the adjustments in non-cash working capital accounts statement, and • the statement of cash flows. 1. the adjustments in non-cash working capital accounts statement (in $) Cash Inflows Trade and other payables Short-term borrowings Total outflows 22,000 20,000 42,000 Cash Outflows Trade receivables Inventories Accrued expenses (50,000) (70,000) ( 6,000) Total inflows Adjustments in non-cash working capital accounts (126,000) (84,000) 2. the statement of cash flows (in $) Operating activities Profit for the year Depreciation Adjustments in non-cash working capital accounts Total Financing activities Long-term borrowings Dividends Total 90,000 35,000 (84,000) 41,000 78,000 (70,000) 8,000 Investing activities Property, plant and equipment Decrease in cash Cash at the beginning of the year Cash at the end of the year © 2014 by Nelson Education Ltd. Downloaded by Zorbek Kazim (gkakha@mail.ru) (50,000) 1,000 4,000 3,000 lOMoARcPSD|18311070 Chapter 3 Statement of Cash Flows 3-9 EXERCISE 6: THE STATEMENT OF CASH FLOWS Use the following accounts to prepare a statement of cash flows for a not-for-profit organization: The statement of cash flows for a not-for for profit organization is as follows: Cash provided by (used for): Operating activities Excess of revenue over expenses Depreciation/amortization Adjustments in non-cash working capital accounts Cash provided from operating activities $35,000 10,000 (5,000) $ 40,000 Investing activities Purchase equipment (110,000) Financing activities Long-term borrowings Contributions from cash endowments Purchase of investments Cash provided from financing activities Net decrease (increase) in cash Cash, beginning of year Cash, end of year 50,000 50,000 (20,000) 80,000 (10,000) 20,000 30,000 © 2014 by Nelson Education Ltd. Downloaded by Zorbek Kazim (gkakha@mail.ru) lOMoARcPSD|18311070 3-10 Chapter 3 Statement of Cash Flows CASES CASE 1: AUSTIN INDUSTRIES INC. Questions Prepare the following statements: 1. The adjustments in non-cash working capital accounts statement for 2013 In $ Cash Inflows Term deposits Trade and other payables Other current liabilities Total cash inflows Cash Outflows Trade receivables Inventories Notes payable Total cash outflows 11,000 3,000 8,000 22,000 (8,000) (22,000) (12,000) (42,000) Adjustments in non-cash working capital accounts (20,000) 2. The statement of cash flows for 2013 In $ Operating activities Profit for the year Depreciation/amortization Adjustments in non-cash working capital accounts Total Financing activities Dividends Share capital Long-term borrowings Total Investing activities Property, plant, and equipment Decrease in cash Cash at beginning of year Cash at end of year © 2014 by Nelson Education Ltd. Downloaded by Zorbek Kazim (gkakha@mail.ru) 38,000 15,000 (20,000) 33,000 (10,000) 26,000 18,000 34,000 (75,000) 8,000 15,000 7,000 lOMoARcPSD|18311070 Chapter 3 Statement of Cash Flows 3-11 CASE 2: GRANT ELECTRONICS INC. Questions 1. Use the above information to prepare a. the adjustments in non-cash working capital accounts for the year 2012, and Grant Electronics Inc. Adjustments in Non-Cash Working Capital Accounts For the year ended 2012 (in $000s) Cash inflows Trade and other payables Short-term borrowings Taxes payable Total cash inflows 200 400 100 Cash outflows Trade receivables Inventories Total cash outflows (700) (800) Adjustments in non-cash working capital accounts 700 (1,500) (800) © 2014 by Nelson Education Ltd. Downloaded by Zorbek Kazim (gkakha@mail.ru) lOMoARcPSD|18311070 3-12 Chapter 3 Statement of Cash Flows b. the statement of cash flows for the year 2012. Grant Electronics Inc. Statement of Cash Flows For the year ended 2012 (in $000s) Operating activities Profit for the year Depreciation/amortization Adjustment in non-cash working capital accounts Net cash from operating activities Financing activities Long-term borrowings Dividends Share capital Net cash from financing activities 4,182 1,300 (800) 4,682 1,200 ( 600) 500 1,100 Investing activities Property, plant, and equipment Increase in cash Cash at beginning of year Cash at end of year (5,600) (182) 600 782 Note: The profit for the year in the amount of $4,182,000 is calculated by multiplying the projected $102.0 million revenue by the projected return on revenue objective of 4.1%. 2. Can the company raise more than half the cash from internally generated funds (as mentioned by the CEO) to finance the capital budget proposal? The internally generated cash amounts to $4,682 thousand, which is substantially higher than half of the capital budget proposal. Internally generated cash flows amount to 83.6% of the total funding. © 2014 by Nelson Education Ltd. Downloaded by Zorbek Kazim (gkakha@mail.ru)
