CHAPTER CASH FLOW ANALYSIS Expected. ‘Learning Outcomes After studying Chapter 7, you should be able to: . I. Understand the usefulness of the statement of cash flows as far as decision making is concemed. Know the classifications of the cash flow activities. Identify the various sources and applications of cash according to the firm’s a) Operating activities b) Financing activities ¢c) Investing activities Be familiar with the content and form of the Statement of Cash Flows. _ Calculate cash flow from operating activities using the a) Direct method b} Indirect method O04CHAPTER 7 CASH FLOw ANALYSIS INTRODUCTION Clearly, income statements and statements of financi: common financial documents available to the Public. But financial decisions may find themselves at something of a | these two documents ( loss if they only have {reports on past Performance) on Which to base their decisions for today and into the future, al position are the most statements following Reporting Standards (IFRS) principles. IFRS Procedures require that the firm ize revenue at the time of sale, but sometimes the company receives the cash before or after the time of sale. Likewise, IFRS counsels the firm to show Production and other expenses on the statement of financial position as the sales of those B00ds take place. So Production and other expenses associated with a Particular product's sale only appear on the income statement (for, example, cost of goods sold and depreciation) when that product sells. Of Course, just as with the fevenue recognition, actual cash outflows incurred with Production may occur at a very different point in time usually much earlier than IFRS allow the firm to formally recognize the expenses, In addition, income statements Contain several noncash entries, the largest of which is depreciation. Depreciation attempts to capture the noncash expense incurred as fixed assets deteriorate from the time of purchase to the Point when those assets must be replaced. Let’s illustrate the effect of depreciation: Suppose a firm Purchases a machine for P100,000. The machine has an expected life of five years and at the end of those five years, the machine will have no expected salvage- value. The firm lays out a P100,000 cash outflow at the time entire P100, i flow occurred at the time of purchase and it totaled P100;000 rather than 20,000. Figures therefore132__ Chapter 7 shown on an income statement may not represent the ‘actual cash inflows ang outflows for a firm during a particular period. 1 ever, are far more interested in actual cash flows than they are in the somewhat artificial, backward-looking accounting profit listed on the income statement. This is very important distinction between the accounting and finance point of view. Finance professionals know that the firm needs cash, not accounting profit, to pay the firm’s obligations as they come due, to fund the firm’s operations and growth, and to compensate the firm’s ultimate ‘owners (its shareholders). ‘Thus, the statement of cash flows is a financial statement that shows the firm’s cash flows over a given period of time. This statement reports the amounts of cash that the firm generated and distributed during a particular time period. The bottom line on the statement of cash flows (the difference between cash sources and uses) equals the change in cash on the firm’s statement of financial position from the previous year's cash account balance. That is, the statement of cash flows reconciles income statement if of financial position items to show changes in the cash and marketable securities account on the statement of financial position over the particular analysis period, Financial managers and investors, hows USEFULNESS OF THE ST/ -ATEMENT OF CASH FLOWS “Happiness is a positive cash flow” is certainly true. Although net income provides a long-term measure of a company’s success OF failure, cash is its lifeblood. Witheat cash, a company will not survive. For small and newly developing companies, cash flow is the single most important element for survival. Even medium and large companies must control cash flow. Creditors examine the cash flow statement carefully because they are concerned about being paid. They begin their examination by finding net cash provided by operating activities. A high amount indicates that a company is able to generate sufficient cash from operations to pay its bills without further borrowing. Conversely, a low.or negative amount of net cash provided by operating activities indicates that a company may have to borrow or issue equity securities to acquire sufficient cash to pay its bills. Consequently, creditors look for answers to the following questions in the company’s cash flow statements: 1. Is the company generating sufficient positive cash flows from its ongoing operations to remain variable? 2. Will the company be able to meet its financial obligations to creditors? 3. What expansion activities took place and how were those financed? items and noncash statement ,Cash Flow Analysis 133 4. Will the company be able to i ivi ¢ Pay its customary dividend? 7 why os cash decrease even though a net income ‘was reported? . To what extent will the company have to borrow money in order to make needed investments? 7. What happened to the proceeds received from the issuance of capital One should recognize that companies can fail even though they report net income The difference between net income and net cash provided by tivities pre operating acti Analysts increasingly use cash-flow-b; provided by operations instead of or i change is that they question the accru: ased measures of income, such as cash flow in addition to net income. The reason for the al-accounting-based net income numbers, Sadly, these days even cash flow from operations isn’t always what it seems tobe. For example, in 2005 WorldCom Inc. (USA) disclosed that it had imy capitalized expenses. It moved $3.8 billion of cash outflows from the “cash from operating activities” section of the cash flow statement to the “investing activities” section, thereby greatly enhancing cash provided by “operating activities”, Similarly, in 2009 Pier 1 Imports (USA) restated its cash flow statements for 2008 and 2007. The problem? Pier 1 had improperly classified as an operating.cash flow some payments received on the sale of receivables. Those payments should have been reported in the investing section. The restatement Tesulted in a $164 million, or 64% decline in operating cash flow in 2008 and a $51 million or 47% decline in 2007. The primary purpose of a cash flow statement is to provide relevant information about a company’s cash receipts and cash payments during an accounting period that is useful in evaluating the preceding items. In this regard, the PAS 7 states that the information in a statement of cash flows, if used with information in the other financial statements, should help users to assess and evaluate: 1. acompany’s ability to generate Positive future net cash flows, 2. acompany’s ability to’meet its obligations and pay dividends, 3. a company’s need for external financing, 4 the reasons for differences between a company’s net income and associated cash receipts and payments, and134 Chapter 7 5. both the cash and noncash aspects of a company’s financing and investing transactions during the accounting period. The following information may also be obtained from the cash flow statement: 1. the changes in net assets of an enterprise of an enterprise and its ability to affect the amounts and timing of cash flows in order to adopt to changing circumstances and opportunities, 2. the ability of the enterprise to generate cash and cash equivalents and enables the users to develop models to assess and compare the present value of the future cash flows of different enterprises, and 3. _itenhances the comparability of the reporting of operating performance by different enterprises because it eliminates the effects of using different accounting treatments for the same transactions and events. In addition, the statement of cash flows provide the means of measuring a business firm’s a) Financial liquidity — which refers to the “measures to cash” “of assets and liabilities. b) Financial flexibility — which refers to a company’s ability to respond and adapt to financial adversity and unexpected needs and opportunities. FINANCIAL LIQUIDITY Readers of financial statements often assess liquidity by using the current cash debt coverage ratio. It indicates whether the company can pay off its current liabilities from its operations in a given year. The formula for this ratio is: Net Cash Provided by Operating Activities _ __Current Cash Average Current Liabilities Debt Coverage Ratio The higher the current cash debt coverage ratio, the less likely a company will have liquidity problems. For example, a ratio near 1:11 is good, it indicates that the company can meet all of its current obligations from internally generated cash flow.Cash Flow Analysis 138 FINANCIAL FLEXIBILITY The avant pany Provides information on financial flexibility. It in nae ante vibe’ Tepay its liabilities from net cash provided by operati foe fe aout having to liquidate the assets employed in i operations. Notice its similarity to the current cash debt coverage ratio. However, because it uses average total liabilities in place of average current liabilities, it takes a somewhat longer-range view. The formula for this ratio is: ‘ Net Cash Provided by Operati Activities Cash Debt Average Total Liabi = Ss Coverage Ratio The higher this Tatio, the less likely the company will experience difficulty in meeting its obligations as they come due. It signals whether the company can pay its debts and survive if external sources of funds become limited or too expensive. Free Cash Flow so ‘ABC Company Free Cash Flow Analysis Net cash provided by operating activities x Capital expenditures (x) Dividends (xx) Free cash flow Px | Figure 7-1. Free cash flow computation If the free cash flow is positive, the business firm could have satisfactory financial flexibility. Companies that have strong financial flexibility can 1. take advantage of profitable investment even in tough terms, and 2. be free from worry about survival in poor economic terms.136_ Chapter 7 ‘THE BASIC APPROACH TO A CASH FLOW STATEMENT DEFINITION OF CASH In preparing a statement of cash flows, the term cash is broadly defined to include both cash and cash equivalents. Cash equivalents consist of short-term, highly liquid investments such as treasury bills, SEC registered commercial papers and money market funds. Such investments are made solely for the purpose of generating a return on funds that are temporarily idle. Instead of simply holding cash, most companies invest their excess cash reserves in these types of interest-bearing assets that can be easily converted into cash, . CLASSIFICATION OF CASH FLOW ACTIVITIES OPERATING ACTIVITIES The amount of cash flows arising from operating activities isa key indicator of the extent to which the operations of the enterprise have generated sufficient cash flows to repay loans, maintain the operating capability of the enterprise, pay dividends and make new investments without recourse to external sources of financing. Information about the specific components of historical operating cash flows is useful, in conjunction with other information, in forecasting future operating cash flows. Operating activities include delivering or producing goods for sale and providing services; and the cash effects of transactions and other events that enter into the determination of income. Examples are: Inflows Sales of goods Revenue from services Returns on interest earnings assets (interest) Returns on equity securities (dividends) Receipts from contracts held for dealing and trading purposes Tax refunds unless identified with financing and investing activities—_ ‘Sel: Cash Flow Analysis 137 Outflows Payments for Purchases of inventories Payments for Operating expenses (salaries, rent, insurance, etc.) Payments for Purchases from Suppliers other than m inventor Payments for lenders (interest) . Payments for taxes unless ident; le: 7 5 ame activities ss identified with financial and investing INVESTING ACTIVITIES The separate disclosure of cash flows arising from investing activities is important because the cash flows represent the extent to which expenditures have been made for resources, intended to generate future income and cash flows. Investing activities include acquiring and selling, or otherwise disposing of (a) securities that are not cash equivalents and (b) productive assets that are expected to benefit the firm for long periods of time; and lending money and collecting on loans. Examples are: Inflows Sales of long-lived assets such as property, plant and equipment, intangibles and other long-term assets. Sales of debt or equity securities of other entities Collection of loans (principal) to others (other than advances and loans made by a financial institution) Outflows Acquisitions of long-lived assets such as property, plant and equipment, intangibles and other long-term assets Purchases of debt or equity securities of other entities Loans (principal) to others (other than advances and loans made by a financial institution)138 Chapter 7 Ee FINANCING ACTIVITIES The separate disclosure of cash flows arising from financing activities is important because it is useful in predicting claims on future cash flows by providers of capital to the enterprise. Financing activities include borrowing from creditors and repaying the principal; and obtaining resources from owners and providing them with a return on the investment. Examples are: Inflows Proceeds from borrowing (short-term and long-term) Proceeds from issuing the firm’s own equity securities Outflows Repayment of debt principal Repurchase of a firm’s own shares Payment of dividends Acquisition of the enterprise's own shares CONTENT AND FORM OF THE STATEMENT OF CASH FLOWS A statement of cash flows (SCF) for a period shall report the following: A. Net Cash |. Provided or used by operating activities 2. Provided or used by investing activities i 3. Provided or used by financing activities B. Net effect of those flows on cash and cash equivalents during the period in a manner that reconciles the beginning and ending cash and cash equivalents. Noncash investing and financing activities affecting the financial position shall be excluded from a cash flow statement. Such transactions should be disclosed elsewhere in the financial statements (c.g., notes to financial statements). : Figure 7-2 illustrates the Statement of Cash Flows.= Cash Flow Analysis 139 Sa SSE $$ Statement of Cash Flows For Year Ended December 31, 20X5 Cash Flows From Operating Activities. Net income Add (Deduct) Adjustments for differences between net a income and cash flows from operating activities: Depreciation expense 7 8,000 Increase in salaries payable “800 Increase in accounts payable 2.600 Increase in accounts receivable (7,000) Net cash provided by operating activities P_ 18,400 Cash Flows From Investing Activities Payment for purchase of building P (30,000) Payment for purchase of equipment ( 4,000) Proceeds from sale of land, at cost 10,000 Net cash used for investing activities (24,000) Cash Flows From Financing Activities Proceeds from issuance of ordinary shares P 18,000 Proceeds from issuance of bonds 12,000 Payment of dividends ( 9,000) Payment of note payable (13,000) Net cash provided by financing activities - 8,000 Net Increase in Cash P 2400 Cash balance, January 1, 20X5 —10,900 Cash batance, December 31, 20X5 P13.300 Investing and Financing Activities Not Affecting Cash: Issuance of ordinary shares for land Pe je Acquisition of land by issuance of ordinary shares . Figure 7-2. Illustrative Statement of Cash Flows140 _ Chapter 7 4 cea CALCULATING CASH FLOW FROM OPERATING ACTIVITIES Direct METHOD In reporting the cash flows from operating activities enterprises are encouraged to teport major classes of gross cash receipts and gross cash payments and the net cash flow from operating activities. At minimum, the following classes of operating cash receipts and payments should be separately reported: 1. Cash collected from customers, including lessees, licensees and the like Interest, fees, royalties and-dividends received _ Other operating cash receipts, ifany |. Cash paid to employees and other suppliers of goods or services Interest paid Income taxes paid Other operating payments, if any Contracts held for dealing or trading purposes em ar een Figure 7-3 shows the procedures/ adjustments to convert Income . Statement Amount to Operating Cash Flows (Direct Method). INDIRECT METHOD Enterprises that choose not to provide the major classes of operating cash receipts and payments by the direct method shall determine and report the same amount of net cash flow from operating activities indirectly by adjusting net income to reconcile it to net cash flow from operating activities. Regardless of whether the direct and indirect method of reporting net cash flow from operating activities is used, the reconciliation of net income to net cash flow from operating activities shall be presented. Figure 7-4 presents the procedures/adjustments to convert Net Income to Net Cash Flow from Operating Activities (Indirect Method). ;———- Cash Fi is income ash Flow Analysis _141. ‘Statement ‘Accounts: ‘Adjustments ath lows rom net Operating iS + Decrease in accounts receivable oF Operating Activities Cash Flows so * ‘in accounts receivabt een + Increase in deferred revenue or = Collections from ~ Decrease in deferred revenue ‘customers Interest ( + Decrease in interest receival reverie: = Increase in interest cone 4 + Amortization of premium on ir a bonds Premium on investment in Interest and | cash tnflows dividend et : = dividends From revenue imortization of discount on investment in collected eee + Increase in unearned reven other ~ Decrease in uneamed revenues 7 revenues = Gains on disposals of assets and labities [ = receipts — Investment income (equity method) Cost of + Increase in inventory or goads = Decrease in inventory = a Se + Decrease in accounts payable or eee — Increase in accounts payable Depreciation, depletion and amortization Selling and ‘expense administrativ < + Decrease in accrued expenses or Payments of e — Increase in accrued expenses = operating expenses + Increase in prepaid expenses or expenses \& Decrease in prepaid expenses Cash Outflows. For Operating Interest = Payments of a expense interest. Other - Losses on depos fase and ais) (Other operating, expenses { ~ Investment loss (equity method) payments + Decrease in Income toses payee of = Increase in income taxes paya Payments of moore, ax {Decrease In deferred income taxes payabl” = income taxes or = Increase in'deferred income taxes payable’ Figure 7-3. Adjustme! Operating ts to nts to Convert Income Statement Amount Cash Flows (DIRECT METHOD)142 Chapter 7 Net Income after Taxes Plus Decreases in current assets (except cash, marketable securities and non-trade accounts) - Increases in current liabilties (except financing or non-operating accounts, ‘e.g, bank loan, current maturities of long-term debt) ’ Depreciation, depletion, and amortization expense ‘Amortization of discount on bonds payable Amortization of premium on investment in bonds Increase in deferred income taxes Loss (net) on disposal of assets or liabilities ‘Subsidiary ass under the equity method Interest expense * Income taxes * Minus Increases in current assets (except cash, marketable securities, and non-trade_ accounts) Decreases in current liabllties (except financing or non-operating accounts, e.g., bank loan, current maturities of long-term debt) ‘Amortization of premium on bonds payable ‘Amortization of discount on investment in bonds Decrease in deferred income taxes Gain (net) on disposal of assets or liabilities Subsidiary gain under the equity method Equals Interest paid Income taxes paid Net Cash from Operating Activities * Shown separately Figure 7-4. Adjustments to Convert Net Income to Net Cash Flow from Operating Activities (INDIRECT METHOD)Fo Cash Flow Analysis 143 —___Cash Flow Analysis 143 Illustrative Case 7-1. Worksheet Preparation (Indirect Method) The condensed financial information of the Kalikasan Cor fc is | 0XS is sh below for the preparation of the Statement of Cash Tlowe (Indies Meee after completing the worksheet. ee lerised Financial Information Prepare the Statement of Cash Flows ‘Statement of Financial Position Information Balances Accounts aS eS Osh : P 3,500 P 5,500 ‘Accounts receivable 4400 3'600 Inventory 5,000 6,600 Land 8,200 12,200 Buildings and equipment 35,700 48,700 Accumulated depreciation (6.000) (8.700) otal Asoets: 250,800 67,200 ‘Accounts payable P 5,100 P 3,200 Salaries payable 1,400 1,800 Bonds payable, 10% 7,000 15,000 Ordinary shares, P10 par 8,000 9,000 ‘Additional paid-in capital 16,000 19,000 Retained earnings 13,300 19,900 Total Liabilities and Equity £50,800 P67,900 Income Statement Information for 20X5 Sales revenue P 80,000 Cost of goods sold — 48,600 Gross profit p P 31,400 oe Depretat P 3,400 preciation expense 5 ‘Other expenses 15,200 12,300, Operating income z P 12,100 Other revenues and expenses: cay Gain on sale of equipment Jreoresh capesse’ Pi 00 Income before income taxes - Income tax expense nl Net Income ’ B8,400 Retained Earnings Information for 20X5 Beginning retained earings . F ey ‘Add: Net income P 21,700 Less: Dividends Ending retained earings Pu2a144 Chapter? for 20X5 ‘Supplementary Information purchased for cash at a cost of P15,200. payable with a face value of 1P9,000 were issued for 8,000 at the end of the the tsiance of 100 ordinary shares of P10 share. / value of P1,500 was sold for 2,100 cash. (a) Equipment was (b) Ten-year bonds par shares when the stock year. . (©) Land was acquired through was selling at a market price of P40 per @ Equipment with a cost of P2,200 and a book ‘The worksheet for the preparation of the statement of cash flows and the statement ‘of cash flows are presented below. Solution: Kalikasan Company KALIKASAN COMPANY Worksheet for Statement of Cash Flows For Year Ended December 31, 20X5 Balances Net Change/Worksheet Entries Account Titles Tan. 4, 20X5 | Dec. 34, 20X5|___ Debit Credit Debits Cash 3,500 5,500 | @ 2,000 ‘Noncash Accounts: ‘Accounts receivable 4,400 3,600 © 800 Inventory 5,000 6,600 (d) 1,600 Land 8,200 12,200 (2) 4,000 Buildings and equipment 35,700 48,700 | (9) 15,200] (k) 2,200 Totals [$6,800 76,600 Credits ‘Accumulated deprecation 6,000 700 | (k) 700} (b) 3,400 ‘Accounts payable 5,100 3,200 (e) 1,900 Salaries payable 1,400 1,800 (f) 400 Bonds payable 7,000 15,000 ¢ (hr) 8,000 Ordinary shares, P10 par 8,000 9,000 (1) 1,000 ‘Additional paid-in capital 16,000 19,000 (a) 3,000 Retained ergs 13,300 1900 | q) —_1,900| (@)__8400 jotals: 56,800 | 76,600 27,200 27,200 ‘Net Cash Flow from Operating Activities eo (@) 8,400 j} Depreciation 4 ato (bo) 3,400 Income tax expense 100 Decrease in accounts 3,600 payable © Increase In salaries payable La Less: Increase in inventory () 400 Decrease in accounts payable (d) 1,600 Gain on sale of equipment (e) 1,900 Interest expense (kK) 600 Income tax expense 100 3,600Cash Flow Analysis 145 Net Change/Worksheet Account Titles £ Gredit Cash Flow From Investing, Debit Payment for purchase of equipment Proceeds from sale of equipment 0 2 (@) 15,200 Cash Flows From Financing Activities un Proceeds from issuance of bonds (h) 8,000 Payment of dividends 7 0 1,800 Investing and Financing Activities Not Affecting Cash . Issuance of ordinary shares for land (1) 4,000 Acquisition of land by issuance of ordinary shares 7 (2) 4,000 Net Increase in Cash 2,000 Totals 27,100 27,100 } ——————————— KALIKASAN COMPANY ‘Statement of Cash Flows. For Year Ended December 31, 20X5 ‘Net Cash Flow From Operating Activities Net income before interest and taxes ‘Adjustments for differences between income flows and cash flows from operating activities: ‘Add: Depreciation expense Less: Increase in inventory Decrease in accounts payable Gain on sale of equipment Interest expense Income tax expense ‘Net cash provided by operations Cash Flows From Investing Activities Payment for purchase of equipment Proceeds from sale of equipment Net cash used for investing activities Cash Flows From Financing Activities Proceeds from issuance of bonds Payment of dividends Net cash provided by financing activities Net Increase in Cash (see Schedule'1) Cash balance, January 1, 20X5 Cash balance, December 31, 20X5 12,100 3,400 , 800 400 (1,600) (1,900) (600) (100) P (15,200) P 8,000 — 6.200 P 2,000 3.500 P5,500 Notes to Financial Statements: Investing and Financing Activites Not Affecting Cash Issuance of ordinary shares for land Acquisition of land by issuance of ordinary shares. 4,000 (4,000)146 Chapter 7 rating activities may be Under the direct method, the net cash flows from ope! presented as follows: Cash Flow From Operating Activities Cash Inflows Collections from customers (P80,000 + 800) 80,800 Cash Outflows ‘ yment ie 52,100 Payments to suppliers (P48,600 + P1,600 + P1,900) , Payment of other operating expenses (P19,300 - P3,400 - 400) 15,500 Payment of Interest expense Payment of income taxes expense 3,600 Total 71,900 Net Cash Flows from operating activities P 8,900 Alpha Company Cash Flow Statement i: For the Year Ended December 31, 20X4 7 Cash flows from operating activities Cash receipts from customers Pro _Cash paid to suppliers and employees ____— oa) Cash generated from operations 20x Interest paid (00) Income taxes paid boo) Net cash from operating activities Prox Cash flows from investing activities ‘Acquisition of subsidiary X, net of cash acquired P (100%) Purchase of property, plant and equipment (ox) Proceeds from sale of equipment 20K Interest received x Dividends received 0K Net cash used in investing activities (200%) Cash flows from financing activities Prox Proceeds from issuance of share capital Proceeds from long-term borrowings OK Payment of finance lease liabilities (0x) Dividends paid * 000%) Net cash used in financing activities 00) Net increase in cash and cash equivalents Pro Cash and cash equivalents at beginning of ee x Cash and cash equivalents at end of period Pox * This could also be shown as an operating cash flow. Figure 7-5. Illustrative Cash Flow Statement (Direct Method) under PAS 33 effective January 1, 20081. 2. What is 7 Cifference between net cash flow from operating activities, rom invest ivitic i st gotivitieg? ‘esting activities and net cash flow from financing 3. What are the free cash flows for a firm? What does it mean when a firm’s free cash flow is negative? Multiple Choice Questions Which of the following items is included in the adjustment of net income to obtain cash flow from operating activities? a. Depreciation expense for the period. b. The change in deferred taxes. © The amount by which equity income recognized exceeds cash received. . d.— Allof the above, Which statement is true for gains and losses from capital asset sales? a. They do not affect cash and are exchided from the statement of cash flows, b. They are included in cash flows from Operating activities. . They are included in cash flows from investing activities. d. They are included in cash flows from financing activities. Which of the following assets is included in the-adjustment of net income to obtain cash flow from operating activities? a. — Accounts receivable. b. Inventory. 7 c. Prepaid expenses. d. — Allof the above.a _ bility accounts is included in the ‘h flow from operating activities? 148 Chapter 7 4. Which of the following current lial adjustment of expenses to obtain cas a. Accounts payable. v b. Notes payable and current maturities of long-term debt. c. Accrued liabilities. d. Both (a) and (c). Items 5 to 8 are based on the following data: The following information is available for Ubbie’s Jewelry and Gift Store: Net income P5000 Depreciation expense oa fa 2,500 Increase in deferred tax liabilities 500 Decrease in cash 3,000 Increase in marketable securities 1,000 Decrease in accounts receivable 2,000 Increase in inventories 9,000 Decrease in accounts payable 5,000 Increase in accrued liabilities 1,000 Increase in property and equipment ‘ 14,000 Increase in short-term notes payable . 19,000 4,000 Decrease in long-term notes payable Use the indirect method to answer the questions. 5. What is net cash flow from operating activities? a. (3,000) b. P(1,000) c. P 5,000 4. P13,000 6. What is net cash flow from investing activities? a. P 14,000 b. P(14,000) c. P21,000 d. P(16,000)oe Cash Flow Analysis 149 What is ni i . What i neta flow from financing activities? r b. P(15,000) ©. 17,000 4. (14,000) What is the change in cash? a. (3,000) b. 3,000 c. 2,000 d. (2,000) Which of the following is an inflow of cash? a. Funds spent in normal business operations. b. The purchase of a new factory. c. The sale of the firm’s bond, d. The retirement of the firm’s bonds. Depreciation is a source of cash inflow because a. itis a tax-deductible noncash expense. b. it supplies cash for future asset purchases. ©. it isa tax-deductible cash expense. d. it is a taxable expense. Assuming a tax rate of 35%, depreciation expenses of P400,000 will a. reduce income by P140,000. b. reduce taxes by P140,000. c. reduce taxes by P400,000. d. have no effect on income or taxes, since depreciation is not a cash expense. A statement of cash flows allows a financial analyst to determine a. whether a cash dividend is affordable. b. how increases in asset accounts have been financed. c. whether long-term assets are being financed with long-term or short-term financing. d. all of the given choices.150 Chapter 7 13, Assuming a tax rate of 40%, the after-tax cost of a P200,000 dividend payment is a. 200,000. b. 70,000. _ c. P130,000. d. None of the above. The statement of cash flows does not include which of the following sections?* a. Cash flows from operating activities b. Cash flows from sales activities c. Cash flows from investing activities d. Cash flows from financing activiti Which of the following would represent a use of funds and, indirectly, a reduction in cash balances? 4 a. Anvincrease in inventories b. A decrease in marketable securities c. An increase in accounts payable d. The sale of new bonds by the firm A firm’s purchase of plant and equipment would be considered a a. _ use of cash for financing activities. b. use of cash for operating activities. c. source of cash for investment a d. use of cash for investment activities.Problems Problem 1 (Statement of Cash Flows) Luis Shop had cash flows from investing activiti from financing activities of P3,450,000. The ban eo and cash flows | . The balance in the firm’s h t was P950,000 at the beginning of 20x5 and P 1,025,000 at the end of the year rations for 20X5, Problem 2 (Free Cash Flow) You are. considering an investment in East Corporation and want to evaluate the firm’s free cash flow. From the income state of P17 million, and its depreciation expense was P5 million, Fixed assets increased by P32 million from 20X4 to 20X5. The firm’s current assets increased by P20 million and spontaneous current liabilities increased by P12 million. Calculate East Corporation’s operating cash flow, investment in operating capital and free cash flow for 20X5. Problem 3 (Free Cash Flow) Tiffany Corporation reported free cash flows for 20X5 of P23 million and investment in operating capital of P13 million. The firm listed P8 million in depreciation expense and P17 million in taxes on its 20X5 income statement. Calculate Tiffany Corporation’s 20X3 EBIT. 7 Problem 4 (Statement of Cash Flows) Janice Company has net cash- flow from financing activities for the last year of 20 million. The company paid P105 million in dividends last year. During the year, the change in notes payable (balance) was 23 million and the change in common and preferred stock was P0. The end year balance for long-term debt was P185 million. Calculate the begiming of year balance for long-term debt. ——____ Cath Flow Analysis 151152__Chapter 7 Problem 5 (Free Cash Flow) Gabrielle Corporation had free cash flow during 20X4 of P12 million. The change in gross fixed assets on Gabrielle’s statement of financial position during 20X4 was P10 million and the change in net operating working capital was P14 million. Using this information, fill in the blanks on Gabrielle’s income statement below. 7 GABRIELLE CORPORATION Income Statement for the Year Ending December 31, 20X4 (In millions of pesos) 2K Net sales bee Less: Cost of goods sold “15.6 Gross profits 31.5 Less: Depreciation 6.0 Eamings before interest and taxes (EBIT) Less: Interest Eamings before taxes (EBT) Less: Taxes (25%) Net incomeCash Flow Analysis 153 Problem 6 (Free Cash Flow) Mitch’s Petals Galore, of 110 million, tax e: Using this informatio position below. Inc. had free cash flow during 20X4 of P43 millic i ion, EBIT xpense of P25 million, and depreciation of P14 million. m, fill in the blanks on Mitch's statement of financial Mitch's Petals Galore, Inc. Statement of Financial Position as of December 31, 20X3 and 20K4 {in millions of pesos) 20X3 20X4 Assets Current assets: Cash and marketable securities P25 P28 Accounts receivable 65 5 Inventory 400 118 Total 190 221 Fixed assets: Gross plant and equipment 300 333 Less: Depreciation 40 _54 Net plant and equipment 260 279 Other long-term assets 50 50 Total 310 329 Total assets 500 2550 Liabilities and Equity Current liabilities: “ Accrued wages and taxes P15 P47 Accounts payable 50 Notes payable 5 —45 45 Total ; 110 ie Long-term debt: 190 Stockholders’ equity: 5 5 Preferred stock (5 million shares) Z Common stock and paid-in 0 40 surplus (20 million shares) 155 192 Retained eamings 0 37 Total Total iabilties and equity 500 e550154 Chapter 7 Problem 7 (Working with Financial Statements) Shown below are partial financial sta in the blanks on the four financial statements. Garcia's Health Care, Inc. Statement of Financial Position as (in millions of pesos) Assets Current assets: Cash and marketable securities Accounts receivable Inventory Total Fixed assets: Gross plant and equipment Less: Depreciation Net plant and equipment Other long-term assets Total Total assets Liabilities and Equity Current liabilities: ‘Accrued wages and taxes Accounts payable Notes payable Total Long-term debt: Stockholders’ equity: Pi “-erred stock (25 million shares) Common stock and paid-in surplus (200 million shares) Retained earnings Total Total liabilities and equity ‘of December 31, 20X4 and 20X5 tements for Garcia’s Health Care, Inc. Fill 20x4 - 20X5 P P_ 421 1,020 1,581 1,760 3,290 4,743 640 840 a 4,972 790 4,893 5,864 P7889 P 242 P 316 791 867 pera an 1,747 2,055 7 3,090 60 60 (ee 637 2,440 3,312 3,137 4,009 P7889 p9tsdToo Cash Flow Analysis 155 - ———Lath Flow Analysis 185. Garcia's He, Income Statement for Years End oa (inmiione went 20X4 and 20%5 20x4 Net sales 20X5 ‘ P P 4,980 Less: Cost of goods sold 2.135 2.135 Gross profits 2213 2,609 Less: Depreciation 494 200 Eamings before interest and taxes (EBIT) Ly 2,409 Less:. Interest 285 Earnings before taxes (EBT) 1,737 2,094 Less: Taxes P Net income 2.1327 Less: Preferred stock dividends P P__ 60 Net income available to common . stockholders 1,045 1,267 Less: Common stock dividends 395 395 Addition to retained eamings P P 872 Per (common) share data: Earnings per share (EPS) P Pp Dividends per share (DPS) P P Book value per share (BVPS) e P Market value (price) per share (MVPS) 22.500 26,850156 Chapter 7 Garcia's Health Care, Inc. Statement of Cash Flows for Year Ending December 31, 20X5 (in millions of pesos) A. Cash flows from operating activities Net income - Additions (sources of cash): Depreciation Increase accrued wages and taxes Increase in accounts payable ‘Subtractions (uses of cash): Increase in accounts receivable Increase in inventory Net cash flow from operating activities B, Cash flows from investing activities ‘Subtraction: Increase fixed assets Increase in other long-term assets Net cash flow from investing activities C. Cash flows from financing activities Additions: Increase in notes payable Increase in long-term debt Increase in common and preferred stock Subtractions: Pay dividends Net cash flow from financing activities D. Net change In cash and marketable securitiesaan hee ee —_____Cash Flow Analysis 156A Cash Flow Analysis 156A. Garcia's Health Care, Inc, Statement of Retained Eamings as of December 31 20X5 (in millions of, pesos) ‘ Balance of retained eamings, December 31, 20x4 - rt ‘0 Plus: Net income for 20X5, Less: Cash dividends paid Preferred stock > Common stock Total cash dividends paid Balance of retained eamings, December 31, 20X5 rt Problem 8 Listed below are the three broad types of activiti d ‘ ities that can either generate or use cash in any business, followed by descriptions of various items, a. Operating activities b. Investing activities Financing activities 2 Payment of dividends. Adjustment for deprecation, Purchase of merchandise inventory. Purchase of vehicles, Repayment of 90-day loans. Issuing capital stock. Payment of wages'to employees. Payment of taxes. Cash from sale of property and equipment. . Loans to other companies. Adjustments for changes in current asset and current liability items, Cash from selling investments in other companies. = TTT s156B Chapter 7 Problem 9 Presented below is Rose Company’s statement of cash flows for the year ended December 31, 20X5: Rose Company Statement of Cash Flows For the Year Ended December 31, 20X5 (in thousands) Cash Flows from Operating Activities: Net income P389 ‘Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities: Depreciation Expense P131 Increase in Accounts Receivable (287) Increase in Merchandise Inventory (104) Increase in Prepaid Expense (70) Decrease in Accounts Payable (304) Increase in Notes Payable 300 (334) | Net Cash Provided by Operating Activities P55 Cash Flows from Investing Activities: Purchase of Building (1,255) Purchase of Equipment (304) Net Cash Used by Investing Activities (1,559) Cash Flows from Financing Activities: Proceeds from Long-Term Loan P800 Proceeds from Sale of Common Stock 300 Payment of Cash Dividends 400) Net Cash Provided by Financing activities P1,000 7 | Pio Net Decrease in Cash During 20X5 P.(504) |— Cash Flow Analysis 156C Required: Respond to the following questions: a. For whieh of the three broad types of activities di ori of its cash during 20x57 'YPES of activities did Rose use the majority b. What does your answer to the reviou: Company? Pp 'S question tell you about Rose ce From which of the three broad types of activities did Rose obtain the majority of its cash during 20X5? d._ Is the activity you identified in the previous requirement an ay ropriate source of cash in the long unit? a a Explain your reasoning. Problem 10 Presented below is Henry Company’s statement of cash flows for the year ended December 31, 20X6: Henry Company Statement of Cash Flows For the Year Ended December 31, 20X6 {in thousands) Cash Flows from Operating Activities: Net income P1608 Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities: Depreciation Expense P218 Increase in Accounts Receivable (314) Increase in Merchandise Inventory 81 Increase in Prepaid Expense (100) Decrease in Accounts Payable 104 Increase in Notes Payable 50 12 Net Cash Provided by Operating Activities P1,620 Cash Flows from Investing Activities: Purchase of Building en Purchase of Equipment Net Cash Used by Investing Activities P(1,200)156D Chapter 7 Cash Flows from Financing Activities: Repayment of Long-Term Loan _ cae P(350) 2 Proceeds from Sale of Common Stock 350 =) Payment of Cash Dividends (100) Net Cash Provided by Financing activities P_i00 Net Increase in Cash During 20X6 P320 Required: Respond to the following questions: For which of the three types of activities did Henry use the majority of its cash during 20X6? b. What does your answe! Company? c. From which of majority of its cash during 20X6? d. Is the activity you identified in the previous requirement an appropriate source of cash in the long run? Explain your reasoning. a r to the previous question tell you about Henry the three broad types of activities did Rose obtain the Problem 11 Presented below are the totals from the main three sections of Arlene Job and Company’s most recent statement of cash flows: Net Cash Provided by Operating Activities P 1,812,000 Net Cash Used by Investing Activities P(1,280,000) P( 153,000) Net Cash Used by Financing Activities Required: ‘a. What do these totals tell you about Job and Company? b. What additional information would you want to see before you analyze Job and Company’s ability to generate positive cash flow in the future? Did Job and Company have a net income or loss for the period? What additional information would you want before trying to predict. the company’s net income for next period?