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.

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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.

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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

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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

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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.

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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.

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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.

LiquidAssets10

The only section of the statement of cash flows that must be adjusted to convert a statement of cash flows from the indirect to the direct method is:

A) cash flows from operations.

B) cash flows from investing.

C) cash flows from financing.

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The cash flows from investing activities and cash flows from financing activities sections of the statement of cash flows are the same for both the indirect and direct methods. Only the cash flows from operations section must be adjusted to convert the statement of cash flows from the indirect to the direct method.

LiquidAssets10

How does decreasing accounts payable turnover affect a company’s cash flow from financing activities and is this source of cash sustainable?

Financing cash flow

Sustainable source

A) No impact No

B) Increase No

C) No impact Yes

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Decreasing accounts payable turnover saves cash by delaying payments to suppliers. The result is an operating source of cash, not a financing source. Decreasing accounts payable turnover is not a sustainable source of cash flow because suppliers will refuse to extend credit, at some point, if payment is slower and slower.

LiquidAssets10

Consider the following:

Statement #1:	One approach to presenting a common-size cash flow statement is to express each inflow of cash as a percentage of total cash inflows and each outflow of cash as a percentage of total cash outflows.
Statement #2:	Expressing each line item of the cash flow statement as a percentage of revenue is useful in forecasting future cash flows.

Which of these statements regarding a common-size cash flow statement is (are) CORRECT?

A) Only statement #1 is correct.

B) Both statements are correct.

C) Only statement #2 is correct.

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A cash flow statement can be presented in common-size format by expressing each line item as a percentage of total revenue or by expressing each inflow of cash as a percentage of total cash inflows and each outflow as a percentage of total cash outflows. Expressing each line item of the cash flow statement as a percentage of revenue is useful in forecasting future cash flows since revenue usually drives the forecast.

LiquidAssets10

Which of the following best describes a ratio that measures a firm’s ability to acquire long-term assets with cash flows from operations, and a performance ratio, respectively?

Acquire assets with CFO

Performance ratio

A) Investing and financing ratio Cash-to-income ratio

B) Reinvestment ratio Cash-to-income ratio

C) Reinvestment ratio Debt payment ratio

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The reinvestment ratio measures a firm’s ability to acquire long-term assets with cash flows from operations. In contrast, the investing and financing ratio, which is more comprehensive, measures the firm’s ability to purchase assets, satisfy debts, and pay dividends.
The cash-to-income ratio measures the ability to generate cash from a firm’s operations and is a performance ratio for cash flow analysis purposes. The debt payment ratio measures the firm’s ability to satisfy long-term debt with cash flow from operations but it is more of a coverage ratio than a performance ratio.