1. The income statement reports revenues earned and expenses incurred during a period of time. It is prepared on an accrual basis. The balance sheet reports the assets, liabilities, and equity of a business at a point in time. The statement of cash flows reports cash receipts and cash payments of a business, from three broad categories of business activities: operating, investing, and financing.
2. The statement of cash flows reports cash receipts and cash payments from three broad categories of business activities: operating, investing, and financing. While the income statement reports operating activities, it reports them on the accrual basis: revenues when earned, and expenses when incurred, regardless of the timing of the cash received or paid. The statement of cash flows reports the cash flows arising from operating activities. The balance sheet reports assets, liabilities, and equity at a point in time. The statement of cash flows and related schedules indirectly report changes in the balance sheet by reporting operating, investing, and financing activities during a period of time, which caused changes in the balance sheet from one period to the next. In this way, the statement of cash flows reports information to link together the financial statements from one period to the next, by explaining the changes in cash and other balance sheet accounts, while summarizing the information into operating, investing, and financing activities.
4. The major categories of business activities reported on the statement of cash flows are operating, investing, and financing activities. Operating activities of a business arise from the production and sale of goods and/or services. Investing activities arise from acquiring and disposing of property, plant, and equipment and investments. Financing activities arise from transactions with investors and creditors.
5. Cash inflows from operating activities include cash sales, collections on accounts, and notes receivable arising from sales, dividends on investments, and interest on loans to others and investments. Cash outflows from operating activities include payments to suppliers and employees, and payments for operating expenses, taxes, and interest.
6. Depreciation expense is added to net income to adjust for the effects of a noncash expense that was deducted in determining net income. It does not involve an inflow of cash.
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10. Cash inflows from investing activities include cash received from sale of operational assets, sale of investments, maturity value of bond investments, and principal collections on notes receivable. Cash outflows from investing activities include cash payments to purchase property, plant, and equipment and investments, and to make loans.
11. Cash inflows from financing activities include cash received from issuing stock, the sale of treasury stock, and borrowings. Cash outflows from financing activities include cash payments for dividends, the purchase of treasury stock, and principal payments on borrowing.
EXERCISES
E13 –6.
Cash flows from operating activities —indirect method
Net income .............................................................................................. $7,625
Depreciation expense ..............................................................................
Accounts receivable increase ($12,500 – $10,000) ................................
Inventory decrease ($8,000 – $15,000) ..................................................
Salaries payable increase ($1,750
– $800) ............................................
8,500
(2,500 )
7,000
950
Net cash provided by operating activities ........................................... $21,575
E13 –8.
Req. 1
Cash flows from operating activities —indirect method
Net loss ................................................................................................... ($98,819 )
Depreciation and amortization ................................................................
Increase in receivables ...........................................................................
Decrease in accrued interest ..................................................................
259,380
(18,161 )
Increase in accounts payable .................................................................
Decrease in accrued payroll and benefits ...............................................
Increase in other liabilities ......................................................................
571
(3,236 )
53,030
Cash flows from operating activities .................................................. $174,558
Note: The increase in long-term debt and additions to equipment do not affect cash flows from operating activities.
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E13-8. (continued)
Req. 2
The primary reason for the net loss was the depreciation and amortization expense.
These represent non-cash expenses. Large depreciation and amortization expense, offset partially by increased working capital requirements, turned Time Warner’s net loss into positive operating cash flow. The reasons for the difference between net income and cash flow from operations are important because they help the financial analyst to determine if the trends are sustainable or whether they represent one-time events.
E13
–15.
DIVE IN COMPANY
Statement of Cash Flows
For the Year Ended December 31, 2008
Cash flows from operating activities:
Net income .....................................................................
Adjustments to reconcile net income to net cash
provided by operating activities:
Increase in accounts receivable ....................................
Increase in prepaids .....................................................
Decrease in wages payable ...........................................
Net cash provided by (used for) operating activities ..
Cash flows from Investing activities:
Cash paid for equipment
Net cash provided by (used for) investing activities ..
Cash flows from financing activities:
Cash proceeds from issuing stock ..................................
Net cash provided by financing activities ....................
Net increase (decrease) in cash during the year ...................
Cash balance, January 1, 2008 ............................................
Cash balance, December 31, 2008.......................................
$ 300
(300 )
(300
200
200
(800 )
4,000
$3,200
(200 )
(50 )
(750 )
(700 )
)
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P13 –1.
Req.1
Related Cash
Flow Section
Δ in Cash
O
Balance sheet at December 31
2011
Cash
Accounts receivable
$68,250
15,250
$65,500
22,250
2010 Change
+2,750
-7,000
10
3
Net increase in cash
Add to net income the decrease in A/R
O
I
O
Merchandise inventory 22,250 18,000 +4,250 4 Subtract from net income the increase in Inventory
Property and equipment 209,250 150,000 +59,250 7 Payment in cash for equipment
Less: Accumulated depreciation
(59,000) (45,750) -13,250 2
Add to NI because depreciation expense does not affect cash
O
O
F
F
O,F
$256,000 $210,000
Accounts payable $9,000 $19,000 -10,000 5
Subtract from net income the decrease in Accounts
Payable
6 Add to net income the increase in Wages payable Wages payable 4,000 1,200 +2,800
Note payable, long-term 59,500 71,000 -11,500 8 Cash used for repayment of note principal
Contributed capital
Retained earnings
98,500
85,000
65,900
52,900
+32,600
+32,100
9
1
Issuance of stock for cash
Increased for net income amount of $46,750
Decreased for dividends declared & paid $14,650
$256,000 $210,000
Income statement for 2011
Sales $195,000
Cost of goods sold
Depreciation expense
Other expenses
92,000
13,250
43,000
Net Income $46,750
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P13-1 (continued)
MetroVideo Inc.
Statement of Cash Flows
For the Year Ended December 31, 2011
Cash flows from operating activities:
Net income $46,750 1
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation expense
Decrease in accounts receivable
Increase in merchandise inventory
Decrease in accounts payable
Increase in wages payable
$13,250 2
7,000 3
(4,250)
(10,000)
2,800
4
5
6 8,800
Net cash provided by operating activities
Cash flows from investing activities:
Cash payments to purchase fixed assets
Cash flows from financing activities:
Cash payments on long-term note
Cash payments for dividends
Cash receipts from issuing stock
(11,500) 8
(14,650) 1
32,600 9
55,550
(59,250) 7
Net cash provided by financing activities
Net increase in cash during the year
Cash balance, January 1, 2011
Cash balance, December 31, 2011
Req. 2
6,450
2,750 10
65,500
$68,250
An overall increase in cash of $2,750 came from inflows of $55,550 from operating activities and a stock issuance of $32,600. A large percentage of the cash inflows were invested in equipment ($59,250), with $11,500 used to pay down long-term financing and $14,650 for dividends.
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P13 –3.
Req.1
Related Cash
Flow Section
Δ in Cash
Balance sheet at December 31
Cash
2011
$68,250
2010
$65,500
Change
+2,750
10 Net increase in cash
O
O
Accounts receivable
Merchandise inventory
15,250 22,250
22,250 18,000
-7,000 3 Add to sales to compute collections from customers
+4,250 4 Add to CGS to compute payments to suppliers
I
O
Property and equipment 209,250 150,000 +59,250 7 Payment in cash for equipment
Less: Accumulated depreciation
(59,000) (45,750) -13,250 2 Depreciation expense does not affect cash
$256,000 $210,000
O
O
F
F
O,F
Accounts payable $9,000 $19,000 -10,000 5 Add to CGS to compute payments to suppliers
Wages payable 4,000 1,200 +2,800 6
Subtract from Other expenses to compute Payments for wages
Note payable, long-term 59,500 71,000 -11,500 8 Cash used for repayment of note principal
Contributed capital
Retained earnings
98,500 65,900 +32,600 9 Issuance of stock for cash
85,000 52,900 +32,100 1
Increased for net income amount of $46,750
Decreased for dividends declared & paid $14,650
$256,000 $210,000
Income statement for 2011
Sales
Cost of goods sold
Depreciation expense
Other expenses
Net Income
$195,000
92,000
13,250
43,000
$46,750
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P13-3 (continued)
MetroVideo Inc.
Statement of Cash Flows
For the Year Ended December 31, 2011
Cash flows from operating activities:
Collections from customers ($195,000 +
$7,000)
Payments to suppliers ($92,000 + $4,250
+ $10,000)
Payments for wages ($43,000
– $2,800)
$202,000 3
(106,250)
(40,200)
4, 5
6
Net cash provided by operating activities
Cash flows from investing activities:
Cash payments to purchase fixed assets
Cash flows from financing activities:
Cash payments on long-term note
Cash payments for dividends
Cash receipts from issuing stock
(11,500) 8
(14,650) 1
32,600 9
55,550
(59,250) 7
Net cash provided by financing activities
Net increase in cash during the year
Cash balance, January 1, 2011
Cash balance, December 31, 2011
Req. 2
6,450
2,750 10
65,500
$68,250
An overall increase in cash of $2,750 came from a positive inflow of $55,550 from operating activities and a stock issuance of $32,600. A large percentage of the cash inflow was invested in equipment ($59,250), with $11,500 used to pay down long-term financing and $14,650 for dividends.
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ANNUAL REPORT CASES
CP13 –3.
Req. 1
American Eagle
Outfitters
Urban Outfitters
Quality of = Cash flow from operations $749,268 = 1.93 $187,117 = 1.61 income ratio Net income 387,359 116,206
American Eagle Outfitters has a higher, and therefore better, quality of income ratio than does Urban Outfitters.
Req. 2
Industry
Average
American Eagle
Outfitters
Urban Outfitters
Quality of Income = 1.62 1.93 1.61
Urban Outfitte rs’ quality of income ratio is more or less equal to the industry average, while American Eagle has a higher than average (and therefore better) quality of income ratio.
Req. 3
American Eagle
Outfitters
Urban Outfitters
Capital acquisitions ratio
= Cash flow from operations $749,268 = 3.32 $187,117 = 0.88
Cash Paid for Plant &
Equipment
225,939 212,029
American Eagle Outfitters has a higher capital acquisitions ratio than does Urban
Outfitters. This implies that American Eagle Outfitters has a greater ability to fund additional capital expenditures from the cash flow provided by its operating activities.
Req. 4
Industry American Eagle Urban Outfitters
Average Outfitters
Capital Acquisitions = 2.42 3.32 0.88
American Eagle O utfitters’ capital acquisitions ratio is higher and Urban Outfitters’ is lower than the industry average. This implies their relative ability to fund additional capital expenditures from the cash flow provided by their operating activities compared to the average company in the industry.
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