Financial Statement Anlysis 10e Subramanyam Wild_Chapter 7

Chapter 07 - Cash Flow Analysis Analysis

Chapter 7 Cash Flow Analysis nalysis REVIEW Cash is the residual of cash inflows less cash outflows for all prior periods of a company. company. Net cash flows, or simply cash flows, refer to the current periods cash inflows less cash outflows outflows.. Cash flows are different different from accrual measures of performance performance.. Cash flow measures reco!ni"e inflows when cash is recei#ed not necessarily earned, and outflows when cash is paid not necessarily incurred. $he statement of cash flows reports cash flow measures for three primary %usiness acti#ities& operatin!, in#estin!, and financin!. 'peratin! cash flows, or cash flows from operations, is the cash %asis counterpart to accrual net income. Information on cash flows helps us assess a companys a%ility to meet o%li!ations, pay di#idends, increase capacity, and raise financin!. It also helps us asse assess ss the the (u (ual alit ity y of earni earnin! n!s s and and the the depe depend nden ence ce of inco income me on esti estima mate tes s and and assumptions re!ardin! future cash flows. flows. $his chapter descri%es cash flows and and their rele#a rele#ance nce to our analy analysis sis of financ financial ial statem statement ents. s. We descri descri%e %e curren currentt report reportin! in! re(uirements and their implications for our analysis of cash flows. We e)plain useful analytical ad*ustments to cash flows usin! financial data to impro#e our analysis. We direct direct specia speciall attent attentio ion n to transa transacti ction on recons reconstru tructi ction on,, $+acco +account unt,, and con#er con#ersio sion n analyses.

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'$-INE •

tatement of Cash Flows Rele#ance of Cash Reportin! %y Acti#ities Constructin! the Cash Flow tatement pecial $opics

•

Reportin! Cash Flows from 'perations Indirect /ethod 0irect /ethod Con#ertin! from Indirect to 0irect /ethod Ad*ustments to Cash Flow Components Additional 0isclosures and Ad*ustments

•

Analysis Implications of Cash Flows -imitations in Cash Flow Reportin! Interpretin! Cash Flows and Net Income Alternati#e Cash Flow /easures Company and Economic Ec onomic Conditions Free Cash Flow Cash Flows as Validators

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peciali"ed Cash Flow Ratios Cash Flow Ade(uacy Ratio Cash Rein#estment Ratio

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Appendi) 7A Analytical Cash Flow Wor1sheets

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ANA-2 ANA-2I '34EC$IVE '34EC$IVE •

E)plain the rele#ance of cash flows in analy"in! analy"in! %usiness acti#ities.

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0escri%e reportin! of cash flows %y %usiness acti#ities. acti#ities.

•

0escri%e the preparation and analysis of the statement of cash flows.

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Interpret cash flows from operatin! acti#ities.

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Analy"e Analy"e cash flows under alternati#e company and %usiness conditions.

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0escri%e alternati#e measures of cash flows and their usefulness.

•

Illustrate an analytical tool in e#aluatin! cash flows 5Appendi) 7A6.

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E$I'N 8. $he te term cash flow was was pro%a%ly first coined %y analysts. $hey reco!ni"ed that the accrual accrual syste system m of income income measur measuremen ementt permit permits s the intro introduc ductio tion n of a #ariet #ariety y of alternati#e accountin! treatments and conse(uent distortions. $he crude concept of cash flow9net income plus ma*or noncash e)penses 5such as depreciation69was deri#ed to %ypass these distortions and %rin! income measurement closer to the discipline of actual cash flows. $his cash flow measure, still a popular surro!ate for cash from operations 5CF'6, is crude %ecause it falls short of relia%ly appro)imatin! in most cases the correct measure of CF'. Confus Confusion ion with the term term cash flow flow deri#e deri#es s from from se#era se#erall source sources. s. 'ne source source of confusion stems from the initial and incorrect computation of the crude measure of cash flow as income income plus ma*or noncash noncash e)penses. e)penses. $he fi!ure fi!ure fails fails to reflect reflect actual cash flows. Another and more serious confusion arises from the assertion %y some, and particularly %y mana!ers dissatisfied %y the le#el of their reported net income, that cash flow is a measure of performance superior to or more #alid than net income. $his assertion implicitly assumes that depreciation, and other noncash costs, are not !enuine e)penses. E)perience shows that only net income is properly re!arded as a measure of performance and can %e related to the e(uity in#estment as an indicator of operatin! performance. If we add %ac1 depreciation to net income and compute the the resu result ltin in! ! retu return rn on in#e in#est stme ment nt,, we are, are, in effe effect ct,, conf confus usin in! ! the the retu return rn on in#estment with an element of return on in#estment in fi)ed assets. :. While fra!mentary fra!mentary information information on the sources and uses of cash can %e o%tained from comparati#e %alance sheets and from income statements, a comprehensi#e picture of this important area of acti#ity can %e !ained only from a statement of cash flows 5CF6. $he CF pro#ides information information to help answer a nswer (uestions such as& What amount of cash is !enerated %y operations; • What utili"ation utili"ation is made of cash pro#ided %y operations; • What is the source of cash c ash in#ested in new plant and e(uipment; • • What use is made of cash from a new %ond issue or the issuance of common stoc1;
SFAS 95 re(uires that the statement of cash flows classify cash receipts and cash payments %y operatin!, financin! and in#estin! acti#ities. Operating activities encompass all the earnin!+related acti#ities of the enterprise. $hey $hey encomp encompass ass,, in additio addition n to all the the income income and e)pens e)pense e items items found on the income statement, all the net inflows and outflows of cash that operations impose on the enterprise. enterprise. uch operations operations include include acti#ities acti#ities such as the e)tension of credit credit to customers, customers, in#estmen in#estmentt in in#entor in#entories, ies, and o%tainin! o%tainin! credit from suppliers. suppliers. $hi $his s means operatin! acti#ities relate to all items in the statement of income 5with minor

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e)cepti e)ception ons6 s6 as well well as to %alance %alance sheet items items that relate to operatio operations ns mostly mostly wor1in! wor1in! capital capital accounts accounts such as accounts accounts recei#a%le, recei#a%le, in#entor in#entories, ies, prepayments, prepayments, accounts paya%le, and

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accruals. SFAS 95 also also specifies that operatin! acti#ities include all transactions and e#ents that are not of an in#estin! or financin! nature. Financing activities include o%tainin! resources from owners and pro#idin! them with with a retu return rn of or a return on 5di#iden 5di#idends6 ds6 their in#estment. in#estment. $hey also include o%tainin! resources from creditors and repayin! the amounts %orrowed or otherwise settlin! the o%li!ations. Investing activities include include ac(uirin ac(uirin! ! and sellin! sellin! or otherwise otherwise disposin! disposin! of %oth securities that are not cash e(ui#alents and producti#e assets that are e)pected to !ene !enerat rate e re#e re#enu nues es o#er o#er the the lon! lon!+t +ter erm. m. $h $hey ey also also incl includ ude e lend lendin in! ! mo mone ney y and and collectin! on such loans.

=. We can distin! distin!uish uish amon! amon! three three cate!ories cate!ories of ad*ustments ad*ustments that that con#ert accrual accrual %asis net income to cash from operations& 5i6 E)penses, losses, re#enues, and !ains that do not use or !enerate cash such as those in#ol#in! noncash noncash accounts 5e)cept those in ii6, 5ii6 Net chan!es in noncash accounts 5mostly in the operatin! wor1in! capital !roup6 !roup6 that that relate relate to operat operatio ions9 ns9the these se modify modify the accrual+% accrual+%ase ased d re#enu re#enue e and e)pense items included in income, 5iii6 >ains and losses 5such as on sales of assets6 that are transferred to other sections of the CF so as to show the entire cash proceeds of the sale. ?. $he two method methods s of reporti reportin! n! cash flow flow from from operati operations ons are& are& Indirect Indirect Method Method & nde nderr this this meth method od net net inco income me is ad*u ad*ust sted ed for for no nonc ncas ash h item items s re(u re(uir ired ed to con# con#er ertt it to CF'. CF'. $he ad#a ad#ant nta! a!e e of this this meth method od is that that it is a reconcilia reconciliation tion that disclose discloses s the differences differences %etween net income income and CF'. ome analysts estimate future cash flows %y first estimatin! future income le#els and then ad*ust ad*ustin in! ! these these for leads and la!s la!s %etween %etween income income and CF' CF' 5that 5that is, noncash noncash ad*ustments6. Direct (or Inflow-Otflow! Method & $his method lists the !ross cash receipts and dis%ursements related to operations. /ost respondents to the E)posure 0raft that prece precede ded d SFAS 95 preferred this method %ecause this presentation discloses the total amount of cash that flows into the enterprise and out of the enterprise due to operations. $his !i#es analysts a %etter measure of the si"e of cash inflows and outflows o#er which mana!ement has some de!ree of discretion. As the ris1s that lenders are e)posed to relate more to fluctuations in CF' than to fluctuations in net income, information on the amounts of operatin! cash receipts and payments is important in assessin! the nature of those fluctuations.

@. $he function function of the income income statement statement is to to measure measure the profita%il profita%ility ity of of the enterprise enterprise for a !i#en period. $his is done %y matchin! e)penses and losses with the re#enues and !ains earned. While no other statement measures profita%ility as well as the incom income e stateme statement, nt, it does does not show the timin timin! ! of cash cash flows flows and the effect of operations on li(uidity and sol#ency. $he latter is reported on %y the CF. Cash from operations 5CF'6 reflects a %roader concept of operations relati#e to net income. It encompasses all earnin!+related acti#ities of the enterprise. CF' is concerned not only with e)penses and re#enues %ut also with the cash demands of these acti#ities, such such as in#est in#estmen ments ts in custo customer mer recei#a recei#a%l %les es and in in#ent in#entori ories es as well well as the financin! pro#ided %y suppliers of !oods and ser#ices. CF' focuses on the li(uidity aspect of operations and is not a measure of profita%ility %ecause it does not include import importan antt costs costs such such as the the use of lon lon!+l !+li# i#ed ed assets assets in operat operation ions s or impor importan tantt

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re#enu re#enues es such such as the e(uity e(uity in the the earnin earnin!s !s of non noncon conso solid lidate ated d su%si su%sidia diarie ries s or affiliates.

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7. $he CF sheds li!ht li!ht on 5i6 5i6 the effects effects of earnin! earnin! acti#ities acti#ities on on cash resources, resources, 5ii6 5ii6 what assets are ac(uired, and 5iii6 how assets are financed. It also can hi!hli!ht more clearly the distinction %etween net income and cash pro#ided %y operations. $he a%ility of an enterprise to !enerate cash from operations on a consistent %asis is an important indicator of financial health. No %usiness can sur#i#e o#er the lon! run without without !eneratin! !eneratin! cash from its operation operations. s.
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ositi#e FCF implies that this is the amount a#aila%le for company purposes after pro#isions for financin! outlays and e)penditures to maintain producti#e capacity at current le#els. Internal !rowth and financial fle)i%ility depend on an ade(uate amount of FCF. FCF. Note that the amount of of capital e)penditures needed to maintain maintain producti#e capacity at current le#els is !enerally not disclosed %y companies. It is included in total capital e)penditures, which also can ca n include outlays for e)pansion of producti#e capacity. capacity. 3rea1in! 3rea1in! down capital e)penditures e)penditures %etween %etween these two component components s is difficul difficult. t. $he FA3 FA3 considered considered this issue, issue, %ut in SFAS 95 it it decided not to re(uire clas classi sifi fica cati tion on of in#e in#est stme ment nt e)pe e)pend ndit itur ures es into into main mainte tena nance nce and and e)pan e)pansi sion on cate!ories. . For financia financiall statement statement analysis, analysis, the CF pro#ides pro#ides clues clues to important important matters matters such as& •

• • • • •

• •

Feasi% Feasi%il ility ity of financ financin! in! capita capitall e)pend e)penditu itures res and possi% possi%le le sourc sources es of such such financin!. ources of cash to finance an e)pansion in the %usiness. %usiness. 0ependence of the firm on e)ternal sources of financin! 5such as de%t or e(uity6. Future di#idend policies. A%ility A%ility to meet future de%t ser#ice re(uirements. Financial fle)i%ility, that is, the firms a%ility to !enerate sufficient cash so as to respond to unanticipated needs and opportunities. Insi!ht into the financial ha%its of mana!ement and indications of future policies. i!nals re!ardin! the (uality of earnin!s.

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EERCIE E)ercise 7+8 5:G minutes6 $he 2ear 88 CF' of Camp%ell is hi!her 5%y H=G.7 million6 than its 2ear 88 net income for two main reasons& 8. ome items items decreased decreased net income %ut did not use cash9specifically cash9specifically&& a. 0epreci 0epreciatio ation n and amorti"ati amorti"ation on are e)penses e)penses not re(uirin re(uirin! ! a cash cash outlay outlay 5H:G.@6. %. 0eferred 0eferred income income ta)es ta)es are an e)pense e)pense that has no present present cash paymen paymentt 5H?.?6. c. e#eral e#eral char!es char!es and and e)penses e)penses did not not re(uire re(uire outlays outlays of cash cash 5H@.:6. 5H@.:6. d. A decrease decrease in in#entory in#entory implies that that cost of sales are are char!ed char!ed %y reducin! reducin! in#entory le#els rather than %y ma1in! cash payments of H=.7. :. ome items tems !enerat rated operat eratiin! cash inflow did not enter int into the determination of net income9specifically& a. $he decrease decrease in accoun accounts ts recei#a recei#a%le %le means means that cash is collecte collected d %eyond %eyond the amounts reco!ni"ed as sales re#enue in the income statement 5H87.86. %. $here are se#eral se#eral other items items that had had a similar similar effect, amountin amountin! ! to HG.@. E)ercise 7+: 5=G minutes6 a. SFAS re(uires res that that the the CF CF class classif ify y cash cash recei receipts pts and and paym paymen ents ts %y SFAS 95 re(ui operatin!, financin!, and in#estin! acti#ities. encompass ss all the earnin!+re earnin!+relate lated d acti#it acti#ities ies of the ("! Operatin Operating g activit activities ies encompa enterprise. $hey encompass, in addition to all the income and e)pense items found on the income statement, all the net inflows and outflows of cash that operations impose on the enterprise. uch operations include acti#ities such as the the e)ten e)tensio sion n of cred credit it to custo custome mers, rs, in#e in#estm stmen entt in in#e in#ento ntorie ries, s, and and o%tainin! credit from suppliers. $his means operatin! acti#ities relate to all items in the statement of income 5with minor e)ceptions6 as well as to %alance sheet items that relate to operations mostly wor1in! capital accounts such as accou account nts s rece recei# i#a% a%le, le, in#e in#ent ntori ories, es, prep prepay aymen ments, ts, accou account nts s paya paya%le %le,, and and acc accruals. SFA also spec specif ifie ies s that that op oper erat atin in! ! acti acti#i #iti ties es incl includ ude e all all SFAS 95 also transactions and e#ents that are not of an in#estin! or financin! nature. includ ude e o% o%ta tain inin in! ! reso resour urce ces s from from ow owne ners rs and and (#! Fina Financi ncing ng activi activitie ties s incl pro#idin pro#idin! ! them them with a return return of or a return on 5di#idends6 their in#estment. $hey $hey also also incl includ ude e o% o%tai taini nin! n! reso resour urces ces from from credi creditor tors s and and repay repayin in! ! the the amounts %orrowed or otherwise settlin! the o%li!ations. (3! Investing activities include ac(uirin! and sellin! or otherwise disposin! of %oth securities that are not cash e(ui#alents and producti#e assets that are e)pected to !enerate re#enues o#er the lon!+term. $hey also include lendin! money and collectin! on such loans.

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E)ercise 7+:9concluded %. SFAS re(uires that all si!nific si!nificant ant financin financin! ! and in#esti in#estin! n! acti#it acti#ities ies %e SFAS 95 re(uires disclosed. For e)ample, noncash transactions that include the con#ersion of de%t to e(uity, the ac(uisition of assets throu!h the issuance of de%t, and e)chan!es of assets or lia%ilities, should %e disclosed in a separate schedule of noncash in#estin! and financin! acti#ities. c. 586 Net inco income me is the the starti startin! n! point point of of the computat computation ion of of CF'. CF'. SFAS 95 does does not re(uire the separate disclosure of e)traordinary items in the CF. 5:6 0epreciation 0epreciation is added %ac1 as an e)pense not not re(uirin! re(uirin! cash. 56 $he write+off write+off of uncolle uncollecti% cti%le le recei# recei#a%le a%les s does not affect affect cash. cash. imilar imilarly ly,, the the %ad %ad de%t de%t e)pe e)pens nse e does does no nott re(u re(uir ire e an ou outla tlay y of cash. cash. ince ince this this corp corpor orat atio ion n uses uses the the indi indire rect ct meth method od for for pres presen enta tati tion on of CF', CF', no additional ad*ustment is needed %eyond the ad*ustment for the chan!e in the net accounts recei#a%le, which includes the credit to the allowance for dou%tful accounts. 5=6 $he H8=G,GGG increase increase in accounts recei#a%le recei#a%le means that that some sales ha#e not %een collected in cash and, accordin!ly, net income is reduced %y H8=G,GGG in arri#in! arri#in! at CF'. $he H@G,GGG decline in in#entorie in#entories s means that cost of !oods sold includes includes in#entories in#entories paid for in prior years, and did not re(uire cash this year. As such, net income is increased %y H@G,GGG in arri#in! at CF'. 5?6 $his HG,GGG HG,GGG is an e)pense e)pense re(uiri re(uirin! n! cash9no cash9no ad*ustm ad*ustment ent is called called for. for. $his $h is amo amount also also mu must st %e disc disclo lose sed d as part part of the sup supplem plemen enta tall disclosures. 5@6 A reconstru reconstructed cted analytical analytical entry would appear appear as& Cash Cash.. .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... G,G G,GGG GG Accumu mula latted 0epreci eciatio tion.. n..... ...... ..... ?G, ?G,GGG E................................................ 7?,GGG >ain on sale of machine.............. ?,GGG $he $h e HG, HG,GG GGG G incr increa ease se in cash cash is show shown n as a sour source ce from from in# in#esti estin! n! acti#ities. $he H?,GGG !ain is deducted from 5remo#ed from6 net income so that that the the enti entire re proc proceed eeds s of the the sale sale are shown shown as part part of in#e in#estm stmen entt acti#ities. 576 'nl 'nly y the cash payment payment of H8GG,GG H8GG,GGG G is shown in the CF as an in#esti in#estin! n! acti#ity outflow. In a separate schedule, the purchase of %uildin!s and land for noncash considerations is detailed. 56 $his is a non noncas cash h transactio transaction n that that is disclosed disclosed in a separate separate schedu schedule le of noncash in#estin! and financin! acti#ities. 56 $he declaration of a cash di#idend di#idend creates a current current lia%ility. lia%ility. 0urin! 2ear 2ear , no cash outflow occurs and there is nothin! to report on the 2ear  CF. 58G6$his e#ent has no effect on cash nor need it %e reported in con*unction with the CF. CF.

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E)ercise 7+ 5G minutes6 a. Cash Cash Flows Flows from 'per 'peratio ations ns Comput Computatio ation& n& Net in income..................................................................... Add 5deduct6 items to con#ert to cash %asis& 0epreci 0epreciatio ation, n, depletio depletion, n, and amorti" amorti"atio ation............ n............ 0efe 0eferre rred d inco income me ta)es ta)es.. ..... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ..... Amo mort rti" i"at atio ion n of %on %ond d disc discou oun nt... t..... .... .... .... .... .... .... .... .... .... .... .... .... .... .. Increa Increase se in in accou accounts nts paya%le. paya%le..... ........ ........ ........ ........ ........ ........ ........ ...... 0ecrease in in#entories.. s........................................... ndistri%uted earnin!s of unconsolidated su%si su%sidi diari aries es and and affili affiliate ates... s...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ..... .. Amo morrti" ti"atio tion of of pre premi miu um on on %o %onds pa paya%le a%le.. .... .... .... .... Increase in accounts recei#a%le.. e............................. Cash pro#ided %y operations .....................................

H8G,GGG H,GGG H,GGG =GG =GG ?G 8,:GG 8,:GG ?G 5:GG6 5:GG6 5@G6 @G6 5GG6

8G,?GG H:G,?GG

58,8@G6 H8,=G

%. 586 $he issuance of treasury stoc1 for employee stoc1 plans 5as comp compen ensa sati tion on66 re(u re(uir ires es an add% add%ac ac1 1 to net net inco income me %eca %ecaus use e it is an e)pense not usin! cash. 5:6 $h $he e cash cash ou outfl tflow ow for for inter interes estt is no nott inclu include ded d in e)pens e)pense e and and mu must st %e inclu include ded d as cash cash ou outfl tflow ow in in#e in#esti stin! n! acti# acti#iti ities es 5as part part of ou outla tlays ys for for property.6 56 56 If the the diff differ eren ence ce %etw %etwee een n pens pensio ion n e)pe e)pens nse e and and actu actual al fund fundin in! ! is an accrued lia%ility, the unpaid portion must %e added %ac1 to income as an e)pe e)pens nse e no nott re(u re(uir irin in! ! cash cash.. If the the amou amount nt fund funded ed e)ce e)ceed eds s pens pensio ion n e)pense, then net income must %e reduced %y that e)cess amount.

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E)ercise 7+= 5G minutes6 a. 3e!i e!innin! %al %alance ance of acco ccounts rec recei# ei#a%le. %le........ ...... .. Net sales........ sales ................. .................. .................. ..................... ............ 8,7,GGG $otal tal po pote tent ntia iall rece receip ipts. ts... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .. Endi Endin n! %ala %alanc nce e of acco accoun unts ts rece recei# i#a% a%le le.. .... .... .... .... .... .... .. Cash Cash coll collec ecte ted d from from sale sales.. s.... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... ..

H G?, G?,GGG GGG

%. Endi Endin n! %ala %alanc nce e of in#en n#ento tory ry.. .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... Cost Cost of sal sales es.. .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .. $otal ..... ........ ...... ...... ...... ...... ...... ...... ...... ...... ...... ..... ..... ...... ...... ....H8 .H8,@ ,@, ,GGG GGG 3e!i 3e!inn nnin in! ! %ala %alan nce of in# in#ento entory ry.. .... .... .... .... .... .... .... .... .... .... .... .... .... urc urcha hase ses. s... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... ..

H ?=, ?=,GG GGG G J8,8 J8,8?G ?G,G ,GGG GG

3e!i 3e!inn nnin in! ! %ala %alan nce of acco accou unts nts pay paya%le a%le.. .... .... .... .... .... .... urc urcha hase ses s 5fro 5from m a%o# a%o#e6. e6... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... $otal tal po pote tent ntia iall paym paymen ents ts.. .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .. Endin! %ala alance of accounts paya% aya%le le.. .... .... .... .... .... .... .... .... .. Cas Cash pay payme ment nts s for for acco accoun unts ts pay paya%le a%le.. .... .... .... .... .... .... .... ....

H ?@, ?@,GG GGG G 8,:@ 8,:@, ,GG GGG G H8, H8,8 8,G ,GGG GG + @G= @G=,GGG GGG H8,: H8,::7 :7,G ,GGG GG

H:,: H:,:=: =:,G ,GGG GG + :?, :?,GG GGG G H8, H8,=7 =7,G ,GGG GG

+ =8, =8,GG GGG G H8,: H8,:@ @,G ,GGG GG

c. Issu Issuan ance ce of comm common on stoc stoc1. 1... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .. Issu Issuan ance ce of trea treasu sury ry stoc stoc1. 1... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .. $otal tal no nono nope pera rati tin! n! cas cash rece receip ipts ts.. .... .... .... .... .... .... .... .... .... .... .... ..

H

8,G 8,GGG GG 87,G 87,GGG GG ,G ,GGG GG

H

d. Incr Increa ease se in land land.. .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .. Inc Increas rease e in plan lant and and e(ui e(uipm pmen ent. t... .... .... .... .... .... .... .... .... .... .... .... .... $otal tal pay payment ments s for for no non ncurr curren entt asse assets ts.. .... .... .... .... .... .... .... ..

H 8?G, 8?G,GG GGG G 8,G 8,GGG GG H 8@, 8@,GG GGG G

E)ercise 7+? 5:G minutes6 Sorce

a. %. c. d. e. f. !. h. i. *.

$se

Ad%st&ent

'ategor

 



' F F I F NCN I NC F '

     



7-13


E)ercise 7+@ 5:G minutes6 Sorce

a. %. c. d. e. f. !. h. i. *.

$se

Ad%st&ent

'ategor



' F NCN I NC NCN I NC NE NE

   

E)ercise 7+7 5G minutes6 )et Inco&e

8. :. . =a. =%. =c. ?. @. 7. . . 8G. 88. 8:. 8.

NE NE J + NE586 + NE + + J J56

NE NE J NE J5:6 J5:6 J J 5lon!+run +6 +5?6 NE J5=6 NE J NE NE

'ash fro& operations

J J J NE J5:6 J5:6 J J 5lon!+run +6 J NE J5=6 J J NE NE

'ash position

J J J J

586

0eferred ta) accountin!. 0epends on whether ta) sa#in!s are reali"ed in cash. 56 If profita%le. 5=6 If accounts recei#a%le collected. 5?6 0epends on whether interest is paid or accrued. acc rued. 5:6

Further e)planations 5listed %y proposal num%er6& 8. u%stitutin! u%stitutin! payment payment in stoc1 stoc1 for payment payment in cash for its di#idends di#idends will will not affect affect income income or CF' %ut will increase cash position. :. In the short run, run, postponem postponement ent of capital capital e)pendi e)penditure tures s will sa#e cash cash %ut ha#e no effect effect on income or CF'. In the lon! term, %oth income and CF' may suffer due to lower operatin! efficiency.

7-14


E)ercise 7+79continued . Cash Cash not spent spent on repair repair and mainten maintenance ance will will increa increase se all three three measures measures..
7-15


E)ercise 7+ 5:G minutes6 a. 0eprecia 0epreciation tion is neither neither a source source nor a use of cash. Instea Instead, d, depreciati depreciation on is an allocation of the cost of an asset o#er its useful life. %. A ma*or ma*or cause cause of the %elief %elief that deprecia depreciation tion is a source source of cash is the Badd %ac1B %ac1B prese present ntati ation on in the the CF CF prepar prepared ed usin usin! ! the the indir indirec ectt format format.. $h $his is presen presentat tatio ion n adds adds deprec depreciat iation ion to net net inco income me and and !i#es !i#es the the erro errone neou ous s impression that it increases cash from operations. c. $here $here is on one e sense sense in which which deprec depreciat iatio ion n is a sourc source e of cash, cash, and for this this reason we must not over emphasi"e emphasi"e the idea that depreciation is not a source of cash. Namely, when sellin! prices are sufficient to reco#er the depreciation e)pense allocated to products sold, then re#enues do pro#ide mana!ement with a discretionary, e#en if temporary, inflow of cash 5assumin! no si!nificant chan!e chan!e in operatin operatin! ! wor1in! wor1in! capital6 capital6.. Normall Normally y, mana!e mana!emen mentt will ha#e ha#e to in#est this cash in fi)ed assets replacements to continue in %usiness on a lon!+term %asis.
7-16


E)ercise 7+ 5@G minutes6 a. Cash Cash Collecti Collections ons Comput Computation ation&& Accounts Recei#a%le 5Net6 3e! Ma ales M8 End M

?@=.8 @:G?. @8=?.=

Cash collections M%

@:=.?

Notes& Ma 3al 3alance ance at 7O: 7O:OO2ear 8G.. G..... ....... ...... .... ........ ...... ........ ...... .... ........ ...... .... ........ ...... H@:= H@:=.? .? M M -ess& increase in 2ear 8G................. 8G...... ..................... ..................... ............. .. 5@G.=6 M@8 H?@=.8 M%$his amount is o#erstated %y the pro#ision for dou%tful accounts e)pense that is included in another e)pense cate!ory.

%. Cash Cash 0i#iden 0i#idends ds aid aid Compu Computatio tation& n& 0i#idends aya%le 0i#idend paid M77

87.?

:.

3e! M=

8 = : .:

0i#idend declared Ma M

7.G

End M=

Note Ma& Item M represents di#idends declared, not di#idends paid 5see also Item M776.

c.

Cost Cost of >oo >oods ds and and er# er#ice ices s rod roduc uced ed Comp Comput utati ation on&& In#entories

3e! M= Amount to %alance

End M=

8.

=G?.?

Cost of products sold M8=

 : . =

[email protected]

d. $he entry for the income income ta) ta) pro#ision pro#ision for 2ear 2ear 88 is& Inco Income me ta) ta) e)p e)pense ense M:7 M:7.. .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... :@?. :@?.  0eferred 0eferred income ta) 5current6 5current6 plu!................. plu!............ ..... 8:.8 Income ta) ta) pay paya%le.............................................. :G.= 0eferred income ta) 5noncurrent6 Ma ............ ....... ....... .. :.= Notes& 586 $he entry increases increases current lia%ilities lia%ilities %y H8:.8 H8:.8 since deferred deferred income ta) 5current6 5current6 is credited %y this amount. It also increases current lia%ilities %y H:G.= M8:=A, the amount of income ta)es paya%le. 5:6 $he Ma is the difference in the %alance of the noncurrent deferred income ta) item M87@ D H:?.? + H:?.8 D H:.=. 56 Also, Also, H:.= J H8:.8 D H?.?, which is total deferred de ferred ta) M? or M8:7A

7-17


E)ercise 7+9continued e. 0epreciation 0epreciation e)pense e)pense has no effect on on cash from operations. operations. $he $he credit, when when recordin recordin! ! the depreci depreciatio ation n e)pense e)pense,, !oes !oes to accumul accumulated ated deprecia depreciation tion,, a noncash account. f. $hese $hese pro#isio pro#isions ns are added added %ac1 %ecause %ecause they they affect affect only nonc noncash ash accou accounts, nts, the char!e to earnin!s must %e remo#ed in con#ertin! it to the cash %asis. !. $he $he KEff KEffec ectt of e)ch e)chan an!e !e rate rate chan chan!e !es s on cash cashL L repr repres esen ents ts tran transl slat atio ion n ad*ustments 5differences6 arisin! from the translation of cash from forei!n currencies to the .. dollar. h. Any !ain or loss loss is reported reported under Bother, Bother, netB9Item netB9Item M@G. M@G. i. Free ree ca cash flo flows D Cash flow from operations P Cash used for capital additions P 0i#idends paid 2ear 2ear 88& 88& HG?.: HG?.: P H@8.8 H@8.8 P H87.? D HG@.@ 2ear 2ear 8G& H==.= H==.= P H7.@ P H8:=. D H5@.?6 H5@.?6 2ear 2ear & H?7. P H:=.8 H:=.8 P H@.7 D H58.?6 H58.?6 *. tart+up companies companies usually usually ha#e !reater capital addition re(uirements re(uirements and lower cash inflows from operations. Also, start+ups rarely pay cash di#idends. Free cash flow earned %y start+up companies is usually used to fund the !rowth of the company, especially if successful. 1. 0urin! 0urin! the laun launch ch of a new product product line, line, the statement statement of cash flows flows can %e affected in se#eral se#eral ways. First, cash flow flow from operations operations is lower %ecause su%stantial ad#ertisin! and promotion is re(uired and sales !rowth has not yet yet %een %een ma)im ma)imi" i"ed ed.. eco econd, nd, su%st su%stan antia tiall capita capitall additi additions ons are are usua usuall lly y necessary to pro#ide the infrastructure for the new product line. $hird, cash flow from financin! can %e affected if financin! is o%tained to launch launch this new product line.

7-18


E)ercise 7+8G 58? minutes6 a. Re#enues Re#enues are, in certain certain instances, instances, reco!ni"ed reco!ni"ed %efore %efore cash is recei#ed recei#ed 5that is, when earned6. E)penses are, in certain instances, reco!ni"ed after cash is paid 5that is, matched with re#enues6. re#enues6. As a result, net income can %e positi#e when operat operatin! in! cash flows flows are ne!ati#e ne!ati#e.. Conside Considerr some e)amples& e)amples& 586 If accounts recei#a%le increase su%stantially durin! the year, this implies that re#enues re#enues outpaced outpaced cash collections. collections. 5:6 If a company %uilds %uilds up its in#entory in#entory le#els su%stantially su%stantially,, then cash cash is paid out %ut no e)pense is reco!ni"ed. reco!ni"ed. 56 If the company reduces its accounts paya%le %alances su%stantially durin! the year, then cash flows can %e ne!ati#e when net income is positi#e. %. 'peratin 'peratin! ! cash flows can ser#e ser#e as one indicato indicatorr of earnin earnin!s !s (uality (uality %ecause %ecause o#er o#er a nu num%e m%err of years, years, cash flows should should appro)imat appro)imate e earnin!s. earnin!s. If cash flows from operations are consistently lower than earnin!s, it is possi%le that the reported earnin!s are not of hi!h (uality. 5As with any %road !uideline, one must loo1 for corro%oratin! e#idence.6 E)ercise 7+88 58? minutes6 a. 0urin! 0urin! the !rowth !rowth sta!e, a company company in#ests in#ests hea#ily hea#ily in infrastru infrastructu cture re !rowth and into ad#erti ad#ertisin! sin! and promotio promotion. n. As the company company transit transition ions s into the Kcash cowL sta!e, the company reduces the in#estment in#estment in %oth infrastructure infrastructure !rowth and ad#ertisin ad#ertisin! ! and promotional promotional acti#ities. acti#ities. $his transition transition would %e manifested in the statement of cash flows %y increased operatin! cash flows 5less cash outflows for ad#ertisin! and promotion, hi!her mar!ins, so forth6 and decreased use of cash for in#estin! acti#ities. %. $he decline of of a Kcash cowL cowL would would %e reflected reflected in the statement statement of cash flows flows %y declinin! declinin! cash flows from from operations. operations. $he declinin! declinin! operatin! cash cash flows will result from declinin! sales of the fadin! Kcash cowL products.

7-19


R'3-E/ ro%lem 7+8 5@G minutes6 W'RQ
@: ? =8 == 8 7?

0i#idends 0i#idends Recei#ed E(uity in income of unconsolidated affiliates.............................. := 0istri%utions %eyond e(uity in income of affiliates c................................. D 0i#idends from unconsol. affiliates............ 8@A CA< F-'W FR'/ 'ERA$I'N ................ a

% c

Reported

Ad*ust.

Re#ised

H @ , : G = .8 : @ .G 8 7 .8

H 7 .? C C

H@,:88.@ : @ .G 8 7 .8

H@,:=7.: H ? ,   8 .G

H7.? H 7 .?

H@,:?=.7 H ? ,   .?

5:G.@6 5?.?6 5@.:6

5:G.@6 5?.?6 5@.:6

H 5=.76 5:?.6 = : . 5:8.6 5:@.6 ?. H ? , = ? G .:

H 5=.76 5:?.6 = : . 5:8.6 5:@.6 ? . H ? , = ? 7 .7

G.G H 7 .?

: .= ?. H  .: H G  G ? .:

: .= G.G H G .G H G .G

? . H  .: H G  G ? .:

$otal costs and e)penses M::A J $a)es on earnin!s M:7 J /inority interests M:? J Interest income M8 D H?,?8. J H:@?. J H7.: J H:@.G D H?,8 It is assumed that accruals, payrolls, etc., are part of item M87?. A reconcilin! reconcilin! amount to tie in with the H.: di#idends di#idends from affiliates 5item 8@A6 #ersus e(uity in earnin!s of affiliates 5item :=6.

7-20


ro%lem 7+: 57? minutes6 a. W'RQ
Re#ised

H @ , : G ? .

H 7 .?

H @ ,: 8  . 

5@G.=6

5@G.=6

G.G H @ , 8 = ? .=

G.G H 7 .?

G .G H @ ,8 ? : .

H @ , : 8 = .

H 7 .?

H @ ,: : : . =

5:GG.6 5.6

5:GG.6 5.6

? @G

5.86 5:=.76

5.86 5:=.76

58G.76

58G.76

@  . G.G H ? , 7 G = .=

@  . G .G H?,788.

0i#idends 0i#idends Recei#ed E(uity in income of unconsolidated unconsolidated af affiliates......................................................... := + ndistri%uted e(uity in income of affiliates......................................................... 8@A D 0i#idends from unconsol. affils.................. Cash Flow From 'perations.......................... SS

Ad*ust.

?7 ?

Chan!es in Current Assets and -ia%ilities related to operations I 506 in in#entories......................................... @: I 506 in prepaid e)pense...................... e)pense.......... ..................... ......... 5I6 0 in accounts paya%le.............................. paya%le.............................. 5I6 0 in ta)es paya%le........................... paya%le.................................... ......... 5I6 0 in accruals, payrolls, payrolls, etc................ etc.......... ........... ....... 5I6 0 in di#idends di#idends paya%le............................. I or 0 other SS................................................. @ I or 0 in noncurrent amounts....................... D Cash 0is%ursements............................

S

Reported

G.G H 7 .?

8  .? [email protected] 7.= H == ==.=

8  .? G.G

[email protected] 7 .= H == ==.=

'ther, net M@G H8.@ J M8@A [email protected] D H:=.7 Camp%ell shows a com%ined fi!ure instead of details of operatin! assets and lia%ilities.

7-21


ro%lem 7+ 57? minutes6 a. Tett Company tatement of Cash Flows For the 2ear Ended 0ecem%er 8, 2ear : Cash flows from operatin! acti#ities Net Income.............................................................. H7,GGG Add 5deduct6 items to con#ert to cash %asis 0epreciation....................................................... ?,GGG -oss on sale of fi)ed assets............................. 8,GGG >ain on sale of in#estment............................... 5,GGG6 0ecrease in in#entory........................................ :,GGG Increase in recei#a%les..................................... 5?,GGG6 0ecrease in accounts paya%les....................... 57,GGG6 Net cash pro#ided pro#ided from operatin! operatin! acti#ities acti#ities Cash flows from in#estin! acti#ities ale of fi)ed assets............................................... ale of in#estments............................................... urchase of fi)ed assets...................................... Net cash pro#ided from in#estin! acti#ities Cash flows from financin! acti#ities ale of unissued common stoc1.......................... urchase of treasury stoc1................................... Net cash used %y financin! acti#ities.................. Net Increase in cash..............................................

@,GGG ,GGG 5=,GGG6 88,GGG 8,GGG 588,?GG6 58G,?GG6 ?GG

Spple&ental disclosre of 'ash Flow infor&ation

Cash paid durin! the year for& Interest................................................................................ Income ta ta)es...................................................................... Schedle of noncash investing and financing activities& Ac(uisition of fi)ed assets %y issue of %onds..................... Con#ersion of %onds into common stoc1............................

7-22

G

=,GGG @,GGG G,GGG 8G,GGG


ro%lem 7+9continued %. Tett Company Comparison of Accrual and Cash Reportin! Inco& co&e Stat tate&en e&entt

'ash fro& ro& operati ratio o ns

ales...........................................

H7G,GGG

H@?,GGG

>ain on sale of in#estments. . . .

,GGG

5a6

H7,GGG

H@?,GGG

urchases..................................

5=G,GGG6

5=7,GGG6

0ecrease in in#entory...............

5:,GGG6

9

0epreciation...............................

5?,GGG6

5c6

E)penses paid...........................

58,GGG6

-oss on sale of fi)ed assets. . . .

58,GGG6

Net income.. e..... ...... ....... ....... ...... .... .... .... .... .... .... .... ....

Collection from customers

ayments to suppliers 5%6

58,GGG6 5d6

H 7,G 7,GG GG

Cash from operations...............

H

G

Notes& 5a6 'mitted 'mitted %ecause it is lin1ed lin1ed with proceeds proceeds from sale of in#estmen in#estments ts 5in#estin! 5in#estin! acti#ities6. 5%6 urchase urchase of H=G,GGG J 0ecrease in accounts accounts paya%le paya%le of H7,GGG. H7,GGG. 5c6 No cash cash re(uir re(uired. ed. 5d6 -in1ed with sales of fi)ed fi)ed assets 5in#estin! 5in#estin! acti#ities6. acti#ities6.

c. $he income income statemen statementt prepa prepared red on the the accr accrua uall %asis %asis is desi!n desi!ned ed to reflec reflectt profita%ility. Cash from operations measures the effects on cash of operatin! acti#ities, and is %est for li(uidity and sol#ency analyses.

7-23


ro%lem 7+= 57? minutes6 a. 0a) Corporation tatement of Cash Flows For the 2ear Ended 0ecem%er 8, 2ear : 5H thousands6 Cash pro#ided from 5used for6 operations Net Net Incom Income. e.... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ..... H8@G H8@G Add 5deduct6 items to con#ert to cash %asis& Amo mort rti" i"at atio ion. n... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .. 8G 0epr 0eprec ecia iati tio on... n..... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .. ? Inc Inc. in acco accou unts nts paya% aya%le le.. .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... G Inc Inc. in defe deferr rred ed inco income me ta). ta)... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .. 8: Inc. in in ot other cu current li lia%i a%iliti lities es...... ...... ....... ...... ...... ...... ...... ...... ....... ...... .... .. 7 Inc. Inc. in in acco accoun unts ts rece recei# i#a% a%le. le... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .. 58G 58G66 Inc. Inc. in in#e in#ent ntor ories ies.. ..... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ..... ..... ...... ...... ...... ...... ... 58=?6 58=?6 Inc. Inc. in prep prepai aid d e)pe e)pens nses es.. .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... 5:?6 5:?6 Net cash used for operations......................................... Cash pro#ided from 5used for6 in#estin! acti#ities urc urcha hase se of paten patents. ts.... ..... ..... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ..... .. Add ddit itio ion n to pla plant nt and and e(u e(uip ipme ment nt.. .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... Add ddit itio ion n to oth other er ass asset ets. s... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .. Net cash used for in#estin! acti#ities........................... Cash pro#ided from 5used for6 financin! acti#ities Add ddit itio ion n to lon! lon!+t +ter erm m de%t. de%t... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .. Issu Issuan ance ce of comm common on stoc stoc1. 1... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... 0i#i 0i#ide dends nds paid paid ...... ......... ...... ...... ...... ...... ...... ...... ...... ...... ..... ..... ...... ...... ...... ...... ...... ...... ...... ...... ..... .. Net cash pro#ided from financin! acti#ities................ Net decrease in cash.......................................................

58=G6 58=G6 57GG 57GG66 5:?6 5:?6 5@?6

GG GG :GG :GG 58G6 58G6 8 H58=G6

Spple&ental disclosre of cash flow infor&ation

Cash paid durin! year for& Interest................................................. Income ta)es.......................................

H:,GGG H7G,GGG

7-24

H58@@6


ro%lem 7+=9continued %. $he ma*or ma*or reasons reasons for the differe difference nce %etween %etween net net income income of H8@G and cash outflow for operations of H8@@ are the hea#y in#estments in in#entories of H8=? and the increased le#el of financin! of customers e#idenced %y a H8G hi!h hi!her er rece recei# i#a% a%le les s %ala %alanc nce. e. Comp Compar ared ed to thes these e hea# hea#y y in# in#estm estmen ents ts in operatin! assets, accounts paya%le ha#e increased #ery modestly. With risin! sales and profits, the company is e)periencin! a prosperity s(uee"e. c. $his situatio situation n must %e addressed addressed %efore %efore the li(uidity li(uidity pro%lem pro%lem %ecomes %ecomes more serious. $he followin! actions are reasona%le recommendations& 8. $he $he lar! lar!er er #olu #olume me of pu purc rcha hase ses s *ust *ustif ifie ies s incr increa ease sed d trad trade e cred credit it.. $h $he e resu resulti ltin! n! e)pan e)pansio sion n of acco accoun unts ts paya paya%l %le e wou would ld incr increas ease e cash cash from from operations. :. $h $he e comp compan any y needs needs a lar!e lar!err e(ui e(uity ty capit capital al %ase. %ase. With increas increasin in! ! profi profits ts and with the company %ein! in a !rowth industry this may %e a !ood time to sell stoc1 without dilutin! earnin!s per share. . Issu Issuan ance ce of e(uit e(uity y wil willl form form a !o !ood od %ase %ase for for furth further er %orro %orrowin win! ! shou should ld %usiness continue to e)pand rapidly. =. After fter addi additio tional nal e(uit e(uity y capita capitall has has %een %een o% o%tai taine ned d the the compa company ny should should consider lowerin! the di#idend payout. For a fast !rowin! and profita%le company such as 0a), a di#idend payout ratio of @U 5H8GOH8@G6 is (uite hi!h hi!h.. >i#en >i#en its curre current nt profi profitt op oppor portu tuni nitie ties, s, more more earn earnin in!s !s shou should ld %e retained in the %usiness.

7-25


ro%lem 7+? 5=G minutes6 Nia!ara Company tatement of Cash Flows For 2ear 2ear Ended 0ecem%er 8, 2ear 2ear  Cash flows from operatin! acti#ities Cash receipts from operations ales ales Ma... Ma...... ...... ..... ..... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ..... HG HG Cash payments for operations urc urcha hase ses s of in# in#ento entory ry M%.. M%.... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .. 5@=? 5@=?66 ell ellin in! ! and and !ene !enera rall e)pe e)pens nses es ... ..... .... .... .... .... .... .... .... .... .... .... .... .... .... .... 58GG 58GG66 Inte Intere rest st e)pe e)pens nse e Mc. Mc... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... 5=G6 5=G6 Inco Income me ta) ta) e)pe e)pens nse e Md.. Md.... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .. 5G6 5G6 Cash fl flows fr from op operations.........................................

H8@?

Cash flows from in#estin! acti#ities urchase of fi)ed assets.........................................

58?G6

Cash flows from financin! acti#ities Repa Repay yment ment of no note tes s pay paya%le a%le.. .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... Issu Issua ance of lon! n!+t +te erm de%t... t.......... ...... .... .... .... .... .... .... .... .... .... .... .... .... .... .. Cash Cash di# di#iden idends ds paid. paid... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .. Cash flows used in financin!....................................... Net increase in cash......................................................

5:?6 5:?6 ?G 5G 5G6 5?6 H 8G 8G

3e!innin! cash %alance................................................ Endin! cash %alance..................................................... Notes& Ma ales.. ales..... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ....... ........ ........ ....... ...... ... -ess -ess incr increa ease se in rece recei# i#a% a%le les.. s.... .... .... .... .... .... .... .... .... .... .... ..... ...... ...... ...... ...... ..... .. Cash collections................. collections............................... ........................... ............................. ................ M% Cost Cost of !ood !oods s sold... sold...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ... Add Add incr increa ease se in in#e in#ento ntori ries. es... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .. -ess -ess incr increa ease se in paya%l paya%les. es... .... .... .... .... .... .... .... .... .... .... .... ..... ...... ...... ...... ..... ..... ...... ...

?G H @G

H8,GGG H8,GGG 5:G 5:G 6 HG H 5@?G6 5@?G6 5:G6 5:G6 :? 5@=?6

Mc Intere Interest st e)pens e)pense.. e..... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ....... ........ ........ ........ ........ .... -ess -ess incr increa ease se in inte intere rest st pay paya%le a%le.. .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... ....

H

5?G6 5?G6 8G

Md Md Incom Income e ta) ta) e)pe e)pens nse. e... .... .... .... .... .... .... .... .... .... .... .... .... .... .... ..... ...... ...... ...... ...... ..... ..... ...... ..... -ess increase in deferred income ta)......................... ta)................... ......

H

5=G6 5=G6 8G

5=G6

5G6 Note& urchase urchase of fi)ed assets is computed from depreciati depreciation on e)pense plus chan!e in fi)ed assets assets 5H8GGJH? 5H8GGJH?G6. G6. 0i#idends 0i#idends paid paid is comput computed ed from from net income income and chan!e chan!e in retain retained ed earnin!s 5H@G+HG6. Spporting schedle for 'FO & Net income...... income.......... ......... .......... ......... ......... ......... ......... ......... ......... ......... ......... .......... ......... ......... ......... ......... ......... ......... ......... .......... ......... ... H @G Add Add depreci depreciati ation.. on..... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ....... ...... 8GG Incre Increas ase e in defe deferr rred ed ta). ta)... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... ..... ..... .. 8G Increas Increase e in recei# recei#a%l a%les. es.... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ....... ........ .... 5:G6 5:G6 Increas Increase e in in#ento in#entory. ry.... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ....... ........ ........ ...... .. 5:G6 5:G6 Incre Increas ase e in accou account nts s paya%l paya%le.. e.... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... ..... ...... ...... ...... ..... .. :? Increas Increase e in intere interest st paya%le paya%le... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ....... ........ ...... .. 8G Cash Cash flows flows from operatio operations.. ns..... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ..... .. H8@? H8@?

7-26


ro%lem 7+@ 5? minutes6 Effects

Analytical Entries 5'ptional6

a. M+2, 88,GGG MCC, 88,GGG

3ad 0e 0e%t E) E)pense.......................... Allowance for 3ad 0e%t..........

88,GGG

%. M+2, 8@,GGG M2A, 8@,GGG

0epreciation................................... Accumulated 0epreciation. . . . .

8@,GGG

c. MNA MNAA, 8GG, 8GG,GG GGG G MN0E, 8GG,GGG

3uil 3uild din!. in!... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .. -on!+$erm Note aya%le.........

8GG, 8GG,GG GGG G

f. MJC, 8G,GGG M+2, :,GGG MCC, 8: 8:,GGG

Cash................................................. -oss................................................. In#entory...................................

8G,GGG :,GGG

!. MJC, ?, ?,GGG M0C, ?, ?,GGG MCC, :? :?,GGG MJ2, 8?,GGG

Cash................................................. Accounts Re Recei#a%le..................... In#entory................................... >ain...........................................

?,GGG ?,GGG

h. MCC, ,GGG M+2, ,GGG

Allowance........................................ 3ad 0e%t E)pense.......................... Accounts Recei#a%le...............

?,GGG ,GGG

i. MAA MAA, 8GG,GGG ,GGG M+C, 8GG,GGG M+2, :G,GGG M2A, :G,GGG

Assets sets..... ...... ....... ...... ...... ...... ...... ...... ...... ....... ...... ...... ....... ...... .... Cash.......................................... 0epreciation e)pense.................... Accumulated 0epreciation. . . . .

8GG, GG,GGG

*. MJC, ,GGG MA0, , ,GGG M2A, 8,GGG M+2, 8,GGG

Cash........... Cash.................... ................. ................. ..................... ............ -oss on ale................................... /achinery 5net6.........................

,GGG 8,GGG

88,GGG 8@,GGG 8GG,GGG

d. None e. None

7-27

8:,GGG

:?,GGG 8?,GGG

,GGG 8GG,GGG :G,GGG :G,GGG

,GGG


ro%lem 7+7 5@G minutes6 art I. Effects a. M0-, 8G 8GG,GGG M+C, 8GG,GGG

Analytical En Entries 5' 5'ptional6 Current o ortion of of -+ -+$ 0e 0e%t... ....... ...... .... Cash..........................................

%. MJC, =,GGG MA0, =, =,GGG M2A, 8,GGG M+2, 8,GGG

Cash................................................. -oss................................................. E(uipment.................................

=,GGG 8,GGG

c. M+2 M+2, 7?,GGG MCC, 7? 7?,GGG

-oss................................................. In#entory...................................

7?,GGG

d. MJC, :, :,GGG M0E, :,GGG

Cash................................................. aid+In Capital................................ $reasury stoc1..........................

:,GGG :,GGG

e. MNA MNAA, GG, GG,GG GGG G MN0E, GG,GGG

lan lantt Asse Assets ts.. .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .. /ort!a!e aya%le.................... /ort!a!e aya%le9Current. . .

GG, GG,GG GGG G

f. MJC, @,GGG MJ2, G,GGG M2, :=,GGG

In#estment....................................... E(uity in NI of u%sidiary. . .. . . . Cash................................................. In#estment

G,GGG

!. MJC, 8G, 8G,GGG MJ2, =G,GGG M0C, 8G,GGG MNC, :G :G,GGG

Cash................................................. Accounts Re Recei#a%le, cu current....... Accounts Recei#a%le, noncurrent ales..........................................

8G,GGG 8G,GGG :G,GGG

h. M0C, , ,GGG MJ2, ,GGG

In#entory......................................... Cost of >oods old.................

,GGG

i. M0C M0C, :@G, @G,GGG GGG MCC MCC, 8@G 8@G,,GGG GGG M0E, =8G,GGG M+C, @G,GGG

Current Assets sets.. ....... ...... ...... ...... ...... ....... ....... ...... .... .... .. lan lant an and E( E(uipme ipmen nt... t......... ...... .... .... .... .... .... .... Current -ia%ilities.................... -on!+$erm 0e%t....................... Cash 5H=GG+H=G6.......................

:@G, @G,GGG @7G, 7G,GGG

*. M+2, M+2, @G,GGG MCC, @G,GGG

E)pense......... E)pense.................. .................. ................. ................ ........ @G,GGG Allowance for dou%tful accounts

7-28

8GG,GGG 8GG,GGG

?,GGG

7?,GGG

G,GGG :?G,GGG ?G,GGG G,GGG @,GGG @,GGG

=G,GGG ,GGG

8@G,GGG =8G,GGG @G,GGG @G,GGG


ro%lem 7+79continued art II. Effects

Analytical En Entries 5' 5'ptional6

a. MAA MAA, 8:G, 8:G,GG GGG G M+C, 8:G,GGG

In# In#estm estmen ent. t... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .. Cash..........................................

8:G, 8:G,GG GGG G

%. M2, 7, 7,?GG MJ2, 7,?GG

In#estment....................................... E(uity in Earnin!s....................

7,?GG

c. MJC, ,GGG MJ2, ,GGG M2, @, @,GGG

In#estment....................................... E(uity in Earnin!s.. Cash................................................. In#estment................................

,GGG

8:G,GGG 7,?GG ,GGG ,GGG ,GGG

d. MJC, =,GGG MA0, =,GGG M2, 8,GGG MJ2, 8,GGG

Cash................................................. E(uipment 5net6........................ >ain on ale ............................

=,GGG

e. MJC, @G @G,GGG MI-, @G,GGG

Cash................................................. Note aya%le 5current6............

@G,GGG

f. MN0R, ,GGG MN0E, ,GGG

3onds aya%le............................... Common stoc1......................... aid+In Capital..........................

,GGG

!. MJC, @,GGG M0E, @,GGG

Cash................................................. $reasury stoc1.......................... aid+In Capital..........................

@,GGG

h8.MA h8.MAA A, :GG, :GG,GG GGG G M0E, 8GG,GGG M+C, 8GG,GGG h:.M0 .M0C, G G,GGG MAA MAA, 8 8G,GGG ,GGG M0E, 8=G,GGG M+C, @G,GGG

In# In#estm estmen ent. t... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .. Common stoc1......................... Cash.......................................... Current As Assets 5H 5H8:G+H=G6............. lan lant an and E( E(uipme ipmen nt... t......... ...... .... .... .... .... .... .... Current -ia%ilities.................... -on!+$erm 0e%t....................... Common stoc1......................... Cash 5H 5H8GG+H=G6.......................

:GG, :GG,GG GGG G

i. M+2, =,GGG M2A, =,GGG

/inority Interest E) E)pense............. /inority Interest.......................

=,GGG

7-29

,GGG 8,GGG

@G,GGG :,GGG 7,GGG =,GGG :,GGG 8GG,GGG 8GG,GGG G,GGG 8G, G,GGG @G,GGG =G,GGG 8GG,GGG @G,GGG =,GGG


ro%lem 7+79continued art II. Effects

Analytical En Entries 5' 5'ptional6

*. M+2, M+2, ?G,GGG MCC, ?G ?G,GGG

In#entory In#entory -oss.............. -oss................................ .................. In#entory...................................

?G,GGG

1. None

Allow. for dou%tful accounts......... Accounts recei#a%le

8,:GG

l. MNA MNAA, 8:G,GG ,GGG MN0E, 8:G,GGG

-ease eased d E(u E(uipmen ment.. t...... ...... .... .... .... .... .... .... .... .... .... -on!+$erm de%t........................

8:G, :G,GGG

m. None

Retained Earnin!s.......................... Common stoc1 ........................ aid+in Capital......................... Capital.........................

8G,GGG

3ad 0e%ts E)pense....................... Allow for 0ou%tful Accounts. .

:7,GGG

n. M+2, :7,GGG MCC, :7,GGG

7-30

?G,GGG 8,:GG 8:G,GGG 8:G,GGG @G,GGG :7,GGG


ro%lem 7+ 5=? minutes6 3IR0 C'R'RA$I'N 3alance heet As of 4anuary 8, 8 , 2ear 2ear 8 Assets Cash.............................................................................. Accounts re recei#a%le................................................... In#entory....................................................................... Current as assets............................................................. ropert roperty y, plant, plant, and e(uipme e(uipment... nt......... ........... ........... ............ ........... ....... .. -ess ess& Accumulated ated depreci recia atio tion... n........ ....... ...... ...... ...... ...... ....... ...... .... .. 'ther noncurrent in#estments................................... $otal assets..................................................................

H ?G,GGG G,GGG 88G,GGG H:?G,GGG H=@?,GGG H=@?,GGG :? :?,GG ,GGG

-ia%ilities and E(uity Accounts paya%le........................................................ Current portion of lon!+term de%t............................. Current lia%ilities......................................................... -on!+term de%t............................................................ Common st stoc1............................................................ Retained earnin!s....................................................... $otal li lia%ilities an and e( e(uity..........................................

:G,GGG ,GGG :=?,GGG H7:?,GGG H @G @G,GGG 88G,GGG H87G,GGG 8?,GGG :G,GGG G,GGG H7:?,GGG

)ote* +-Acconts for ,econstrction of alance Sheet (Optional! Cash 3e! 3e! 5H8GG 5H8GG,GG ,GGG G Endin Endin! ! + H?G,GG H?G,GGG G Incr Incr.6

?G,GG ?G,GGG G 'perations

Net income 586 0epreciation e)pense 5:6 -oss on sale of e(uip 56 Increase in accounts paya%le 5=6

8 ? G ,G G G ? , G GG ? ,G G G =G , G GG

? G ,G G G G,G G,GGG GG : G ,G G G

5?6 >ain on sale of in#estments 5@6 5@6 In Increa crease se in acco accoun unts ts rece recei# i#a% a%le le 576 Increase in in#entory

In#estin! ale of e(uipment 56 ale of in#estments 56

8G , G GG ? , G GG

8?G,GGG 58G6 Addi dditio tions ns to proper property ty and and e(uip. e(uip.

Financin! Issuance of common stoc1 5886 Additions to lon!+term de%t 58 58:6 Endin!

8G , G GG 8? , G GG 8 G G ,G G G

7-31

 G ,G G G  G ,G G G

586 Cash di#idends 58=6 0ecrease in current portion of lon!+term de%t


ro%lem 7+9continued Retained Earnin!s 586

 G ,G G G

roperty, lant, and E(uipment

 G ,G G G 8 ? G ,G G G

3e! 586

3e! 58G6

= @ ? ,G G G 8 ? G ,G G G

8 ? G ,G G G

End

End

? ? G ,G G G

'ther Noncurrent In#estments 3e !

:=? , GG G

E nd

:GG , GG G

= ? ,G G G

@ ? ,G G G

56,56  5a6

Accumulated 0epreciation 5?6,56

5a6

-on!+term 0e%t

? G ,G G G

:? , G GG  ? ,G G G

3e! 5:6

:7G , G GG

End

Common toc1

8  ? ,G G G 8 ? ,G G G

3e! 58:6

:G , G GG 8 G ,G G G

3e! 5886

: G G ,G G G

End

GG , G GG

End

Accounts Recei#a%le

In#entory

3e ! 5@6

 G ,G G G  G ,G G G

3e! 576

88G,GGG : G ,G G G

E nd

8:G , GG G

End

8  G ,G G G

Accounts aya%le

Current ortion of -on!+$erm 0e%t

@ G ,G G G = G ,G G G

3e! 5=6

8 G G ,G G G

End

7-32

58=6

 G ,G G G

88G,GGG

3e!

 G ,G G G

End


ro%lem 7+ 5G minutes6 Curr Curren entt Ratio

a. %. ay. c. ay. d. Rec. e. f. !. h.J i.

Wor1i or1in! n! Capi Capita tall Effect Amount

HG G

Cash Cash from from 'p 'per erat atio ions ns Effect Amount

J +

NE NE

+ NE

+

+

7G,GGG

NE

NE

NE

G

+ J J J +

+ NE J G,GGG +

8GG,GGG G 8?,GGG NE :G,GGG

H8,GGG G

Analy nalyti tica call Entr Entrie ies s 5'pt 5'ptio iona nal6 l6 0r. Cr.

Wa!es aya%le urchases

Cash Acct.

G

-oss

Acct.

J

,GGG

Cash

Acct.

NE NE NE G NE

G G G Cash G

-and Cash Note aya%le Cash Note Recei#a%le -and aid+in Cap /achine Cash +$

-ia%. -+$ -ia%. *. + 1. ay. l. m. ay n.NE

+

?G,GGG

NE

G

+

+

8G,GGG

NE

J NE

NE NE

G G

NE

G

t1 o. NE p. + ay. (. J r. + s. + ec t. NE E)p. u.NE NE #. J w. J 3uildin!

G

3ond aya%le aya%le remium on 3. ay. Retained Earnin!s

Cash >ain 0i#.

NE NE

G G

0i#idend aya%le Retained Earnin!s

Cash t1 0i#

NE

G

toc1 0i#idend ay.

NE NE

G G

NE NE

G G

No entry Cash

Notes

NE + +

G :G,GGG 8?,GGG

+ NE +

:G,GGG Accounts aya%le G atent 8?,GGG -o -oss

Cash Cash /1t%le

NE

G

NE

G

'r!.

G J J

NES :,GGG G,GGG

G NE NES

0epreciation E)p. Accum 0ep G Accounts Recei#a%le ales G Cash

-oss

aid+in Cap Capital

>ain

7-33


).

J /achine

y. ay

+

J +

?,GGG =G,GGG

NE NE

G

Cash

G

Notes Recei#a%le Income $a) E)pense

Inc $a) 0ef

5-$6 S$ransaction does not effect effect cash from operations.
7-34

$a)


ro%lem 7+8G 5=? minutes6 a. $h $he e two two meas measur ures es are are summ summar ary y perf perfor orma manc nce e metr metric ics s from from two two diff differ eren entt stateme statements nts 5or portio portions ns of statemen statements6 ts6 that that deal deal with with op operat eration ions9t s9the he income income statement and the cash from operations 5CF'6 section of the statement of cash flows. $here is considera%le confusion amon! users of financial statements a%out %oth the concept of BoperationsB and a%out the different aspects of operations that these two measures are desi!ned to portray. $he function of the inco&e state&ent is is to measure the profitailit of of the enterprise enterprise for a !i#en !i#en period. period. $his is done %y reco!ni"in! reco!ni"in! re#enue when earned, earned, and then then matchi matchin! n! e)pense e)penses s with those those re#enu re#enues. es. /oreo# /oreo#er er,, costs costs incur incurred red durin! a period that do not create future %enefits must %e char!ed to e)pense re!ardl re!ardless ess of the a#aila a#aila%il %ility ity of related related re#enues re#enues a!ains a!ainstt which which they they can %e matched. While no other statement measures profita%ility as well as the income statement, statement, it does not show the timin! timin! of cash flows and the effect of operations operations on li(uidity and sol#ency. Conse(uently, other speciali"ed statements are needed to focus on the latter factors, which are different dimensions of earnin!+related acti#ities. 'ash 'ash fro& fro& opera operati tion ons s ('FO! ('FO! encom encompa passe sses s the the %roa %roade derr conc concep eptt of oper op erati ation ons s comp compare ared d with with net net inco income me.. It enco encomp mpass asses es all all earni earnin! n!+re +rela late ted d acti#ities of the entity and it is concerned not only with re#enues and e)penses %utt also %u also with with the the cash cash dema demand nds s of these these acti# acti#it itie ies s such such as in#e in#estm stmen ents ts in customer recei#a%les and in in#entories as well as the financin! pro#ided %y suppliers of !oods and ser#ices. We can arri#e at operatin! cash receipts and dis%ursements %y ad*ustin! net income for items needed to con#ert it to the cash %asis 5indirect format6. We must remem%er that CF' focuses on li(uidity and is not a measure of profita%ility as it e)cludes important costs such as the use of lon!+li#ed assets in operations, nor important re#enues such as e(uity in the earnin!s of nonconsolidated su%sidiaries or affiliates. %. Analy Analysis sis of $ra $ransa nsactio ctions ns Net Income

8. :. . =. ?. @. 7. . . 8G . 88. 8: . 8 . 8= . 8? . 8@ . 87 . 8 . 8 . :G . :8 . :: .

J J NE NE NE + NE + NE + NE + + + NE J + NE + + NE NE

Cash from 'perations

NE NE NE NE J NE NE NE + NE NE NE NE NE NE NE NE NE NE NE NE +

7-35


ro%lem 7+88 57? minutes6 a. As an initial step, step, the effect effect of the Qraft Qraft ac(uisition ac(uisition must first %e remo#ed remo#ed from from the hilip /orris 5/6 accounts. $he resultin! %alance sheet chan!es are hilip /orris /orri s nad*usted nad*u sted 2ear 2ear 7 2ear 2ear  Chan!e Chan!e 8?7

H

7?

H 5@G86

Accts. Rec%le .

H:,G@?

H :,:::

In#entories ....

=,8?=

?,=

8,:G

8,::

5:6

E .............

@,?:

,@=

:,G@@

8,7=G

:@

>oodwill ........

=,G?:

8?,G78

88,G8

8G,@8

@?

+$ 0e%t........

8,==G

8,:?

5886

7GG

586

Accts. ay. . . . .

78

8,777

@

?7

=G

Accrued lia%..

:,:77

,=

8,?78

?G

8,G=8

-+$ 0e%t.........

@,:

87,8::

8G,:

GG

,:

7-36

H

Qraft

/ Ad*. Chan!e Chan!e


ro%lem 7+889continued $his permits one to deri#e the statement of cash flows9indirect format


H ?,:G?

Cash flows from in#estin! acti#ities Increase in property, plant  e(uipment 5%ef 5%efor ore e depr deprec ecia iati tion on6. 6... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... Increa Increase se in !ood !oodwill will 5%efore 5%efore amorti" amorti"atio ation6.... n6.......... ............ ...... 0ecr 0ecreas ease e in in#e in#estm stmen ents. ts.... ...... ...... ...... ...... ...... ...... ...... ...... ...... ..... ..... ...... ...... ...... ..... Ac(uisi c(uisitio tion n of su% su%sid sidiar iary9 y9Qr Qraft aft S..... S........ ...... ...... ...... ...... ...... ...... ...... ..... Net cash used %y in#estin! acti#ities.........................

58:,7=86

Cash flows from financin! acti#ities 0ecr 0ecrea ease se in sho short rt+t +ter erm m de%t. de%t... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... Incr Increa ease se in lon!+ lon!+ter term m de%t.. de%t..... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ..... ..... ...... ... 0ecrease 0ecrease in e(uity 5repurchase6 5repurchase6 SS........................... SS........................... 0i# 0i#iden idends ds decl declar ared ed.. .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... Incr Increa ease se in di# di#iden idends ds paya paya%l %le.. e.... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... Net cash pro#ided %y financin! acti#ities................. Net increase in cash.....................................................

5G 5G66 576 =G? 588 588,6 ,6

58 5866 ,: ,: 5?=G6 5=8 5=866 =7

Spple&ental Spple&ental disclosre of cash flow infor&ation Intere Interest st paid paid durin! durin! year year ...... ......... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ....... ........ ........ ........ ........ ...... .. Incom Income e ta)es ta)es paid paid durin durin! ! the year... year...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ....... ........ ........ ........ ....... ...

H

7,@8= 7

H @7G H8,? H8,?

Notes& S $otal $otal of Qraft Qraft asset assets s and lia%il lia%iliti ities es remo#e remo#ed d from year year to year year chan!e chan!es s and shown as cash cash outlay for in#estin! acti#ity. SS $he net issuance issuance or repurch repurchase ase of e(uity e(uity is computed computed %y reconci reconcilin! lin! the stoc1hold stoc1holders ers e(uity e(uity account as follows& 8:O8O 8:O8O2e 2ear ar 7 %alanc %alance.. e..... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ....... ........ ........ ........ ....... ... H@,: H@,: 2ear  net income.................... income.................................. ............................ ........................... ................................................. .................................... :,7 0i#iden 0i#idend d declar declared.. ed..... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ....... ........ ........ ...... .. 5=86 5=86 $otal. $otal.... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ....... ...... ,:8 ,:8 8:O8O 8:O8O2e 2ear ar  %alan %alance. ce.... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ....... ........ ........ ........ ........ .... 57,@7 57,@766 0ecrea 0ecrease se in e(uity e(uity 5repur 5repurchas chase6. e6.... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ....... .... H ?=G

7-37


ro%lem 7+889continued %. Note& For the complete statement of cash flows, the followin! presentation 5direct format6 of the cash flows from operatin! acti#ities section should replace the cash flows from operatin! acti#ities section 5usin! the indirect format6 for the statement of cash flows in part a.


H:,= H:,=

Cash payments for operations urcha urchases ses of in#ento in#entory ry M%...... M%.......... ........ .......... ........... ........... ............ ........ ellin ellin! ! and admin administ istrat rati# i#e e e)pen e)penses ses Mc... Mc..... ..... ...... ...... ..... .. Inte Intere rest st e)p e)pen ense se Md. Md... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... Income Income ta) e)pense e)pense Me...... Me.......... ........ ........ ........ ........ ........ ......... ........... ......... ...

588, 588,7=@6 7=@6 58,@ 58,@6 6 5@7G 5@7G66 58,?6 58,?6

Cash flows from operations.........................................

H?,:G?

Notes Ma& Ma& ales. ales.... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ....... ........ ........ ........ ........ ........ ...... 0ecrea 0ecrease se in account accounts s recei# recei#a%le a%le... ...... ...... ...... ....... ........ ........ ........ ........ ........ ...... Cash collections................................................................

H8,7= H8,7=: : @G8

M%& M%& Cost Cost of of !ood !oods s sold. sold.... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ....... ........ ....... ... 0ecr 0ecrea ease se in in#e in#ento ntori ries. es... .... .... .... .... .... .... .... .... .... .... .... .... ..... ...... ...... ...... ..... ..... ...... ...... ..... .. Increase in accounts paya%le...........................................

58:,8 58:,8?@6 ?@6 : =G

588,7=@6

Mc& Mc& elli ellin! n! and and admi admini nist stra rati ti#e #e e)pens e)pense.. e.... .... .... .... .... .... .... .... .... .... .... .... .... ..... ..... .. Incr Increa ease se in accr ccrued ued lia% lia%il ilit itiies. es..... ...... .... ........ ...... ........ ...... .... ........ ...... .... ........ ...... .... ..

58=, 58=,=8 =8G6 G6 8,G= 8,G=8 8

58,@ ,@6 6

H:,=

Md& In Interest e)pense 5as !i#en6............................................... Me& Me& Incom Income e ta) ta) e)pe e)pens nse. e... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... ..... ..... Increase Increase in income income ta)es paya%le..... paya%le......... ........ ......... ......... ......... ............. .......... 0ecrease in deferred income ta)es..................................

7-38

5@7G6 58, 58,G G66 @: 5:?6

58, 8,?6


ro%lem 7+889concluded c. Free cash cash flow can can %e defined defined in #arious #arious ways. $he $he startin! startin! point is cash flow flow from operatin! operatin! acti#iti acti#ities es of H?,:G? H?,:G? million. million. tudents tudents may want to remo#e remo#e interest e)pense from operatin! cash flow if they do so, it should %e on an after+ta) after+ta) %asis. %asis. From From operati operatin! n! cash flow, capital capital e)pendi e)penditur tures es should should %e deducted. It would %e proper to differentiate capital e)penditures re(uired to maintain maintain e)istin! e)istin! %usine %usiness ss from from those those that that !enera !enerate te !rowth. !rowth. $he simplest simplest calc calcul ulat atio ion n wo woul uld d %e op oper erat atin in! ! cash cash flow flow less less capi capita tall e)pe e)pend ndit itur ures es&& H?,:G?+HG D H=,::? million. 'ther #ariations are possi%le. tudents should also su%tract di#idends paid of H=. $his yields a free cash flow of H,8. $he implic implicati ation ons s of free free cash cash flow flow for for a compa company nyXs Xs futu future re earn earnin in!s !s and and financial condition can include the& 8. Repa Repaym ymen entt of de%t de%t resul resultin tin! ! in lower intere interest st cost cost and and hi!h hi!her er earn earnin in!s !s.. $his $h is wou would ld also also redu reduce ce de%t de%t ratio ratios s and and impro# impro#es es inte interes restt co#e co#era ra!e, !e, possi%ly leadin! to hi!her de%t ratin!s. :. Repurch rchase of e(uity ity. $his may may rais aise earnin!s per share are and 5if repurchased %elow stated %oo1 #alue per share6 would increase this %oo1 #alue. . Increas Increased ed a%ility a%ility to ma1e ma1e ac(uisitio ac(uisitions ns 5such as Qraft6, Qraft6, which which can pro#ide pro#ide future !rowth, %etter di#ersification, and lower ris1. =. Increas Increased ed fundin! fundin! of intern internal al !rowth throu!h throu!h capital capital spendin!, spendin!, research research and de#elopment, new product introduction costs, and so forth. ?. Incr Increa ease se in di# di#iden idends ds,, pro# pro#id idin in! ! lar! lar!er er payo payout ut of earn earnin in!s !s to e(ui e(uity ty in#estors. @. Incr Increas eased ed li(ui li(uidit dity y 5fina 5financ ncia iall fle)i% fle)i%ili ility ty6, 6, allowi allowin! n! the the firm firm to resp respon ond d to une)pected needs and opportunities.

7-39


ro%lem 7+8: 5@G minutes6 a. TE$A C'R'RA$I'N 'RQ
/ear 5

'peratin! Cash Receipts and 0is%ursements 0is%ursements Cash Receipts from 'perations Net sales Ma 58@,GGG J 8,GGG6 58??,GGG J :,GGG6 MA.................................................. 'ther re#enue re#enue and income... income........ .......... .......... .......... ............... .................... .......... 5I6 0 in current recei#a%les........................................... 5I6 0 in non+curren non+currentt recei#a%les recei#a%les M%........ M%.................... ...................... .......... 'ther ad*ustments Mc................................................... D CA< C'--EC$I'N.................................................

8S :S  = ? @

Cash 0is%ursements for 'perations $otal e) e)penses Ma Ma M3 M3................................................... 7S -ess& E)penses and losses not usin! cash + 0epreciation and amorti"ation...................................  + Noncurrent deferred income ta)es............................  + 'th 'ther minority int intere erest.. st.... .... .... .... ........ ...... .... ........ ...... .... ........ ...... .... ........ ...... .... .... .. 8G + 'th 'ther loss on discontinued operations.. s.......... ...... .... .... .... .... .... 88 + 'ther...... 'ther........... .......... .......... .......... .......... .......... .......... .......... ............. .................... ...................... .......... 8: Chan!es in Current Assets and -ia%ilities related to 'perations I 506 in in#entories......................................................... I 506 in prepaid e)pense................................................ 5I6 0 in accounts paya%le and accruals....................... 5I6 0 in ta)es paya%le..................................................... 5I6 0 in accruals............................ accruals....................................................... .................................. ....... I or 0 other..... other.......... .......... .......... .......... .......... .......... .......... .......... .......... ................. ................... ....... I or 0 other..... other.......... .......... .......... .......... .......... .......... .......... .......... .......... ................. ................... ....... I or 0 in noncurrent accounts M%................................. D CA< 0I3RE/EN$...........................................

8 8= 8? 8@ 87 8 8 :G :8

0i#idends 0i#idends Recei#ed E(uity in income of unconsolidated affiliates............ ::S + ndistri%uted e(uity in income of affiliate... e..... .... .... .... .... .... .. : D 0IVI0EN0 FR'/ NC'N'- AFFI-IA$E........... := 'ther Cash Receipts 50is%ursements6....................... :?S CA< F-'W FR'/ 'ERA$I'N Md........................ :@

7-40

H :G = , GG G 5  ,G G G 6

H 87  , GG G 5 : ,= G G 6

: G8 , GG G

8 7? , @G G

8 @ , GG G

8 7G , GG G

5 @ ,G G G 6 5 8 ,@ G G 6 5:GG 5:GG66 57GG6

8 ? , G G 5 : ,? G G 6 5 ? ,7 G G 6

8 ? , :G G : ,G G G 58, 58,=GG 6 @GG H @ ,= G G

5 = ,G G G 6 5 8 ,G G G 6

@ ,G G G :G G 5 : ,G G G 6 5 8 ,G G G 6

8 @ , :G G 5 8 ,G G G 6 8,GG  GG H 7 ,7 G G


ro%lem 7+8:9continued Notes& 5S6 $hese fi#e lines must e(ual e(ual reported reported net income per income statemen statementt M2ear M2ear @ #erification& #erification& H:G=,GGG +H8@,GGG J H:,GGG D H8G,GGG. 5a6 Includin! Includin! ad*ust ad*ustmen ments ts 5!ross 5!rossin!+up in!+up66 of re#enue re#enue and e)pens e)pense e of discont discontinue inued d operat operation ions s reported in note. 5%6 0etermined 0etermined to relate relate to operations operations 5descri%ed 5descri%ed in footnotes6. footnotes6. 5c6 uch as remo#al remo#al of !ains !ains included a%o#e a%o#e 5descri%ed 5descri%ed in footnotes6. footnotes6. 5d6 Reconcile Reconcile to amount reported reported %y company. company. If not reported, reported, reconcile reconcile to chan!e in cash for period. 5A6 ales from from discontinued discontinued operations operations 5see Note =6 2ear @ 2ear ? 8@7,GG 7,GGG G 8,GGG 8G,GGG 7,GG :GG 8,8GG 8,:GG 7GG 7GG 58,GGG6 + 87,GGG 8=7,GGG E)penses of discontinued operations.. s......................................... 8,8GG :=,:GG -oss -oss on disc discon onti tinu nued ed oper operat atio ions ns.. ........ ...... .... ........ ...... .... ........ ...... ........ ...... .... ........ ...... .... .... .... .. 58,8G 8,8GG6 G6SS 58,: 8,:GG 6SS 8@,GGG 87G,GGG S Replac Replaced ed %y sales sales of of H8,G H8,GGG GG 5Not 5Note e =6 + e)pens e)penses es H8,8 H8,8GG. GG. SS Replaced Replaced %y sales of H:,GGG H:,GGG 5Note =6 + e)pens e)penses es H:=,:GG H:=,:GG.. MNote& MNote& 0ue to the ac(uisiti ac(uisition on of $R' Company Company in 2ear 2ear @, the operati operatin! n! wor1in wor1in! ! capita capitall accounts include amounts so ac(uired and may distort cash inflows and outflows from operations.

536 E)p E)penses pe per in incom come st state atement.. t............................................... ....... ... Inc Income ta)es )es............................................................................. ...... ...... /inori /inority ty intere interest. st.... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ..... .. 0iscontinued operations.. s............................................................... -oss -oss on disp disposa osal. l... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... ..... ...... ..... ..... ...... ..... Cumulati#e effect of accountin! chan!e.....................................

%. /ear 0

Incom ncome e ta) ta) e)pe e)pens nse. e... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... ..H8 H8G, G,GG GGG G $a)es in K%elow lineL items& J $a) on cumulati#e effect.................................................... 8,GGG P $a) $a) on discontinue discontinued d operations......... operations................. ................. ....................... .............. 58,8GG6 P $a) $a) on loss loss with disposal disposal 57GG6 @,@GG Increase in in defer ferred red in income come ta). ta)...... ...... ...... ...... ...... ...... ........ ...... .... .... .... .... .... .... .... .... .. 58,@ 58,@G GG6 Incre ncreas ase e in in ta) ta)es es pay paya%le a%le.. .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .. 5?,G 5?,GGG GG66 Incom ncome e ta)e ta)es s paid paid.. .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... ....H ..H :,@G :,@GG G S 0ata for for 2ear 2ear ? not pro#ided pro#ided in financial statement statements. s.

7-41

/ear 51

H7, H7,GG GG ++ 58,:GG6 ++ ,:GG 58,GGG ,GGG66 58,G 58,GGG GG66 H=,@ H=,@GG GG


ro%lem 7+8:9continued c. Chan!e in %alances of KAccounts aya%le and AccrualsL9per %alance sheet............................. sheet.......... ............................ ........... H@,GGG -ess& -ess& Ad*us Ad*ustmen tmentt due to dispos disposal al Ma.......... Ma................ ............ ............ ...... H GG -ess& Ad*ustment due to $R' ac(uisition M%.. ............... ,:GG Ad*ustment to net income to arri#e at CF'...................

,?GG H:,?GG

E)planations& Ma Note = descri%es the loss on disposal9summari"ed as follows& -oss on disposa disposal... l........ .......... .......... .......... .......... .......... .......... ............... ...................... ..................... ......... 8,=GG roperty, plant  e(uipment .............................................. In#entories S ........................................................................ Accounts paya%le  accruals S.......................................... and $a) $a) paya%l paya%le e S ...... ......... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ... -oss on disposal.................................................................

8 , G GG 8GG GG

7GG 7GG

No cash is in#ol#ed in this loss.
8GG GG 8,GGG S 7GG 7GG

S $he amount of H@,?GG shown as additions to E reflects this ad*ustment.

M% Note Note  descri descri%es %es the ac(uisi ac(uisiti tion on of $R' Compan Company y. Teta Teta assume assumed d account accounts s paya%les and accruals of H,:GG. $hese must %e remo#ed from the determination of CF' to not distort this fi!ure. $he H,:GG is shown as part of the amount determinin! the ac(uisition price of $R'.

7-42


CAE Case 7P8 5=? minutes6 a. 8. 0epreci 0epreciatio ation n e)pense e)pense repre represen sents ts the alloca allocation tion of the the cost of fi)ed fi)ed assets assets o#er o#er the useful life of the asset. Amorti"at morti"ation ion e)pense e)pense represe represents nts the allocation of the cost of intan!i%le assets o#er the useful life of the asset. In each of these cases, the in#estin! cash outflow occurs when the asset is ac(uired 5and not when its cost is su%se(uently allocated to e)pense6. :. Chan!es Chan!es in deferred deferred ta)es ta)es impact impact reported ta) e)pense, e)pense, %ut not ta)es ta)es paid. Conse(uently, the statement of cash flows %e!ins with net income 5usin! reported ta) e)pense6 and ad*usts for chan!es in deferred ta)es in order to deri#e cash ta)es paid. . 0ecreases 0ecreases in recei#a%les recei#a%les cause cause operatin! operatin! cash flows to %e !reater than net income %ecause cash has %een collected relatin! to re#enues recorded in a pre#ious period. =. 0ecreas 0ecreases es in in#entor in#entory y cause cause operatin! operatin! cash flows flows to %e !reater !reater than net net inco income me %eca %ecaus use e cash cash was !ene !enerat rated ed as in#e in#ento ntorie ries s are are sold sold and and no nott replenished. %. Net income income is much much less than operati operatin! n! cash flows in :GG? primari primarily ly %ecause %ecause of the add+%ac1 of depreciation and amorti"ation, cash inflows arisin! from the ta) %ene %enefit fits s relat relatin in! ! to employ employee ee stoc1 stoc1 op optio tions ns,, and and the the reduc reducti tion on of operatin! wor1in! capital. c. Free cash cash flows D Cash flow from operations operations P Capital Capital additions additions P 0i#idends 0i#idends :GG?& H?,8G P H?:? P HG D H=,7? :GG=& H,@7G P H: P HG D H,=8 :GG& H,? P HG? P HG D H,: d. 0ell has used used free cash flows primarily primarily to repurcha repurchase se shares shares of its stoc1. $he $he e)cess has %een in#ested in mar1eta%le securities. e. 0ell 0ell can can retu return rn cash cash to shar shareh ehol olde ders rs #ia di# di#iden idend d paym paymen ents ts and and stoc stoc1 1 repurchases. Cash paid for di#idends is "ero, %ut stoc1 repurchases ha#e amounted to H,?G million 5H=,:8JH:,GGGJH:,:G6 o#er the past  years.

7-43


Case 7P: 5=G minutes6 a. Analy nalysi sis s of the the stat statem emen entt of cash cash flow flows s su!! su!!es ests ts that that this this stra strate te!y !y wa was s implemented durin! 2ear . pecifically, durin! that year the cash flows of -andsX End to %uildup its in#entory to implement its new policy are #ery hi!h 9 H8G=.?=? million cash outflow to ac(uire additional in#entory. %. 8. 0epre 0eprecia ciatio tion n e)pens e)pense e repres represen ents ts the alloc allocati ation on of the cost cost of fi)ed fi)ed assets assets o#er o#er the useful life of the asset. Amorti"at morti"ation ion e)pense e)pense represe represents nts the allocation of the cost of intan!i%le assets o#er the useful life of the asset. In each of these cases, the in#estin! cash outflow occurs when the asset is ac(uired 5and not when its cost is su%se(uently allocated to e)pense6. :. Incr Increas eases es in recei recei#a #a%l %les es caus cause e op opera eratin tin! ! cash cash flows flows to %e less than than net inco income me %eca %ecaus use e re#e re#enu nues es 5refl 5reflect ectin! in! recei# recei#a%l a%les6 es6 are are incl includ uded ed in net net inco income me,, %u %utt the the rela relate ted d cash cash may may no nott yet yet %e rece recei# i#ed ed.. Con# Con#er erse sely ly,, decreases in recei#a%les cause operatin! cash flows to %e !reater than net income %ecause cash is recei#ed for re#enues reco!ni"ed in prior periods. . 0ecreas 0ecreases es in in#entor in#entory y cause cause net income income to %e hi!her hi!her than operati operatin! n! cash flows %ecause sales re#enue is reco!ni"ed when earned %ut the in#entory sold sold can can %e paid paid for for in earlie earlierr perio periods. ds. Incr Increa eases ses in in#e in#ento ntory ry caus cause e operatin! cash flows to %e less than net income %ecause cash was used to increase increase in#entory le#els. le#els. When these in#entories in#entories are su%se(uently su%se(uently sold, re#enues will %e earned and net income will %e increased.
7-44


Case 7+ 5G minutes6 a. 2ahoo 2ahoo issued issued stoc1 5common 5common and preferred6 preferred6 to !enerate !enerate the necessary necessary cash cash flows to finance its %usiness acti#ities and !rowth opportunities. %. Net income income 5re# 5re#en enue ues s and and e)pe e)pens nses6 es6 appea appears rs to %e dri# dri#in in! ! operat operatin! in! cash flows for 2ahoo. As net income increases 5decreases6, operatin! cash flow increases 5decreases6. c. 2aho hoo o has has su%s su%stan tantia tiall cash cash reser reser#e #es s !ene !enerat rated ed #ia #ia e(ui e(uity ty issu issuan ances ces.. $h $his is e(uity capital is necessary to finance pro*ected !rowth in the upcomin! years. nti ntill the the compa company ny re(ui re(uires res the the cash, cash, it is %ein! %ein! in#e in#este sted d in mar1 mar1eta eta%le %le securities in a desire to earn a hi!her than KnormalL rate of return. d. $his amount amount represen represents ts cash recei#ed recei#ed %efore %efore re#enu re#enue e is reco!ni reco!ni"ed "ed 5that is, the ser#iceOproduct is not yet deli#ered6. /ost of this deferred re#enue li1ely is related to prepaid ad#ertisin! re#enue recei#ed in ad#ance.

7-45


Case 7+= 5@G minutes6 a. W2A$$ C'R'RA$I'N tatement of Cash Flows For the 2ear Ended 0ecem%er 8, 2ear 8G Cash flows from operatin! acti#ities Net income income S........... S................ .......... .......... .......... .......... .......... .......... .......... .......... .......... .............. ............. .... H8@,GGG Add 5deduct6 ad*ustments to cash %asis 0eprec 0epreciat iatio ion n e)pens e)pense... e...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ....... ...... :=@,GGG :=@,GGG >ain >ain on on sale sale of of e(ui e(uipm pmen entt SS.. SS.... .... .... .... .... .... ..... ...... ...... ...... ...... ...... ...... ...... ...... ... 5=,GG 5=,GGG6 G6 Increa Increase se in accounts accounts recei#a recei#a%l %le... e...... ...... ...... ...... ...... ...... ...... ....... ........ ........ .... 588 5888,GGG6 8,GGG6 Increase Increase in in#entori in#entories... es........ .......... .......... .......... .......... ............. .................... ............... ... 5:8,GGG6 Increa Increase se in accoun accounts ts paya% paya%le.. le..... ...... ...... ...... ...... ...... ...... ....... ........ ........ ........ ...... 8G,GGG 8G,GGG 0ecreas 0ecrease e in in income income ta)es ta)es paya%l paya%le... e...... ...... ...... ...... ...... ...... ...... ...... ....... ...... 5:?,GGG6 5:?,GGG6 Increase Increase in other paya%les... paya%les........ .......... .......... .......... .......... .......... ............... ............ .. :,GGG Net cash fl flow from operatin! acti#ities.............................

H : @  ,G G G

Cash flows from in#estin! acti#ities roc roceed eeds s fro from m sal sale e of of e(u e(uip ipme ment nt.. .... .... .... .... .... .... ..... ...... ...... ...... ...... ...... ...... ...... ..... Addi Additio tions ns to plan plantt and e(uipm e(uipment ent... ...... ...... ...... ...... ....... ........ ........ ........ ........ ........ .... Net cash used %y in#estin! acti#ities................................

587 , G GG 6

=,GGG =,GGG 5:8:,GGG 5:8:,GGG 6

Cash flows from financin! acti#ities Issua Issuance nce of stoc1.. stoc1..... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ..... 0i#i 0i#iden dends ds... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ..... Reduct Reduction ion of of de%t.. de%t..... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ....... ........ ........ ......... ......... .... Net cash pro#ided %y financin! acti#ities......................... Net increase in cash...........................................................

87,GGG 87,GGG 57=,GGG6 57=,GGG6 587,GGG 587,GGG 6 5 7 = ,G G G 6 H 87 8 7 , GG G

Cash %alance, 0ecem%er 8, 2ear .................................. Cash %alance, 0ecem%er 8, 2ear 8G................................ Notes& S 0etermina 0etermination tion of 2ear 2ear 8G 8G net income& income& Retain Retained ed earnin earnin!s, !s, 8:O8O 8:O8O2e 2ear ar 8G.... 8G....... ...... ...... ...... ....... ........ ........ ....... ....... ........ ........ .... Reta Retain ined ed earn earnin in!s, !s, 8:O8 8:O8O2 O2ea earr ... ..... .... .... .... .... .... .... .... ..... ...... ...... ..... ..... ...... ...... ...... ...... ... lus& lus& 0i#iden 0i#idends ds paid... paid...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ..... 2ear 8G net income................... income................................ ........................... ............................ ..................... ....... SS0eri#ation of !ain on sale of e(uipment& Accum Accumula ulated ted depreci depreciati ation, on, 8:O8O 8:O8O2e 2ear ar ..... ........ ...... ...... ...... ...... ...... ...... ....... ...... .. 0eprec 0epreciat iation ion e)pens e)pense.. e..... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ....... ........ ....... ....... .... Accum Accumula ulated ted depreci depreciati ation, on, 8:O8O 8:O8O2e 2ear ar 8G.... 8G....... ...... ...... ...... ...... ...... ...... ....... ...... Accum ccumul ulat ated ed depre depreci ciat atio ion n on e(uip e(uipme ment nt sold. sold... .... .... ..... ...... ...... ...... ..... .. 'ri!in 'ri!inal al Cost.. Cost..... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ....... ........ ........ ........ ....... ....... ....... ... Accum ccumul ulat ated ed depre depreci ciat atio ion n on e(uip e(uipme ment nt sold. sold... .... .... ..... ...... ...... ...... ..... .. 3asis 3asis of e(uipmen e(uipment.. t..... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ....... ....... ...... ... rocee roceeds ds from from sale.. sale..... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ....... ........ ........ ........ .... >ain >ain on sale.. sale..... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ....... ....

7-46

8 7 ? ,G G G H 8  : ,G G G

H8,@ H8,@,GG ,GGG G 58,? 58,?:@ :@,G ,GGG GG66 88:,GGG 7=,GGG 7=,GGG H 8@,GGG H 8@,GG 8@,GGG G :=@,GG :=@,GGG G H8,8@:,GGG 58,88 58,88,GG ,GGG6 G6 H 8,G 8,GGG GG H H H

@8,GGG @8,GGG 58, 58,GG GGG6 G6 G,GGG G,GGG =,GGG =,GGG =,GGG =,GGG


Case 7+=9continued %. In 2ear 2ear 8G, Wyat Wyattt Corpo Corporat ratio ion n !ene !enerat rated ed cash cash from from op opera eratio tions ns of H:@, H:@,GGG GGG after considerin! operatin! wor1in! capital needs. u%tractin! u%tractin! pro*ected de%t ser#ice of HGG,GGG per year and estimated capital spendin! of H:?,GGG per year from that fi!ure lea#es a decidedly ne!ati#e num%er. $hat is, there is not sufficient cash to fund %oth the de%t ser#ice and the e)pansion pro*ect for any e)tend e)tended ed perio period d of time. time. $h $her erefo efore re,, the the le#era le#era!e !ed d %u %uyo yout ut and and the the capita capitall spendin! plan are mutually not compati%le !oals9at least not as currently proposed. Wyatt cannot do %oth. /oreo#er, it pro%a%ly should not do either one if it wishes to maintain a reasona%le mar!in of safety.

7-47


Case 7+? 57? minutes6 0'VER C'R. tatement of Cash Flows For the 2ear Ended 0ecem%er 8, 2ear 2ear  Cash flows from operatin! acti#ities Net incom income.. e..... ...... ...... ...... ...... ..... ..... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ....... ........ ........ ........ ........ .... Ad*ustments Ad*ustments to reconcile net income to net cash pro#ided %y operatin! acti#ities& 0epreci 0epreciati ation. on.... ...... ..... ..... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ..... ..... ...... ....... ........ .... Amorti"ation Amorti"ation of patent....................... patent................................... ....................... ....................... ................... ....... -oss -o ss on sale sale of e(ui e(uipm pmen ent. t... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... ..... ...... ..... ..... ..... ..... ...... ..... ..... ..... E(ui E(uity ty in inco income me of $op $op Corp.. Corp.... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... ..... ..... ..... ...... ..... .... >ain >a in on on sale sale of mar1 mar1et eta% a%le le e(ui e(uity ty secu securi riti ties es.. .... .... .... .... .... .... .... .... .... .... .... .... .... .. 0ecrease in allowance to reduce mar1eta%le e(ui e(uity ty secu securi riti ties es to to mar1 mar1et. et... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... ..... ..... ..... ..... ..... ... Incr Increas ease e in acco accoun unts ts rece recei# i#a% a%le. le... .... .... .... .... .... .... .... .... .... .... .... ..... ..... ..... ...... ..... ..... ...... ..... ..... ... 0ecre 0ecrease ase in in in#e in#ent ntor orie ies.. s.... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... ..... ..... ..... ..... ..... ...... ..... .... 0ecre 0ecrease ase in in acco accoun unts ts pay paya%l a%le e and and accru accrued ed lia lia%i %ili liti ties es ... ..... .... .... .... .... .. Net ca cash pr pro#ided %y %y op operatin! acti#ities .. ................................ Cash flows from in#estin! acti#ities ale ale of of mar1e mar1eta% ta%le le e(ui e(uity ty secu securi riti ties. es... .... .... .... .... .... .... .... ..... ..... ..... ..... ..... ...... ..... ..... ...... ..... ale ale of e(uipm e(uipmen entt .... ...... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... ..... ..... urcha urchase se of e(uipm e(uipment ent... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ....... ........ ...... .. Net ca cash pr pro#ided %y %y in in#estin! a ac cti#ities .. ................................. Cash flows from financin! acti#ities Issu Issuan ance ce of common common stoc1. stoc1... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... ..... ...... ..... ..... ...... ..... ..... ..... ..... ... Cash Cash di#ide di#idend nd paid.. paid.... ..... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ....... .... aymen aymentt on on note note p paya aya%le %le... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ....... ........ ........ ........ ........ ........ .... Net cash used in financin! acti#ities.. s.......................................... Net in increa rease in cas cash. h.................................................................... ..... Cash at %e!innin! of year ear ........................................................ ...... Cash at end of year. ar............................................. ....... ....... ........ ....... ....... ....... ...

7-48

HG?,GGG HG?,GGG

:,GGG :,GGG ,GGG 8G,G 8G,GGG GG 5G, 5G,GGG GGG66 58, 58,GG GGG6 G6 58?, 58?,GGG GGG66 5?, 5?,GGG GGG66 G,G G,GGG GG 588? 588?,G ,GGG6 GG6 H:7:,GGG

88,G 8,GGG GG 8,G 8,GGG GG 58:G,GG 58:G,GGG6 G6 87,GGG

:@G,G :@G,GGG GG 5?,GG 5?,GGG6 G6 5GG,GG 5GG,GGG6 G6 58:?,GGG6 H8@= 8@=,GGG G7, G7,GGG GGG H=78 =78,GGG


Case 7+?9continued Feasi%ility Analysis of /ana!ementXs roposal Cash Cash from from opera operation tions, s, 2ea 2earr ...... .......... ........ ........ ........ ........ ......... ........... ........... ........... ........ .. Additional dditional interes interestt cost..... cost......... ........ ........ ........ ....... ....... ........ ........ ........ ........ ........ .......... ........... ....... Ann nnua uall e(ui e(uipme pment nt in#e in#estm stmen ents. ts... ..... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ..... .. -ess -ess 2ear ear  ou outla tlay. y... ..... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ..... ..... ...... ...... ...... ...... ...... ...... ...... ..... Annu nnual al in#ento in#entory ry %uildup. %uildup..... ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ......... ........... ........ ro*ect ro*ected ed cash shortfa shortfall... ll....... ........ ........ ....... ....... ........ ........ ........ ........ ........ .......... ............ ........... .....

H :7:,GG :7:,GGG G 5:GG,GGG6 5:GG,GGG6 58G, 58G,GGG GGG66 8:G,GG 8:G,GGG G 5@G,GGG6 5@G,GGG6 H 5=,GGG6 5=,GGG6

Other considerations in Assessing Manage&ent2s roposal*

Non+CF' cash flows in 2ear  are H58G,GGG6 9 a cash outflow.
G7 'peratin!

586 -oss on sale of e(uipment 5=6 Net income 5%6 0ecrease in In#entory 5e6 Amorti"ation of patents 5f6 0epreciation

8G G? G  :

=

5:6 >ain on sale of securities

G G

5c6 E(uity in $op Corp.

? ? 88? 88?

5a6 Increase in accounts recei#a%le

= G 5!6 0ecrease in accounts paya%le

In#estin! 586 roceeds from sale of e( e (uipment 5:6 roceeds from sale of se securities

8

8: 8:G 8:G

5d6 Additions to E

88 Financin!

56 Issue of common stoc1

:@G

E n di n !

=78

7-49

G GG ? ?

5h6 Increase in note paya%le 5?6 0i#idends


Case 7+?9continued /ar1eta%le ecurities, at cost 3e!

:?G

E nd

8?G

8GG 8GG

Allow. to Reduce /ar1eta%le ec. to /ar1et 5:6

5:6

8?

Accounts Recei#a%le ?8? ?

3e!

G

E nd

??G

E nd

8G

In#estment in $op Corp. 5at e(uity6 G G

3e! 5d6

8,G7G 8:G

E nd

=:G

E nd

8,8=?

atent

E nd

8G

GG



5e6

GG

3e!

@GG

E nd

5%6

=?

586

586

87

:G :

3e! 5f6

=?

E nd

5!6

88?

@ @ G

3e!

=?

E nd

0eferred Income $a)es

@?G :GG

3e! 56

8G

3e!

?G

E nd

8G

E nd

Retained Earnin!s ?

G

Accounts aya%le and Accrued -ia%ilities

Common toc1

5?6

E nd

Accum. 0epreciation

-on!+$erm Note aya%le 5h6

8G

E

3e! 5c6

88

3e!

In#entories

3e! 5a6

3e!

:?

Additional aid+In Capital

@? G?

3e! 5=6

87G @G

3e! 56

??

E nd

:G

E nd

7-50

Financial Statement Anlysis 10e Subramanyam Wild_Chapter 7

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