Chapter 07 - Cash Flow Analysis

Chapter 07
Cash Flow Analysis

Multiple Choice Questions

1. Under the accrual basis of accounting, which of the following statements is true?
I. Reported net income provides a measure of operating performance
II. Revenue is recognized when cash is received, and expenses are recognized when payment
is made
III. Cash inflows are recognized when they are received, and cash outflows are recognized
when they are made
A. I only
B. III only
C. I and III
D. I, II and III

2. Which of the following would require an adjustment in the computation of cash flow from
operations using the indirect method?
I. Sale of machinery for $50,000 with a net book value of $35,000
II. Purchase of supplies for cash
III. Remittance by customer in payment of goods purchased this accounting period
IV. Acquisition of land with simultaneous issuance of long-term note
A. I
B. I and II
C. I and III
D. IV

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3. Which of the following would require an adjustment in the computation of cash flow from
operations using the indirect method?
I. Depreciation expense
II. Loss on sale of asset
III. Sale of services to costumers for cash
IV. Utility bill received and paid in cash
A. I
B. I and II
C. I and III
D. IV

4. Beginning and ending accounts receivable are $76,000 and $42,000, respectively. Sales for
the period total $384,000, of which $40,000 was directly for cash. How much cash was
collected from making sales and collecting accounts receivable?
A. $344,000
B. $418,000
C. $378,000
D. $376,000

5. Beginning accounts receivable are $76,000. Sales for the period total $384,000, of which
$40,000 was directly for cash. $418,000 was collected from making sales and collecting
accounts receivable. What is the ending balance for accounts receivable?
A. $42,000
B. $2,000
C. $82,000
D. $68,000

6. A firm has net sales of $6,000, cash expenses (including taxes) of $2,800, and depreciation
of $1,000. If accounts receivable increased in the period by $800, cash flows from operations
equal
A. $2,400
B. $3,200
C. $3,400
D. $4,200

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7. Which of the following represents an investing activity in the statement of cash flows
A. depreciation of plant assets
B. sale of plant assets at a loss
C. stock dividend
D. purchase of inventory

8. Which of the following is not a financing activity in the statement of cash flows?
A. cash dividend
B. repurchase of common stock
C. payment of interest on debt
D. issuance of new debt

The following information should be used to according to the provisions of SFAS 95

(Statement of Cash flows) and using the following data.

9. What is net cash flow from operations?

A. $58,000
B. $55,000
C. $54,000
D. $48,000

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10. What is net cash flow from investing?

A.
B.
C.
D.

$10,000
$5,000
($5,000)
($15,000)

11. What is net cash flow from financing?

A.
B.
C.
D.

$6,000
$3,000
($14,000)
($17,000)

12. What is change in cash?

A.
B.
C.
D.

$49,000
$46,000
$45,000
$39,000

13. On a statement of cash flows that uses the indirect approach, calculation of cash flow from
operations treats depreciation as an adjustment to reported net income because:
A. depreciation is a direct source of cash
B. depreciation is an outflow of cash to a reserve account for the replacement of assets
C. depreciation reduces net income and involves an outflow of cash
D. depreciation reduces net income but does not involve an outflow of cash

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14. Which of the following statements are correct?

I. A company's choice of accounting principles for financial reporting purposes does not affect
net cash flow for the accounting period
II. A company's choice of accounting principles for financial reporting purposes does not
affect operating cash flow
III. If a company sells its receivables this will increase operating cash flow
IV. If a company sells its receivables this will increase financing cash flow
A. I and III
B. I, II and III
C. II and IV
D. I and IV

Hupta Corporation reports for the year ended December 31, 2005 sales of $9,430 and cost of
goods sold of $6,500. Other information as of December 31 is as follows:

15. An increase in accounts payable would be considered:

A. a source of cash
B. a use of cash
C. an adjusting entry
D. a noncash charge to income

16. Cash paid to suppliers for year ended December 31, 2005 is:
A. $6,480
B. $6,440
C. $5,520
D. $6,560

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17. Cash collected from customers for the year ended December 31, 2005 is:
A. $9,480
B. $9,430
C. $8,930
D. $8,980

Below is an example of an incorrectly prepared statement of cash flows. The descriptions of

activities are correct.

18. The correct Cash flows from operating activities is:

A. 65,500
B. 63,500
C. 53,500
D. none of the above

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19. The correct Cash flows from investing activities is:

A. ($41,000)
B. ($45,500)
C. ($48,000)
D. none of the above

20. The correct Cash flows from financing activities is:

A. ($4,500)
B. $3,000
C. $1,000
D. none of the above

21. The correct change in cash for the year is:

A. $4,000
B. $15,000
C. $16,500
D. none of the above

22. The management of a company wishes to window-dress its cash flow from operations.
Which of the following will improve cash flow from operations?
I. factoring accounts receivable
II. paying suppliers more quickly
III. selling of some excess marketable securities
IV. deferring payment of taxes
A. IV only
B. III and IV
C. II, III and IV
D. I and IV

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Tracy Company reports the following in its statement of cash flows:

23. If Tracy shows cost of goods sold of $2,050 on its income statement, cash paid to
suppliers is:
A. $1,550
B. $1,950
C. $2,150
D. $2,650

24. If Tracy shows depreciation expense of $ 275 in its income statement, cash paid for
amortization is:
A. $0
B. $75
C. $525
D. not determinable

25. Tracy used the indirect method of determining cash flow from operations (CFO), had they
used the direct method:
A. CFO would have been higher as gains are not deducted in arriving at CFO
B. CFO would have been lower as losses and depreciation are not added back in arriving at
CFO
C. CFO would have been the same
D. it is not possible to determine what CFO would have been without more information

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26. Which of the following items is deducted from net income to arrive at cash flow from
operations when using the indirect method?
A. depreciation expense
B. amortization expense
C. decrease in accounts receivable
D. decrease in accounts payable

27. Firms report payments for capital leases in the cash flow statement:
A. only as financing cash flows
B. only as investing cash flows
C. partly as operating cash flows and partly as investing cash flows
D. partly as operating cash flows and partly as financing cash flows

28. Compared with firms with capital leases, firms with operating leases generally report:
A. higher cash flow from operations
B. lower cash flow from operations
C. identical cash flow from operations
D. lower or higher cash flow from operations depending upon market interest rates

29. Which of the following would affect cash flow from operations?
A. Sale of land for a gain
B. Payment of dividends
C. Depreciation of fixed assets
D. Capitalizing costs that were previously expensed

30. Which of the following is true? Depreciation:

A. is recorded so that net book value represents fair value of assets
B. does not affect the amount of cash realized from operations as it is a non-cash flow
C. is added back to net income to calculate cash from operations under the direct method
D. represents a fund from which to purchase future assets

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The following information should be used according to the provisions of SFAS 95

(Statement of Cash flows) and using the following data.

31. What is net cash flow from operations?

A. $74,000
B. $75,000
C. $83,000
D. $85,000

32. What is net cash flow from investing?

A. $11,000
B. $7,000
C. ($2,000)
D. ($12,000)

33. What is net cash flow from financing?

A. ($5,000)
B. ($10,000)
C. ($11,000)
D. ($13,000)

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34. What is change in cash?

A. $81,000
B. $72,000
C. $71,000
D. $62,000

35. Which of the following is true? The choice of LIFO versus FIFO will:
A. not affect net income or cash flow from operations
B. not affect net income but will affect cash flow from operations
C. affect both net income and cash flow from operations
D. affect net income but will not affect cash flow from operations

36. Which of the following would be considered a use of cash?

A. depreciation
B. an increase in working capital
C. sale of bonds
D. an increase in wages payable

Schwerin Corporation reports the following on its 2005 financial statements.

37. The net book value of equipment sold was:

A. $120M
B. $100M
C. $ 80M
D. $ 60M

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38. The gross book value of equipment sold was:

A. $120M
B. $100M
C. $ 80M
D. $ 60M

39. Beginning and ending plant assets are, respectively, $325,000 and $370,000. Beginning
and ending accumulated depreciation is, respectively, $82,800 and $95,000. Depreciation
expense for the period was $30,000, and new assets of $76,000 were purchased. Plant assets
were sold at a $10,500 loss. What were the cash proceeds from the sale?
A. $17,800
B. $3,100
C. $2,700
D. $31,000

The following information is given for Building Inc.:

During 2005 new assets were purchased for of $78,000, and plant assets were sold at a
$10,000 loss.
40. What was the book value of the sold assets?
A. $38,000
B. $18,000
C. $10,000
D. $8,000

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41. What were the cash proceeds from the sale?

A. $38,000
B. $18,000
C. $10,000
D. $8,000

42. Beginning and ending prepaid insurance is, respectively, $36,000 and $26,500. During the
period, $30,500 of insurance expense was recorded. How much new insurance was
purchased?
A. $2,500
B. $15,600
C. $49,000
D. $21,000

43. The balance for supplies is $41,000 and $27,000 for 12/31/05 and 12/31/06, respectively.
During the 2006, the company recorded $30,500 of supplies expense was recorded. How
much new supplies were purchased?
A. $44,500
B. $16,500
C. $14,000
D. $30,500

44. The cash flow adequacy ratio

A. Measures a company's ability to generate sufficient cash flow from investing to cover debt
repayments
B. Measures a company's ability to generate sufficient cash flows from operations to cover
capital expenditures and debt repayment
C. Measures a company's ability to generate sufficient cash flows from operations to cover
capital expenditures, inventory additions and dividends
D. Measures a company's ability to generate sufficient cash flows from operations to cover
capital expenditures, debt repayment and dividends

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45. A cash flow adequacy ratio, when measured over the last several years, of less than one:
A. Indicates that a company's net income is too low relative to its sales level
B. Indicates that a company should decrease its dividend payout ratio
C. Indicates that a company needs to pay down its debt to decrease interest costs
D. Indicates that a company's internally generated cash flows have not been sufficient to cover
dividend payments and support past growth levels

True / False Questions

46. Companies can construct the statement of cash flows using either the direct method or the
indirect method.
TRUE

47. Cash flow from operations is usually less volatile than net income.
FALSE

48. The only time a company experiences a negative cash flow from operations is when they
are in trouble.
FALSE

49. Cash flow from operations will often be negative for companies experiencing tremendous
growth.
TRUE

50. Cash flow from investing when averaged over an extended period of time would normally
be expected to be negative (i.e. net outflow).
TRUE

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51. Cash flow from financing is normally negative during the start-up phase for a company.
FALSE

52. Over an extended period of time average cash flow from operations would be expected to
be higher than average net income.
TRUE

53. Amortization of goodwill reduces net income and is a cash outflow.

FALSE

54. Payment of a 5% stock dividend will not appear in the statement of cash flows.
TRUE

55. A gain on sale of an asset would require adjusting net income if preparing the statement of
cash flows using the indirect method.
TRUE

56. An increase in accounts receivable does not require adjusting net income if preparing the
statement of cash flows using the indirect method.
FALSE

57. Depreciation and amortization expense needs to be added back to net income if preparing
the statement of cash flows using the indirect method.
TRUE

58. An increase in assets would usually show as an outflow in the statement of cash flows.
TRUE

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59. A decrease in liabilities would usually show as an outflow in the statement of cash flows.
TRUE

60. Practice requires separate disclosure of cash flows in the statement of cash flows.
FALSE

61. Many financial analysts subtract interest paid from cash from operations, and reclassify it
as part of cash from financing activities.
TRUE

62. Three formats are acceptable under SFAS 95 for presenting cash flow from operations: the
direct method, the summary method and the indirect method.
FALSE

63. The financing section of the statement of cash flows (prepared in accordance with SFAS
95) contains all cash inflows and cash outflows relating to the financing of a company.
FALSE

64. Depreciation expense decreases net income but is not a use of cash.
TRUE

65. Cash flows from operations is better measure of profitability than net income as it is less
susceptible to manipulation by management.
FALSE

66. Users sometimes compute net income plus depreciation and amortization (for example
EBITDA) as a crude proxy for operating cash flows.
TRUE

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67. Increases in working capital are a source of funds.

FALSE

68. Taxes paid on capital gains from the sale of marketable securities are recorded as cash
outflows from operations.
TRUE

69. Net cash flow is not affected by a company's choice of accounting principles for financial
reporting purposes.
TRUE

70. In firms that are experiencing tremendous growth, it is rare that net income will exceed
cash generated by all activities.
FALSE

71. Interest income is recorded as an investing inflow of cash.

TRUE

72. An increase in a liability is a use of cash.

FALSE

73. The cash adequacy ratio is normally measured over an extended period of time to remove
the effect of random disturbances.
TRUE

74. The cash reinvestment ratio measures the percentage of money reinvested in the
company's operating asset's that is funded by retained earnings.
FALSE

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Essay Questions

75. Problem One: Cash Flow from Operations

a. Is it possible to have a positive net income and negative cash flow from operations? If your
answer is no, explain fully. If your answer is yes, provide two examples when one might find
this.
b. Is it possible to have a negative net income and positive cash flow from operations? If your
answer is no, explain fully. If your answer is yes, provide two examples when one might find
this.
Problem One: Cash Flow from Operations
a. Yes it is entirely possible to have positive net income and negative cash flow from
operations. One might expect to see this with a company that is growing very fast. This type
of company will have positive net income but the increase in working capital needed to
sustain the growth depresses the cash flow from operations. One might also see this with a
company that is having problems with their working capital management. Any increases in
working capital will depress cash flow from operations, ceteris paribus.
b. Yes, it possible to have negative net income and positive cash flows from operations. This
can occur if a company has very large depreciation expenses. This was the case with cable
companies when the industry was fairly young. The tremendous amount of fixed assets
needed to start these companies was then depreciated over time.
You might also see this situation in declining industries. Sales are declining and net income is
becoming negative (especially if there are high levels of fixed costs). However, at the same
time working capital is contracting causing operating cash flows to be positive.

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76. Problem Two: Preparation of Statement of Cash Flows

The following cash flow data of Signet Sales for the year ended December 31, 2005 are as
follows:

a. Prepare a statement of cash flows for Signet Sales in accordance using the direct method in
accordance with SFAS 95
b. Discuss, from an analyst's viewpoint, the purpose of classifying cash flows into the
categories required by SFAS 95

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Problem Two: Preparation of Statement of Cash Flows

a.

b. Operating cash flows provide a measure of internally generated funds that can be used to
fund expansion, pay off debt, and pay dividends to shareholders. Operating cash flows are not
a performance measure, but rather should be considered a liquidity measure. The larger the
operating cash flows the less likely a company will need external financing to fund growth,
and the less likely they are to need to liquidate assets.
Investing cash flows show us where a company is investing its cash and whether it is
liquidating assets. Examination of the investing section will determine if the company is
maintaining and/or growing asset base. Financing cash flows provide information about the
financing of a company - whether it is raising capital to support operations, to finance growth,
or whether it is decreasing or increasing leverage.
(CFA Adapted)

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77. Problem Three: Preparation of Statement of Cash Flows

Use the following selected data about Tiles Ltd. and prepare the operating activities section
of a statement of cash flows for the company for 2005 using the indirect method.

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Problem Three: Preparation of Statement of Cash Flows

Operating activities:

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78. Problem Four: Preparation of Statement of Cash Flows

Below is the income statement and balance sheet of Closely Held Corporation. From this
information prepare a statement of cash flows for the year ended September 30, 2005.

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Problem Four: Preparation of Statement of Cash Flows

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79. Problem Five: Borrowing Needs and Preparation of Statement of Cash Flows
You are trying to determine how much money your company, XYZ Corporation, will need to
borrow from the bank, if any. You are in the middle of preparing the pro forma financial
statements for 2005. On the next pages is the completed income statement and partially
completed balance sheet for your company for 2005.
a. Using the information provided below complete the balance sheet for 2005. (Put your
answers in the blank spaces on the balance sheet.)
Inventory turnover (using end-of-year inventory) is 4
Your silent partners demand that 50% of net income is paid out in dividends
You will borrow if you have a cash shortage and will reduce long-term debt if there is an
excess of cash
b. When you have completed part a, prepare a statement of cash flows.

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Problem Five: Borrowing Needs and Preparation of Statement of Cash Flows

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80. Problem Six: Identifying Cash Flows by Activity

Identify whether each of the following is an operating, investing or financing cash outflow or
inflow or if it is a non cash flow, under SFAS No. 95.
Purchase marketable equity securities
Dividends on marketable equity securities
Wages to employees
Depreciation
Issuance of new stock
Interest paid
Goodwill amortization
Acquisition of company using purchase accounting
Sale of land
Tax paid on sale of land
Cash paid by customers
Problem Six: Identifying Cash Flows by Activity

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81. Problem Seven: Preparation of Statement of Cash Flows

Below are the balance sheet and income statement for Anderson Corporation.

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Additional Information
In Year 1, Anderson sold machinery bought at $36, for $18, resulting in a $2 gain on income
statement.
$810 in dividends were paid in Year 1
SG&A expense includes $50 of interest expense, and amortization expense of $30
Cost of good sold includes depreciation of $260
Income tax expense includes deferred tax liability of $20
a. Prepare Cash Flows from Operations using the Direct method
b. Prepare Statement of Cash Flows from Operations using the Indirect method
Problem Seven: Preparation of Statement of Cash Flows
a. Cash Flows from Operations using the Direct method

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b. Cash Flows from Operations using the Indirect method

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82. Problem Eight: Limitations of the Statement of Cash Flows

GAAP requires that the Statement of Cash Flows (SCFs) is prepared in a specific manner. For
the following items, discuss in which section (operating, investing or financing) of the SCFs
they are found, where they might more appropriately be placed and why.
a. dividends received
b. interest paid
c. income taxes
Problem Eight: Limitations of the Statement of Cash Flows
1. Dividends received. These are classified as operating cash flows under GAAP. However,
these are the result of investment decisions made and are not the result of core operations of
the business. One could argue that they should be classified as investing cash inflows.
2. Interest paid. These are classified as operating cash flows under GAAP. However, these are
the result of financing decisions made and are not the result of core operations of the business.
There is a strong argument for classifying them as financing, rather than operating, cash
outflows. This would be consistent with the treatment of dividend payments.
3. Income taxes. All income taxes are classified as operating cash flows under GAAP
regardless of the events giving rise to them. For example, if a piece of land is sold at a gain
the tax incurred appears in the operating section, even though the cash from the sale of the
land is considered an investing cash inflow. It can be argued that the taxes should be allocated
among the events giving rise to them and recorded accordingly.

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83. Problem Nine: Preparation of Statement of Cash Flow Components

JEM Company's comparative balance sheets for 2004 and 2005 appear below.

The following additional information is available: net income for the year 2005 (as reported
on the income statement) was $50,000; dividends of $40,000 were declared and paid; and
equipment that cost $8,000 and had a book value of $1,000 was sold during the year for
$2,500.
Based on the information provided, answer the following:
a. What was cash provided by operations?
b. What was cash provided by investing activity?
c. How much was cash provided by financing activity?
d. What is the total change in cash for 2005?

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Problem Nine: Preparation of Statement of Cash Flow Components

a. Cash provided by operations

b. Cash provided by investing activity

c. Cash provided by financing activity

d. Change in cash
$20,500
(71,000-30,500-20,000)

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