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CHAPTER 5

5-1

No. All public companies report it because the statement of cash


flows is a required statement with a required format.

5-2

A cash flow statement shows the sources of changes in cash


balances and:
a)
b)
c)

aids in predicting future cash flows and evaluating how


management's decisions generate and use of cash;
aids in determining a company's ability to pay dividends and
interest and to pay debts when due;
aids in understanding and identifying changes in the mix of
productive assets.

5-3

Cash equivalents are highly-liquid, short-term investments that


can be converted easily to cash with little delay. Examples
include money market funds and treasury bills.

5-4

Operating activities, investing activities, and financing activities


are the three major types of activities summarized in the
statement of cash flows.

5-5

Major operating activities include:


Collections
from customers (for sales)
from investees (interest & dividends)

Chapter 5

Statement of Cash Flows

Payments
to suppliers (for inventory)
to employees (for wages)
to creditors (interest)
to government (taxes)

191

5-6

Major investing activities include:


a) sales and purchases of property,
b) sales and purchases of securities that are long-term
investments,
c) making and collecting long-term loans .

5-7

Major financing activities include:


a) borrowing from (nontrade) creditors,
b) repaying (nontrade) creditors,
c) issuing equity securities,
d) repurchasing equity securities, and
e) paying dividends.

5-8

Interest paid or received appears in the operating activities


section. Some commentators favor showing interest paid
elsewhere since it is associated with financing.

5-9

Only increasing long-term debt increases cash.


Both
repurchasing common shares and paying dividends decrease
cash.

5-10 Selling fixed assets for cash and collecting a loan increase cash.
Purchasing equipment decreases cash. Purchasing fixed
assets by issuing debt does not affect cash, but it should be
shown in a schedule of noncash investing and financing
activities that is part of the statement of cash flows.
5-11 When liabilities increase, the firm has either raised cash and
promised to pay it back later or it has preserved cash rather than
paying it out to reduce growing accounts payable. So more
liabilities lead to more cash. Likewise, increases in noncash
assets require cash. Either cash is spent to get the asset or an
asset is recorded instead of receiving cash.
5-12 Noncash investing and financing activities generally could have
been accomplished identically in substance (though not in form)
192

by cash transactions. For example, issuing debt to purchase an


asset could have been accomplished by issuing debt for cash
and then using the cash to purchase the asset. Companies
should not be able to prevent disclosure of such a transaction to
readers of the statement of cash flows simply by using a
noncash form of transaction.
5-13 This transaction should not be shown in the body of the
statement of cash flows because it involves no cash flows.
However, it should be reported in an accompanying schedule.
Why? The transaction could have been accomplished by
issuing stock for cash and then buying the fixed asset, whereby
it would be in the statement of cash flows. Readers of
statements of cash flows should be informed about such
transactions.
5-14 Yes. It is important to know of the periodic need to pay off and
refinance debt. Companies with large short-term debt levels
often find it an inexpensive way to borrow, but when interest
rates rise or a company's financial condition worsens,
refinancing may be both difficult and expensive.
5-15 The direct method and the indirect method are the two major
ways of computing net cash flow from operating activities.
5-16 The information for the direct-method cash flow statement
comes directly from entries into a companys cash account.
5-17 The required adjustments are to add noncash expenses and
losses, deduct noncash revenues and gains, add decreases in
operating assets and increases in operating liabilities, and
deduct increases in operating assets and decreases in
operating liabilities.

Chapter 5

Statement of Cash Flows

193

5-18 Sales revenue is recognized on the accrual basis when it is


earned and realized, not when cash is received. Therefore, cash
collections from customers will not ordinarily equal sales
revenue during any given period. Sometimes cash from
customers arrives before it is earned (creating a liability to
perform) or after it is earned (collection eliminates an account
receivable).
5-19 Changes in the inventory and accounts payable accounts
explain the difference between cost of goods sold and cash
payments to suppliers.
5-20 Strictly speaking, net losses, by themselves, do not drain cash.
A net loss is an excess of expenses over revenues; it is an
income statement item rather than an item on a statement of
cash flows. As an extreme example, equipment may be sold
below its book value and cause a net loss, but cash proceeds
resulting from the transaction would be an addition to cash, not
a cash drain.
5-21 Cash + Noncash assets = Liabilities + Paid-in capital + Retained earnings
Cash = Liabilities + Paid-in capital + Retained earnings Noncash assets

5-22 The erroneous impression is that depreciation is a source of


cash because it is added to net income to determine cash flow
from operations. Depreciation is an allocation of an assets
original cost to expense that does not entail a current cash
outlay; that is, depreciation is a noncash expense. It is added to
net income when using the indirect method only to offset its
deduction in computing net income.
5-23 The newsletter reinforces the widely held erroneous impression
that depreciation provides cash. See the solution to 5-22.

194

5-24 Under the indirect method of preparation, depreciation is very


prominent in the calculation, although not directly a source of
cash. Depreciation belongs in a supporting schedule when
using the direct method. Depreciation is one of the items that
reconciles net income to net cash flow from operating activities.
5-25 Profitable companies often lack for cash because they are
growing quickly and must acquire inventory for future sales
while waiting to collect growing receivable balances. New firms
in industries such as computers, electronics, and bio-tech might
experience this.
5-26 Large, non-cash expenses such as depreciation could cause
this. The airline industry might be a good example.
5-27 I would be concerned about this company. Negative cash flow
from operations and new investing is not uncommon among
new, high growth firms. However, at that stage in the growth
pattern the financing is generally from equity and longer-term
debt. The significant use of short-term debt with covenants that
will restrict further debt issues and other actions of the firm
suggests that the equity and long-term debt markets are not and
will not be open to this client. Unless profitability and positive
cash flow from operations are around the corner, this company
could have serious problems raising additional capital. This
may not be a good investment.

Chapter 5

Statement of Cash Flows

195

5-28 It is always hard to know what is in a managers mind. Microsoft


experienced explosive growth. It is bought companies on a
regular basis, but its available cash and liquid investments
continued to grow. It does not make sense to continue to
manage low yielding investments in government bonds and
such. Microsoft chose to distribute this capital to investors as
share buybacks and a very large one-time dividend, with a
commitment to continue paying dividends. Prior to Microsofts
decision to pay dividends, many analysts feared that Microsoft
would choose to make even larger and perhaps ill-advised
purchases of other companies.
5-29 Until 2002 Amazon had negative cash flows from operations,
and it used cash for investing activities. The positive cash flow
from operations indicates that Amazon is maturing. In fact,
having cash flow from operations exceeding investment needs
(that is, positive free cash flow) is a sign that Amazon is entering
a stage where growth may be slowing but profitability is
increasing.
5-30 This attitude would prevent anyone from ever investing in a
brand new company with a great idea. Since these companies
are often risky, this strategy might be quite appropriate for
investors who were retired and relied on investments for living
expenses. However, for a younger person with more ability to
take risk, an appropriate exposure to young, dynamic growth
companies might be quite appropriate. The characteristics
referred to in the question identify the target investments as
young growth companies for the most part but do not reveal
much about other investment decision variables such as the
industry, the age of the firm, the nature of the product, and so
on.

196

5-31 (10 min.)


BREMERHAVN SHIPPING COMPANY
Statement of Cash Flows from Financing Activities
For the Year Ended December 31, 20X8
Cash flows from financing activities:
Proceeds from issue of long-term debt
Payment to retire long-term debt
Payment to retire common stock
Dividends paid
Net cash used for financing activities

200,000

(160,000)
(35,000)
(11,000)
(6,000)

Notice especially that both proceeds from the new issue and the
payment to retire long-term debt are listed. Presenting only the net
amount, 40 of proceeds, is not permitted. Also, the interest is omitted
because it is an operating activity, not a financing activity.
5-32 (5-10 min.)
FAR-EAST TRADING COMPANY
Statement of Cash Flows from Investing Activities
For the Year 20X5
Purchases of fixed assets
Proceeds from the sale of fixed assets
Investment in Repulski Company
Net cash used for investing activities

Chapter 5

Statement of Cash Flows

$(160,000)
20,000
(60,000)
$(200,000)

197

5-33 (5-10 min.)


POULSBO BAY COMPANY
Schedule of Noncash Investing and Financing Activities
Note payable issued for acquisition
of fixed assets
Common stock issued on conversion
of preferred shares
Mortgage assumed on acquisition
of warehouse

191,000
$340,000
630,000

5-34 (5 min.)
The split between cash and credit sales is irrelevant for purposes
of this problem.
Sales
Less increase in accounts receivable
Cash received from customers

$750,000
(30,000)
$720,000

5-35 (5 min.)
Cost of goods sold
Add increase in inventory ($150,000 $100,000)
Deduct increase in accounts
payable ($45,000 $24,000)
Cash paid to suppliers

198

$500,000
50,000
(21,000)
$529,000

5-36 (5-10 min.)


Wage and salary expense
Cash paid to employees
Increase in accrued wages and salaries payable
Beginning balance, accrued wages and
salaries payable
Increase in accrued wages and salaries payable
Ending balance, accrued wages and
salaries payable

$195,000
180,000
$ 15,000
$ 18,000
15,000
$ 33,000

5-37 (5-10 min.)


ORION STRATEGY, INC.
Statement of Cash Flows from Operating Activities
For the Year Ended December 31, 20X6
Collections from customers ($470,000 $5,000)
Cash expenses ($285,000 $35,000)

$465,000
250,000

Net cash provided by operating activities

$215,000

Chapter 5

Statement of Cash Flows

199

5-38 (5-10 min.)


ORION STRATEGY, INC.
Reconciliation of Net Income to Net Cash Provided
by Operating Activities
For the Year Ended December 31, 20X6
Net income
Add depreciation, which was deducted in
computing net income but does not affect cash
Deduct increase in accounts receivable
Net cash provided by operating activities

200

$185,000
35,000
(5,000)
$215,000

5-39 (10 min.)


1.

Sales
Nondepreciation expenses [570,000 100,000]
Depreciation
Net income
Add back depreciation
Net cash provided by operating activities

$880,000
(470,000)
(100,000)
$310,000
100,000
$410,000

2.

Sales
Nondepreciation expenses [570,000 100,000]
Depreciation
Net income
Add back depreciation
Net cash provided by operating activities

$ 880,000
(470,000)
(300,000)
$ 110,000
300,000
$ 410,000

Notice that the additional depreciation did not affect net cash
provided by operating activities. The direct method clearly shows this
phenomenon:
Direct method:
Sales for cash
Operating expenses in cash
Net cash provided by operating activities

Chapter 5

Statement of Cash Flows

$ 880,000
(470,000)
$ 410,000

201

5-40 (5-10 min.)


a.
b.
c.
d.
e.

Financing
Financing
Operating
Investing
Financing

f.
g.
h.
i.

Financing
Operating
Operating
Financing

Because net income and depreciation appear in the body of the


statement of cash flows, AT&T must use the indirect method for
reporting cash flows from operating activities.
5-41 (10-15 min.)
ELI LILLY AND COMPANY
Statement of Cash Flows from Financing Activities
For the Year Ended December 31, 2002
(In Millions)
Dividends paid
Purchase of common stock and
other capital transactions
Stock issuances
Decrease in short-term borrowings
Additions to long-term debt
Repayments of long-term debt
Net cash used for financing activities

202

(1,335.8)
(385.2)
64.6
(18.0)
1,259.6
(7.2)
$(422.0)

5-42 (10-15 min.)


KLM ROYAL DUTCH AIRLINES
Statement of Cash Flows from Investing Activities
For the 2003 Fiscal Year
(in millions)
Net capital expenditure on intangible fixed assets
(28)
Capital expenditures on aircraft
(637)
Investments in affiliated companies
(33)
Disposals of aircraft
308
Net capital expenditures on other tangible fixed assets
(53)
Sales of investments
7
(436)
Net cash used for investing activities
5-43 (10-15 min.)
Items 3 and 6 are completely cash transactions and would be
shown on the body of a statement of cash flows. The others all entail
some noncash investing or financing activity.
Schedule of Noncash Investing and Financing Activities
Exchange of assets
$ 6,000
Issue 6-month note to retire long-term debt*
$ 30,000
Assumption of mortgage on building purchased**
$100,000
Conversion of debt to common stock
$ 60,000
* The $20,000 cash payment would be in the body of the statement of cash flows.
** The $20,000 cash payment would be in the body of the statement of cash flows.

Chapter 5

Statement of Cash Flows

203

5-44 (10-15 min.)


NORTHWEST COMMUNICATIONS
Statement of Cash Flows
For Six Months Ended June 30, 2004
(In Millions)
Operating Activities:
Receipts from customers
Payments to suppliers and employees
Interest paid, net
Taxes Paid
Cash provided by operating activities
Investing Activities:
Capital expenditures for property and equipment
Sales of marketable securities
Other
Cash used for investing activities
Financing Activities:
Issuance of long-term debt
Retirement of long-term debt
Issuance of common stock for employee
stock plans
Dividend payments
Purchase of treasury stock
Cash provided by financing activities
Net (decrease) increase in cash and cash equivalents
Cash and cash equivalents, beginning balance
Cash and cash equivalents, ending balance

204

$ 9,355
(7,499)
(140)
(167)
1,549
(1,710)
191
(134)
(1,653)
135
(160)
251
(17)
(193)
16
(88)
200
$ 112

5-45 (15-20 min.)


POOLS, INC.
Statement of Cash Flows
For the Year Ended December 31, 20X7
(In Thousands)
Cash flows from operating activities:
Cash collections from customers
Cash payments:
To suppliers
To employees
For other expenses
For interest
For income taxes
Cash disbursed for operating activities
Net cash provided by operating activities

$1,400
$(825)
(200)
(100)
( 11)
(35)
(1,171)
229

Cash flows from investing activities:


Purchase of plant and facilities
Cash flows from financing activities:
Issued long-term debt
Paid dividends
Net cash provided by financing activities
Net decrease in cash
Cash, December 31, 20X6
Cash, December 31, 20X7

Chapter 5

Statement of Cash Flows

(435)
110
(41)
69
(137)
176
$ 39

205

5-46 (15-25 min.)


KOBE EXPORTS, INC.
Statement of Cash Flows
For the Year Ended December 31, 20X5
(In Millions)
Cash flows from operating activities
Cash collections from customers
2,413
Cash payments:
To suppliers
(1,653)
To employees
(305)
For other operating expenses
(94)
For interest
(26)
For income taxes
(108)
Cash disbursed for operating activities
(2,186)
Net cash provided by operating activities
227
Cash flows from investing activities:
Purchase of warehouse
Proceeds from sale of equipment
Net cash used in investing activities
Cash flows from financing activities:
Issued common stock
Retired long-term debt
Dividends paid
Net cash used in financing activities
Net decrease in cash
Cash, January 1, 20X5*
Cash, December 31, 20X5
*X 361 = 7
X = 368

5-47 (15-25 min.)


206

(540)
47
(493)
28
(25)
(98)
(95)
(361)
368

ARROYO MANUFACTURING COMPANY


Statement of Cash Flows
For the Year Ended December 31, 20X4
(In Thousands)
Cash flows from operating activities
Cash collections from customers ($371 + $15)
Cash payments:
To suppliers ($209 $5 $5)
To employees
For other expenses
For income taxes
Cash disbursed for operating activities
Net cash provided by operating activities
Cash flows from investing activities:
Purchase of machinery
Proceeds from sale of old machines
Net cash used for investing activities
Cash flows from financing activities:
New issue of long-term debt
Payment of dividends*
Net cash provided by financing activities
Net increase in cash
Balance, cash and cash equivalents,
December 31, 20X3
Balance, cash and cash equivalents,
December 31, 20X4

$ 386
$(199)
(82)
(15)
(8)
(304)
$ 82

$(125)
5
(120)

$ 100
(10)
90
$ 52
45
$ 97

*$15 net income dividends = $5 increase in retained earnings

Chapter 5

Statement of Cash Flows

207

5-48 (20-25 min.)


1.

J. M. SMUCKER COMPANY
Statement of Cash Flows
For the Year Ended April 30, 2003
(In Millions)
Cash Flows from operating activities:
Cash received from customers ($1,311 $43)
Cash paid for operating expenses
($1,147 + 12 - 56 - 34)
Cash paid for other expenses ($9 $12)
Taxes paid ($59 $23)

$1,268
(1,069)
3
(36)
$ 166

Cash flows from investing activities:


Additions to property, plant, and equipment $(49)
Business acquired
(11)
Disposal of property, plant, and equipment
7
Cash flows from financing activities:
Issuance of common stock
Dividends paid
Increase in cash
2.

208

$ 7
(34)

(53)

(27)
$ 86

Operating cash flows substantially exceeded dividend payments


plus Smuckers investing activities. No additional financing was
required. The $7 million of common stock issued was probably
part of executive stock option plans or employee stock purchase
plans.

5-49 (15-20 min.)


FIRENZE, S.A.
Statement of Cash Flows
For the Year Ended December 31, 20X1
(In Millions of Euros)
Cash flows from operating activities:
Cash collections from customers
[910 90]
Cash payments:
To suppliers [540 + 100 220]
(420)
For operating expenses
(220)
For interest
(15)
For taxes
(25)
Cash disbursed for operating activities
Net cash provided by operating activities
Cash flows from investing activities:
Purchase of fixed assets
Proceeds from sale of fixed assets
Net cash used for investing activities
Cash flows from financing activities:
New issue of long-term debt
Dividends paid
Net cash provided by financing activities
Net decrease in cash
Cash balance, December 31, 20X0
Cash balance, December 31, 20X1

Chapter 5

Statement of Cash Flows

820

(680)
140

(315)
100
(215)
65
(30)
35
(40)
60
20

209

5-50 (15 min.)


1.

CSR LIMITED
Statement of Cash Flows
For the Fiscal Year 2003
(In Millions)
Cash flows from operating activities:
Receipts from customers
Payments to suppliers and employees
Dividends and interest received
Income taxes paid
Net cash from operating activities
Cash flows from investing activities
Purchase of property, plant, and equipment
Proceeds from sale of property, plant, and equipment
Other investing activities
Net cash used in investing activities
Cash flows from financing activities
Proceeds from issue of shares
Repurchase of shares
Net proceeds from borrowings
Dividends paid
Interest paid
Net cash from financing activities
Net increase in cash

A$7,572.7
(6,281.3)
78.3
(197.6)
1,172.1
(315.2)
97.7
(897.6)
(1,115.1)
42.8
(6.7)
666.2
(245.1)
(111.4)
345.8
A$ 402.8

2.

Interest paid is an operating item in U.S. cash flow statements.

3.

Interest paid is a cost of financing the companys activities. Like


dividends are a return to suppliers of equity capital, interest is the
return to suppliers of debt capital. Therefore, it is a legitimate item
to be included among financing activities.

4.

The FASB decided that because interest is an expense in the


income statement it should be included with the other expenses
among the operating activities.

210

5-51 (15 min.)


KANSAI ELECTRIC
Statement of Cash Flows
Year Ended March 31
(in Billions of Yen)
Cash flows from operating activities:
Operating revenues
Non-operating revenues
Operating expenses
Non-operating expenses
Net cash provided by operating activities
Cash flows from investing activities
Cost of construction
Net cash used for investing activities
Cash flows from financing activities
Bond issue
Increase in loans
Repayment of bonds
Repayments of loans
Net cash provided by financing activities
Net decrease in cash
Cash balance at beginning of the period
Cash balance at end of the period

Chapter 5

Statement of Cash Flows

2,545
109
(1,954)
(140)
560
(672)
(672)
236
1,546
(262)
(1,419)
101
(11)
72
61

211

5-52 (10-15 min.)


POOLS, INC.
Supporting Schedule to Statement of Cash Flows
Reconciliation of Net Income to Net Cash
Provided by Operating Activities
For the Year Ended December 31, 20X7
(In Thousands)
Net income
Adjustments to reconcile net income to net
cash provided by operating activities:
Add:
Depreciation, which was included
in computing net income but does
not affect cash
Deduct: Increase in accounts receivable
Deduct: Increase in inventory
Add:
Increase in accounts payable
Deduct: Decrease in salaries
and wages payable
Add:
Increase in income taxes payable
Net cash provided by operating activities

212

$ 314

45
(100)
(50)
25
(10)
5
$ 229

[1,500 1,400]
[ 850 800]
[ 850 825]
[ 200 190]
[ 40 35]

5-53 (10-15 min.) Amounts are in millions.


Net Earnings
Add expenses not requiring cash:
Depreciation
Other
Adjust for changes in operating current
assets and current liabilities:
Decrease in accounts receivable
Increase in inventories
Increase in prepaid expenses
Decrease in accounts payable
Increase in income taxes payable
Increase in other accrued liabilities

$514
$191
164
$ 17
(11)
(1)
(84)
71
(54)

355

(62)
$807

5-54 (10-15 min.)


SUMITOMO METAL INDUSTRIES, LTD.
Statement of Cash Provided by Operating Activities
For the Year Ended March 31, 2003
(In Billions of Yen)
Net earnings
Add depreciation and amortization
Add other noncash revenues and expenses, net
Adjust for changes in operating current
assets and current liabilities
Add decrease in receivables
Add decrease in inventories
Add increase in payables
Less other changes in current assets and
current liabilities
Net cash provided by operating activities

Chapter 5

Statement of Cash Flows

17.1
93.0
16.4

30.6
30.7
2.8
(29.5)
161.1

213

5-55 (10 min.)


TANG COMPANY
(In Millions)
1.

Income Statement
Sales
Nondepreciation expenses ($350 $25)
Depreciation (Revised)
Net income

$380
$325
45

Reconciliation of net income to net cash provided


by operating activities:
Net income
Add noncash expenses:
Depreciation
Deduct net increase in noncash
operating working capital
Net cash provided by operating activities
2.

214

370
$ 10

$ 10
45
(17)
$ 38

An increase in depreciation does not affect net cash flow from


operating activities. The $20 million increase in depreciation
decreases net income by $20 million and increases the add back
by $20 million. The net effect is zero. Depreciation is added to net
income merely to offset its deduction when computing net
income, not because it provides cash.

5-56 (10-20 min.)


KOBE EXPORTERS, INC.
Supporting Schedule to Statement of Cash Flows
Reconciliation of Net Income to Net Cash Provided by Operating Activities
For the Year Ended December 31, 20X5
(In Millions)

Net income
254
Adjustments to reconcile net income to net
cash provided by operating activities:
Add: Depreciation
151
Deduct: Increase in accounts receivable (2,510 2,413)
(97)
Deduct: Increase in inventory
(56)
Add: Increase in accounts payable (1,599 + 56 1,653)
2
Deduct: Decrease in wages payable
(24)
Deduct: Decrease in income taxes payable (108 105)
( 3)
Net cash provided by operating activities

Chapter 5

Statement of Cash Flows

227

215

5-57 (10-20 min.)


ARROYO MANUFACTURING COMPANY
Statement of Cash Flows
For the Year Ended December 31, 20X4
(In Thousands)
Cash flows from operating activities
Net income
Adjustments to reconcile net income to net cash
provided by operating activities:
Add noncash expenses:
Depreciation
Add decreases in current assets:
Accounts receivable
Inventories
Add increases in current liabilities
Accounts payable
Interest payable
Net cash provided by operating activities
Cash flows from investing activities:
Purchase of machinery
Proceeds from sale of old machines
Net cash used for investing activities
Cash flows from financing activities:
New issue of long-term debt
Payment of dividends
Net cash provided by financing activities
Net increase in cash
Balance, cash and cash equivalents,
December 31, 20X3
Balance, cash and cash equivalents,
December 31, 20X4

216

$ 15

$ 40
15
5
5
2

67
82

$(125)
5
(120)

$ 100
(10)
90
52
45
$ 97

5-58 (20-30 min.)


SALINAS COMPANY
Statement of Cash Flows
For the Year Ended December 31, 20X1
(In Millions)
Cash flows from operating activities:
Net income
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation
Increase in receivables
Increase in inventories
Increase in current liabilities
Net cash provided by operating activities
Cash flows from investing activities:
Purchase of fixed assets
Cash flows from financing activities:
Issue of long-term debt
$150
Dividends paid
(12)
Cash provided by financing activities
Net decrease in cash
Cash balance, December 31, 20X0
Cash balance, December 31, 20X1

2.

$ 60

40
(35)
(44)
75
$ 96
(240)

138
$ (6)
21
$ 15

Dear Mr. Salinas:


Severe shortages of cash often accompany rapid corporate
growth. Profitable operations usually produce heavy supplies of
cash. But the insatiable demand for cash to expand receivables,
inventories, and fixed assets may deplete the cash on hand
despite profitable operations. In your case, the substantial
increase in the fixed asset levels was perhaps the dominant
factor in consuming cash generated by operations.

Chapter 5

Statement of Cash Flows

217

5-59 (30-40 min.)


1.

ROSENBERG COMPANY
Statement of Cash Flows
For the Year Ended December 31, 20X4
(In Millions)
Cash flows from operating activities:
Cash collections from customers
($275 $14)
Cash payments:
To suppliers ($165 + $20 $14)
For general expenses ($51 + $1)
For taxes ($10 $1)
Cash disbursed for operating activities
Net cash provided by operating activities
Cash flows from investing activities:
Acquisition of plant assets
Proceeds from sale of plant assets
Net cash used for investing activities
Cash flows from financing activities:
Issue long-term debt
Pay cash dividends
Net cash provided by financing activities
Net decrease in cash
Cash balance, December 31, 20X3
Cash balance, December 31, 20X4

218

$261
$(171)
(52)
(9)
(232)
29
$ (98)
6
(92)
$ 50
(2)
48
(15)
20
$ 5

5-59 (continued)
2.
Reconciliation of Net Income to Net Cash
Provided by Operating Activities
Net income
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation
Increase in accounts receivable
Increase in inventory
Increase in prepaid general expenses
Increase in accounts payable for merchandise
Increase in accrued tax payable
Net cash provided by operating activities
3.

$ 9
40
(14)
(20)
( 1)
14
1
$ 29

Rosenbergs stress may be reduced but not eliminated. The


statement of cash flows has shown why cash has fallen by $15
million. Operating activities provided $29 million, and financing
activities provided an additional $48 million, a total of $77 million.
However, $92 million was needed for the net acquisition of plant
assets.
Severe crunches on cash commonly accompany quick corporate
growth. There may be substantial net income and working capital
provided by operations, but heavy demands for cash to expand
receivables, inventories, and plant assets diminish the cash on
hand despite profitable operations. Hence, most "growth"
companies pay skimpy or no dividends.

Chapter 5

Statement of Cash Flows

219

5-60 (10-15 min.) Amounts are in millions of dollars.


Retained Noncash
Liabilities + Earnings Assets

Cash =
Sales
Cash collections from
customers
Cost of goods sold
Purchases
Payments to suppliers
Payments for general expense
Tax expense
Payments for taxes
Net cash provided by operating
activities (a subtotal)
Expenses not requiring cash:
Depreciation
Net income (a subtotal)
Purchase of plant assets
Proceeds from sale of plant
assets
Long-term debt issued
Dividends paid

98

+ 6
+ 50
2

=
=
=

+ 50

Net changes

15

+ 65

220

=
+ 261
171
52
9

=
=
=
=
=
=
=

+ 275

(+ 275)

165

( 261)
( 165)
(+ 185)

+ 185
171
+ 10
9

51
10

(+ 1)

40
9

( 40)

29
=

(+ 98)
( 6)
2
+ 7

(+ 87)

5-61 (40-60 min.) This problems includes the complication of gains


and losses on asset sales and debt retirement.
ADIRONDAK TOYS, INC.
Statement of Cash Flows
For the Year Ended December 31, 20X4
(In Thousands)
Cash flows from operating activities:
Cash collections from customers ($9,739 + $19)
Dividends received
Cash payments:
To suppliers and employees
For interest ($144 $15)
For taxes
Cash disbursed for operating activities
Net cash provided by operating activities
Cash flows from investing activities:
Purchase property, plant & equipment
Purchase stock in Lake Placid Toy
Proceeds from sale of property
Net cash used by investing activities
Cash flows from financing activities:
Issue common stock
Cash received on exercise of stock options
Issue long-term debt
Retire long-term debt
Buy treasury stock
Cash dividends paid
Net cash provided by financing activities
Net increase in cash and cash equivalents

$ 9,758
152

$ 9,910

$ (8,074)
(129)
(390)
(8,593)
$ 1,317
$ (1,986)
(3,848)
500
(5,334)
$ 3,300
170
1,906
(850)
(249)
(240)
4,037
$ 20

Note that (h) regarding the money market fund is irrelevant; it


merely rearranges the composition of the total cash holdings.
The non-cash purchase of new equipment in (d) would be shown
in an accompanying schedule. Similarly for transactions (f) and (j).

Chapter 5

Statement of Cash Flows

221

5-61 (continued)
Reconciliation of Net Income to Net Cash Provided by Operating Activities

Net income
Adjustments to reconcile net income to net cash
provided by operating activities:
Add:
Depreciation and amortization
Add:
Loss on sale of fixed assets (500 576)
Deduct: Gain on extinguishment of debt (900 850)
Deduct: Increase in inventories
Add:
Decrease in accounts receivable
Add:
Increase in accounts and wages payable
Add:
Increase in interest payable
Add:
Increase in taxes payable
Net cash provided by operating activities

$ 672
615
76
(50)
(72)
19
7
15
35
$1,317

Schedule of Noncash Investment and Financing Activities


Issue note payable for purchase of equipment
Issue common stock for conversion of
long-term debt
Issue common stock to acquire Sanchez
Musical Instruments Co.

222

$ 516
$ 960
$ 297

5-62 (20 min.)


NORDSTROM, INC.
Statement of Cash Flows
Cash flows from Operating Activities
For the Year Ended January 31, 2003
(In Millions)
Cash collections from customers
Other cash collections
Total Collections
Cash Payments:
To suppliers
$4,098 (b)
For selling, general and
administrative expenses
1,484 (c)
For interest
82
For taxes
48 (d)
Total cash payments
Net cash provided by operating activities
(a)
(b)
(c)
(d)

Chapter 5

$5,917 (a)
74
5,991

5,712
$ 279

$5,975 $58
$3,971 + $117 + $10
$1,814 $288 - $1 $24 $17
$92 $44

Statement of Cash Flows

223

5-63 (15-20 min.) Amounts are in millions.


1.

Kellogg's free cash flow each year was:


(In Millions)
Operating cash flow
Additions to properties
Free cash flow before dividends
Dividends
Free cash flow after dividends

2.

224

2002
$ 999.9
(253.5)
746.4
(412.6)
$ 333.8

2001
$1,132.0
(276.5)
855.5
(409.8)
$ 445.7

2000
$ 880.9
(230.9)
650.0
(403.9)
$ 246.1

Kelloggs has plenty of cash flow from operations each year to


pay its capital investment needs and its dividends. Its best free
cash flow was in 2001, and it fell slightly in 2002.

5-64 (20-25 min.) Amounts are in millions of dollars.


The McDonald's Corporation cash flow statement is presented on
the following page with all brackets in place and with the original values
for a, b, and c. From a solution perspective the following procedural
matters may be useful.
1. & 2. Most of the descriptions are obvious because they use phrases
such issuances or repayment. In this instance all have the
same sign as in the prior year. In both investing and financing,
the sign of "other" can only be determined by calculating once
the others are determined. While "other" has the same sign as in
the prior year, this is not reliable. Also, the sign of net short-term
borrowings (repayments) is not obvious. While the total could be
either positive or negative, the caption for the total is
unambiguous, cash used for financing. Only a negative $606.8
million will give a total of $511.2 million as cash used for
financing.
3.

A.
B.
C.

4.

Beginning Balance + net earnings dividends = ending balance.


$18,608.3 million +$893.5 million -$297.4 million =$19,204.4 million

5.

McDonalds' cash flow provided by operations has exceeded its


investing needs over the two years. Therefore, there has been no
need for extra financing.

Chapter 5

= $2,890.1 - $2,466.6 - $511.2 = -$87.7 million (a decrease).


= $418.1 million, the ending balance from the prior year.
= A + B = $-87.7 million + $418.1 million = $330.4 million.

Statement of Cash Flows

225

5-64

(continued)
Although not required as part of the problem, we provide here the
complete statement of cash flows for reference:
MCDONALDs
CONSOLIDATED STATEMENT OF CASH FLOWS

(In millions)
Operating activities
Net income
Adjustments to reconcile to cash provided by operations
Depreciation and amortization
Changes in operating working capital items
Accounts receivable
Inventories, prepaid expenses and other current assets
Accounts payable
Taxes and other liabilities
Other
Cash provided by operations

Years ended December 31,


2002
2001
$ 893.5

$ 1,636.6

1,050.8

1,086.3

1.6
(38.1)
(11.2)
448.0
545.5
2,890.1

(104.7)
(62.9)
10.2
270.4
(147.6)
2,688.3

Investing activities
Property and equipment expenditures
Purchases of restaurant businesses
Sales of restaurant businesses and property
Other
Cash used for investing activities

(2,003.8)
(548.4)
369.5
(283.9)
(2,466.6)

(1,906.2)
(331.6)
375.9
(206.3)
(2,068.2)

Financing activities
Net short-term borrowings (repayments)
Long-term financing issuances
Long-term financing repayments
Treasury stock purchases
Common stock dividends
Other
Cash used for financing activities
Cash and equivalents increase (decrease)
Cash and equivalents at beginning of year
Cash and equivalents at end of year

(606.8)
1,502.6
(750.3)
(670.2)
(297.4)
310.9
(511.2)
(87.7)
418.1
$ 330.4

(248.0)
1,694.7
(919.4)
(1,068.1)
(287.7)
204.8
(623.7)
(3.6)
421.7
$ 418.1

226

5-65 (20 min.)


1.

Brookline has a large and growing cash balance. Both sales and
income are declining, indicating that Brookline has not
successfully developed products to replace those responsible for
its peak sales in 2000. The company is apparently managing a
declining situation, selling more fixed assets than it is building or
acquiring. In fact, rather than investing in producing assets,
Brookline seems to be putting any extra cash into passive
investments such as the equity securities of other corporations.
Of the $1,050,000 of net income, $1,500,000 ($900,000 + $600,000)
was investment revenue. $2,100,000 was a gain on the sale of
fixed assets, and these were offset by a $1,200,000 loss on the
building fire. The ongoing business was generating a deficit.
Without the two nonrecurring items and the investment revenue,
there would have been negative net income (i.e. a loss) of
$1,350,000 (= $1,050,000 $1,500,000 $2,100,000 + $1,200,000).
Even after taking account of the $600,000 of depreciation and
amortization, net cash flow from operations would have been a
negative $750,000. Only by reducing working capital by $375,000
and receiving $900,000 in dividends did Brookline get a positive
$525,000 of cash flow from operating activities.
Notice that the two largest sources of cash for Brookline are the
insurance proceeds on the fire and cash from the sale of fixed
assets. Although these items have generated a healthy increase
in cash this year, they cannot be expected to reoccur regularly.

Chapter 5

Statement of Cash Flows

227

5-65 (continued)
2.

Brooklines Statement of Cash Flows follows generally accepted


accounting principles. However, it appears that the company
may be trying to manage its operations to maintain a positive
cash flow from operations. The intent of the operating activities
section of the statement of cash flows is to highlight items that
are likely to be maintained into the future. It seems that most of
the positive cash flow items for Brookline are items that will not
be maintained in the future.
There do not seem to be any violations of ethical standards in
Brooklines financial reports. Users of the reports should be able
to interpret them correctly and to see the unfavorable situation in
which Brookline finds itself, despite the overall increase in cash
and the positive cash provided by operating activities.
Nevertheless, if Brookline had used the direct method instead of
the indirect method in its Statement of Cash Flows, its situation
may have been more clearly communicated to users of the
statements.

228

5-66 (15-20 min.)


An important lesson in learning to understand statements of cash flow
is to recognize operating, investing, and financing activities.
Terminology can differ from company to company. This exercise will
expose students to a variety of items included in companies cash flow
statements. It would be desirable, though probably unlikely, that at
least one company selected by the students uses the direct method. If
so, the amount of learning will increase.
By listing the items included in operating, investing, and
financing categories by a variety of companies, students will begin to
see the types of items included. By pruning the list to eliminate
duplicates, they will learn to recognize different ways of expressing
the same thing.
Requirement 4 is not necessary, but it will reinforce the group
learning that took place in the first three requirements. It will also allow
students to start to recognize the most common elements of cash flow
statements and also to try to interpret some that are quite unusual.

5-67 (45-60 min.)


Each solution will be unique and will change each year. This
problem focuses on interpretation of the cash flow statement,
especially comparing net cash from operating activities with net
income.

Chapter 5

Statement of Cash Flows

229

5-68 (30 min. or more)


1.
The major reason for the increase in Starbucks net cash
provided by operating activities is the increase in net earnings. In
addition, depreciation and amortization significantly increased. The
increases in operating assets was mainly offset by increases in
operating liabilities, so the net effect was not large.
2.
The main use of the $566 million was to support investing
activities. In total Starbucks used $499 million for investing activities,
$357 million of which was used for net additions to property plant, and
equipment.
3.
Starbucks certainly generated enough cash to pay cash
dividends in 2003. However, apparently management decided that a
better use of those funds was to use them for internal expansion both
buying property, plant, and equipment and investing in the securities of
other companies, such as the purchase of Seattle Coffee Company. It
is not true that the shareholders got nothing. Shareholders gain
returns in two ways, dividends and stock price appreciation. As
Starbucks grows, its stock price grows, also. Thus, the shareholders
will benefit from increases in the stock price, even though they do not
get any return in the form of dividends.
5-69 (30-60 min.)
NOTE TO INSTRUCTOR. This solution is based on the web site
as it was in late 2004. Be sure to examine the current web site before
assigning this problem, as the information there may have changed.
1.
Nike used the indirect method. We know that because the
statement begins with net income and adjusts for noncash items
included in net income.

230

5-69 (continued)
2.
Management indicated that cash provided by operations
increased from $922 million in 2003 to $1.5 billion in 2004. The two
main reasons for the increase were the increased net income and
better control of working capital. By better supply chain management
Nike reduced its accounts receivable and increased its accounts
payable, resulting in the freeing up of additional cash.
3.
Cash provided by operations exceeds net income by almost
$570 million. About half of this is caused by adding back depreciation
to the net income. The other half is primarily a result of better control of
working capital.
4.
Nike, like every company using the indirect method, adds
depreciation and amortization to net income to offset their deduction in
computing net income. Depreciation and amortization are expenses,
but they are not cash outflows. They are correctly subtracted from
revenues in computing net income, but they should not be deducted
from cash receipts in computing cash from operations. Adding both
back to net income just cancels the deductions taken when computing
net income.
5.
There were three main investing activities that used cash,
purchases of short-term investments, additions to property, plant, and
equipment, and acquisition of a subsidiary (Converse).
6.
Nike used cash for three main financing activities, including just
over $50 million net reductions in long-term debt ($153.8 million 206.6
million = -$52.8 million), repurchases of stock exceeding new issues by
more than $160 million ($419.8 million - $253.6 million = $166.2 million),
and cash dividends paid of nearly $180 million.

Chapter 5

Statement of Cash Flows

231