LiquidAssets10

A firm has net sales of $3,500, earnings after taxes (EAT) of $1,000, depreciation expense of $500, cost of goods sold (COGS) of $1,500, and cash taxes of $500. Also, inventory decreased by $100, and accounts receivable increased by $300. What is the firm's cash flow from operations?

A) $1,200.

B) $1,800.

C) $1,300.

---

Indirect Method
EAT	+1,000
Depreciation	+500
Change in Inv.	+ 100 a source
Change in Accts. Rec.	(300) a use
CFO	1,300

Direct Method
Net Sales	+3,500
Change in Accts. Rec.	(300) a use
COGS	(1,500)
Cash Taxes	(500)
Change in Inv.	+100 a source
CFO	1,300

LiquidAssets10

The Red Company’s balance sheet as of December 31, 2004 was as follows:

	Dec. 31, 2003	Dec. 31, 2004
Cash	$1,500,000	$1,900,000
Accounts Receivable	3,000,000	3,400,000
Inventory	2,300,000	2,500,000
Property, Plant & Equipment	16,700,000	19,700,000
Less Accumulated Depreciation	(5,300,000)	(8,200,000)
Total Assets	$18,200,000	$19,300,000
Accounts Payable	$2,100,000	$1,900,000
Interest Payable	800,000	1,200,000
Income Taxes Payable	1,000,000	800,000
Notes Payable	2,700,000	2,900,000
Deferred Income Taxes	2,600,000	2,900,000
Common Stock	1,000,000	1,000,000
Retained Earnings	8,000,000	8,600,000
	$18,200,000	$19,300,000

Red’s interest expense was $900,000 and income tax expense was $1,000,000 in 2004. Red prepares its Statements of Cash Flows using the direct method.The other cash outflows section of Cash Flow from Operations (CFO) for 2004 would total:

A) $2,100,000.

B) $1,700,000.

C) $1,400,000.

---

Other cash outflows is the third step in calculating CFO using the direct method. It consists of Cash taxes paid + Cash interest paid.
Cash interest paid = interest expense less increase in interest payable: ($900,000 – (1,200,000 - $800,000) =) $500,000.

Cash taxes paid =		tax expense of $1,000,000
	+	decrease in income taxes payable (1,000,000-800,000) = 200,000
	-	increase in deferred income taxes (2,600,000-2,900,000) = 300,000
		$900,000

Other cash outflows = $500,000 + 900,000 = $1,400,000

LiquidAssets10

Financial information for Jefferson Corp. for the year ended December 31st, was as follows:

Sales	$3,000,000
Purchases	1,800,000
Inventory at Beginning	500,000
Inventory at Ending	800,000
Accounts Receivable at Beginning	300,000
Accounts Receivable at Ending	200,000
Accounts Payable at Beginning	100,000
Accounts Payable at Ending	100,000
Other Operating Expenses Paid	400,000

Based upon this data and using the direct method, what was Jefferson Corp.’s cash flow from operations (CFO) for the year ended December 31st?

A) $900,000.

B) $1,200,000.

C) $800,000.

---

CFO = sales $3,000,000 – change in accounts receivable ($200,000 – $300,000) – purchases $1,800,000 – other cash operating expenses $400,000 = $900,000.
Note that no adjustment for inventories is necessary because purchases are given. From the inventory equation, P = COGS + EI - BI.

LiquidAssets10

Capital Corp.’s activities in the year 2005 included the following:

• 
  At the beginning of the year, Capital purchased a cargo plane from Aviation Partners for $10 million in exchange for $2 million cash, $3 million in Capital Corp. bonds and $5 million in Capital Corp. preferred stock.
• 
  Interest of $150,000 was paid on the bonds, and dividends of $250,000 were paid on the preferred stock.
• 
  At the end of the year, the cargo plane was sold for $12,000,000 cash to Standard Company. Proceeds from the sale were used to pay off the $3 million in bonds held by Aviation Partners.

On Capital Corp.’s Statement of Cash Flow for the year ended December 31, 2005, cash flow from investments (CFI) related to the above activities is:

A) $6,750,000.

B) $9,750,000.

C) $10,000,000.

---

Investing cash of $2 million was used to purchase the cargo plane. Proceeds from the sale of the plane were a source of $12 million of investing cash. Net CFI is $12 million − $2 million = $10 million. The interest payment is included in cash from operations (CFO) and the dividend payment in cash from financing (CFF). Redemption of the bonds is a use of cash from financing (CFF).

LiquidAssets10

Favor, Inc.’s capital and related transactions during 2005 were as follows:

• On January 1, $1,000,000 of 5-year 10% annual interest bonds were issued to Cover Industries in exchange for old equipment owned by Cover.
• On June 30, Favor paid $50,000 of interest to Cover.
• On July 1, Cover returned the bonds to Favor in exchange for $1,500,000 par value 6% preferred stock.
• On December 31, Favor paid preferred stock dividends of $45,000 to Cover.

Favor, Inc.’s cash flow from financing (CFF) for 2005 (assume U.S. GAAP) is:

A) -$45,000.

B) -$95,000.

C) -$1,045,000.

---

Only the preferred stock dividends paid would be considered CFF. Issuing bonds in exchange for equipment and exchanging bonds for stock are both noncash transactions that should be disclosed in a footnote to the Statement of Cash Flows. Interest paid is an operating cash flow under U.S. GAAP.

LiquidAssets10

Mark Industries' income statement and related notes for the year ended December 31 are as follows (in $):

Sales	42,000,000
Cost of Goods Sold	(32,000,000)
Wages Expense	(1,500,000)
Depreciation Expense	(2,500,000)
Interest Expense	(1,000,000)
Income Tax Expense	(2,000,000)
Net Income	3,000,000

During the year:

• Wages Payable increased $100,000.
• Accumulated Depreciation increased $2,500,000.
• Interest Payable decreased $200,000.
• Income Taxes Payable increased $500,000.
• Dividends of $100,000 were declared and paid.

Under U.S. GAAP, Mark Industries’ cash flow from operations (CFO) for the year ended December 31 was:

A) $4,800,000.

B) $5,900,000.

C) $4,400,000.

---

Using the indirect method, net income is adjusted by adding back depreciation (a non-cash expense) and changes in working capital: the increase in wages payable and the increase in income taxes payable are sources of cash, and the decrease in interest payable is a use of cash. Dividends paid are financing cash flows under U.S. GAAP.
CFO = $3,000,000 + $2,500,000 + $100,000 + $500,000 - $200,000 = $5,900,000.

LiquidAssets10

Maverick Company reported the following financial information for 2007:

	in millions
Beginning accounts receivable	$180
Ending accounts receivable	225
Sales	11,000
Beginning inventory	2,000
Ending inventory	2,300
Purchases	8,100
Beginning accounts payable	1,600
Ending accounts payable	1,200

Calculate Maverick’s cost of goods sold and cash paid to suppliers for 2007.

Cost of goods sold

Cash paid to suppliers

A) $7,800 million $7,100 million

B) $7,800 million $8,500 million

C) $3,800 million $8,500 million

---

Cost of goods sold is equal to $7,800 million ($2,000 million beginning inventory + $8,100 million purchases – $2,300 million ending inventory). Cash paid to suppliers is equal to $8,500 million (–$7,800 COGS – $300 million increase in inventory – $400 million decrease in accounts payable). Alternate solution: Cash paid to suppliers is equal to $8,500 million (–$8,100 million purchases – $400 decrease in accounts payable).

LiquidAssets10

In converting a statement of cash flows from the indirect to the direct method, which of the following adjustments should be made for a decrease in unearned revenue when calculating cash collected from customers, and for an inventory writedown (when market value is less than cost) when calculating cash payments to suppliers?

Cash collections from customers:

Cash payments to suppliers:

A) Subtract decrease in unearned revenue Add an inventory writedown

B) Subtract decrease in unearned revenue Subtract an inventory writedown

C) Add decrease in unearned revenue Subtract an inventory writedown

---

Beginning with net sales, calculating cash collected from customers requires the addition (subtraction) of any increase (decrease) in unearned revenue. Cash advances from customers represent unearned revenue and are not included in net sales, so any advances must be added to net sales in order to calculate cash collected.
An inventory writedown, as a result of applying the lower of cost or market rule, will reduce ending inventory and increase COGS for the period. However, no cash flow is associated with the writedown, so COGS is reduced by the amount of the writedown in calculating cash paid to suppliers.

LiquidAssets10

To convert an indirect statement of cash flows to a direct basis, the analyst would:

A) subtract increases in inventory from cost of goods sold.

B) add increases in accounts payable to cost of goods sold.

C) add decreases in accounts receivables to net sales.

---

A decrease in accounts receivable represents an increase in cash so this should be added to sales. Increases in accounts payable represent an increase in cash so these should be subtracted from cost of goods sold. Increases in inventory represent a use of cash so these would be added to cost of goods sold.

LiquidAssets10

To convert an indirect statement of cash flows to a direct basis, the analyst would:

A) reduce cost of goods sold by any decreases in accounts payable.

B) increase cost of goods sold by any depreciation that was included.

C) reduce cost of goods sold by any decreases in inventory.

---

Decreases in inventory represent a source of cash so these would be subtracted from cost of goods sold. Any depreciation and/or amortization included in the cost of goods sold does not represent an actual use of cash, so this amount should be subtracted from cost of goods sold. Decreases in accounts payable represent a use of cash so these should be added to cost of goods sold.