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					                         Chapter 3
                  The Cash Flow Statement

REVIEW QUESTIONS

1. Why is it important for managers to analyze changes in the flow of cash between two
   consecutive accounting periods?

   So that managers can have an appreciation about where cash will be required
   (investing activities) and where it will come from (operating activities and financing
   activities).

2. Differentiate between a “cash inflow” and “cash outflow”.

   Cash inflow is cash that is obtained from different sources (e.g., obtaining a loan,
   selling an assets). Cash outflow is cash that is disbursed or expended for buying or
   paying something (e.g., paying a mortgage, buying a car).

3. What do we mean by internal sources of financing?

   Internal sources of financing is cash that will be generated by managers (operating
   activities) in order to use it to buy assets (investing activities). The two main sources
   of financing are net income and amortization. However, working capital can also be
   a source of cash if managers are able to reduce their inventory, accounts receivable
   and increase their accounts payable and short-term loans.

4. What do we mean by external sources of financing?

   External sources of financing is cash that will be obtained from investors (financing
   activities) such as shareholders and long-term lenders in order to use it to buy assets
   (investing activities).

5. Identify some of the key “cash inflows” and key “cash outflows”.

   Cash inflows include net income, the sale of a capital asset, the sale of investment
   securities and obtaining a new loan or new equity. Cash outflows take place when
   there is a loss from operation, the purchase of a capital asset, the purchase of
   investment securities and the payment of a loan.




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                          Chapter 3 – The Cash Flow Statement


6. Why is amortization considered a cash inflow?

   Amortization is not considered as a cash expense. Instead, it is considered as an
   accounting entry. Since it is not considered a cash outflow like salaries or
   advertising, it is added back to net income.
7. Why are working capital accounts part of the operating activities shown on the cash
   flow statement?

    Managers are responsible for working capital accounts such as accounts receivable
    and inventory. These accounts are also called operating capital. If managers
    mismanage the current asset accounts and show increases between two accounting
    periods, the business has to borrow funds (if internal cash is not sufficient) from the
    banks. These short-term loans are commonly called working capital or operating
    loans.

8. Comment on the key guidelines that can be used to identify whether a change in the
   accounts shown on a balance sheet between two consecutive accounting periods is
   considered a cash inflow or a cash outflow.

    A cash inflow takes place when there is a decrease in an asset account or an increase
    in a liability or equity account. A cash outflow takes place when there is an increase
    in an assets account or a decrease in a liability or equity account.

9. Identify the basic structure of the cash flow statement.

    The cash flow statement contains four sections: operating activities, financing
    activities, investing activities and the cash balance.

10. What is the purpose of the statement of “net change in non-cash working capital?

    The statement of changes in noncash working capital shows the cash flow provided
    (or used) by working capital accounts such as accounts receivable, inventory and
    accounts payable.

11. Comment on the more important items that are usually shown under the section
    “operating activities” in the cash flow statement.

    They are net income and amortization. However, working capital can also be a
    source of cash if managers are able to reduce their inventory, accounts receivable and
    increase their accounts payable and short-term loans.

12. What financial statements are used to prepare the cash flow statement?

    They are the income statement, the statement of retained earnings and the balance
    sheet. The income statement provides the net income and the amortization expense.
    The statement of retained earnings provides the dividends paid to the shareholders.


                                           - 30 -
                     Chapter 3 – The Cash Flow Statement


Two consecutive balance sheets provide the increase or decrease of the asset,
liability and equity accounts.




                                     - 31 -
                        Chapter 3 – The Cash Flow Statement


13. Comment on the more important items that are usually shown under the section
    “financing activities” in the cash flow statement.

   They are the funds provided shareholders and long-term lenders. However, this
   section can also show a cash outflow such as the payment of dividends and of a
   mortgage of bond.

14. Comment on the more important items that are usually shown under the section
    “investing activities” in the cash flow statement.

   They are the purchase of capital assets (i.e., land, buildings, equipment) and
   acquisition of another business. The section can also show cash outflow if a business
   sells one of their capital assets.




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