Chapter Review
16-9iCases & Projects
Ethics in Action
Lucas Hunter, president of Simmons Industries Inc., believes that reporting operating cash flow per share on the income statement would be a useful addition to the company’s just completed financial statements. The following discussion took place between Lucas Hunter and Simmons’ controller, John Jameson, in January, after the close of the fiscal year:
I’ve been reviewing our financial statements for the last year. I am disappointed that our net income per share has dropped by 10% from last year. This won’t look good to our shareholders. Is there anything we can do about this?
What do you mean? The past is the past, and the numbers are in. There isn’t much that can be done about it. Our financial statements were prepared according to generally accepted accounting principles, and I don’t see much leeway for significant change at this point.
No, no. I’m not suggesting that we “cook the books.” But look at the cash flow from operating activities on the statement of cash flows. The cash flow from operating activities has increased by 20%. This is very good news—and, I might add, useful information. The higher cash flow from operating activities will give our creditors comfort.
Well, the cash flow from operating activities is on the statement of cash flows, so I guess users will be able to see the improved cash flow figures there.
This is true, but somehow I think this information should be given a much higher profile. I don’t like this information being “buried” in the statement of cash flows. You know as well as I do that many users will focus on the income statement. Therefore, I think we ought to include an operating cash flow per share number on the face of the income statement—someplace under the earnings per share number. In this way, users will get the complete picture of our operating performance. Yes, our earnings per share dropped this year, but our cash flow from operating activities improved! And all the information is in one place where users can see and compare the figures. What do you think?
I’ve never really thought about it like that before. I guess we could put the operating cash flow per share on the income statement, underneath the earnings per share amount. Users would really benefit from this disclosure. Thanks for the idea—I’ll start working on it.
Glad to be of service.
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How would you interpret this situation? Is John behaving in an ethical and professional manner?
Team Activity
In teams, select a public company that interests you. Obtain the company’s most recent annual report on Form 10-K. The Form 10-K is a company’s annually required filing with the Securities and Exchange Commission (SEC). It includes the company’s financial statements and accompanying notes. The Form 10-K can be obtained either (a) by referring to the investor relations section of the company’s website or (b) by using the company search feature of the SEC’s EDGAR database service found at www.sec.gov/edgar/searchedgar/companysearch.html.
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Based on the information in the company’s most recent annual report, answer the following questions:
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What is the net cash flows from (used for) operating activities reported by the company at the end of the most recent year?
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What is the net cash flows from (used for) investing activities reported by the company at the end of the most recent year?
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What is the net cash flows from (used for) financing activities reported by the company at the end of the most recent year?
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What was the net increase (or decrease) in cash during the year?
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Evaluate the company’s cash inflows and outflows.
Communication
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Tidewater Inc., a retailer, provided the following financial information for its most recent fiscal year:
Net income $ 945,000 Return on invested capital 8% Net cash flows used for operating activities $(1,428,000) Net cash flows from investing activities $600,000 Net cash flows from financing activities $900,000 The company’s Cash Flows from (used for) Operating Activities section is as follows:
Net income $ 945,000 Depreciation 210,000 Increase in accounts receivable (1,134,000) Increase in inventory (1,260,000) Decrease in accounts payable (189,000) Net cash flows used for operating activities $(1,428,000) An examination of the financial statements revealed the following additional information:
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Revenues increased during the year as a result of an aggressive marketing campaign aimed at increasing the number of new “Tidewater Card” credit card customers. This is the company’s branded credit card, which can only be used at Tidewater stores. The credit card balances are accounts receivable on Tidewater’s balance sheet.
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Some suppliers have made their merchandise available at a deep discount. As a result, the company purchased large quantities of these goods in an attempt to improve the company’s profitability.
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In recent years, the company has struggled to pay its accounts payable on time. The company has improved on this during the past year and is nearly caught up on overdue payables balances.
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The company reported net losses in each of the two prior years.
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Write a brief memo to your instructor evaluating the financial condition of Tidewater Inc.
Using the Statement of Cash Flows
You are considering an investment in a new start-up company, Giraffe Inc., an Internet service provider. A review of the company’s financial statements reveals a negative retained earnings. In addition, it appears as though the company has been running a negative cash flow from operating activities since the company’s inception.
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How is the company staying in business under these circumstances? Could this be a good investment?
Analysis of Statement of Cash Flows
Dillip Lachgar is the president and majority shareholder of Argon Inc., a small retail chain store. Recently, Dillip submitted a loan application for Argon Inc. to Compound Bank. It called for a $600,000, 9%, 10-year loan to help finance the construction of a building and the purchase of store equipment, costing a total of $750,000. This will enable Argon Inc. to open a store in the town of Compound. Land for this purpose was acquired last year. The bank’s loan officer requested a statement of cash flows in addition to the most recent income statement, balance sheet, and retained earnings statement that Dillip had submitted with the loan application.
As a close family friend, Dillip asked you to prepare a statement of cash flows. From the records provided, you prepared the following statement:
After reviewing the statement, Dillip telephoned you and commented, “Are you sure this statement is right?” Dillip then raised the following questions:
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How can depreciation be a cash flow?
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Issuing common stock for the land is listed in a separate schedule. This transaction has nothing to do with cash! Shouldn’t this transaction be eliminated from the statement?
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How can the gain on the sale of investments be a deduction from net income in determining the cash flow from operating activities?
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Why does the bank need this statement anyway? It can compute the increase in cash from the balance sheets for the last two years.
After jotting down Dillip’s questions, you assured him that this statement was “right.” But to alleviate Dillip’s concern, you arranged a meeting for the following day.
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How would you respond to each of Dillip’s questions?
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Do you think that the statement of cash flows enhances the chances of Argon Inc. receiving the loan? Discuss.
Team Activity
This activity will require two teams to retrieve cash flow statement information from the Internet. One team is to obtain the most recent year’s statement of cash flows for Johnson & Johnson; the other team, the most recent year’s statement of cash flows for JetBlue Airways Corp.
The statement of cash flows is included as part of the annual report information that is a required disclosure to the Securities and Exchange Commission (SEC). SEC documents can be retrieved using the EdgarScan™ service at www.sec.gov/edgar/searchedgar/companysearch.html.
To obtain annual report information, key a company name in the appropriate space. EdgarScan will list the reports available to you for the company you’ve selected. Select the most recent annual report filing, identified as a 10-K or 10-K405. EdgarScan provides an outline of the report, including the separate financial statements.
As a group, compare the two statements of cash flows.
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How are Johnson & Johnson and JetBlue Airways Corp. similar or different regarding cash flows?
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Compute and compare the free cash flow for each company, assuming that additions to property, plant, and equipment replace current capacity.