CHAPTER 11

THE STATEMENT OF CASH FLOWS

Changes from Eleventh Edition
Updated from the Eleventh Edition.
Approach
This is a topic that has always been difficult for students. The indirect method of developing the amount
of cash flow from operating activities is particularly difficult. The hearings prior to FASB 95 indicated
that the investment analyst community would press companies to continue using the indirect
(reconciliation) method; the primary supporters of the direct method were bankers. Thus, it appears that
students will not be well served in this subject area unless they gain an understanding of the indirect
method.
Since students were introduced to the difference between cash flows and accrual accountings revenues
and expenses way back in Chapter 3, this should be reinforcement at this point, but it usually seems to be
a new revelation to at least a subset of the class. For those who never succeed in fully understanding the
rationale for the adjustments, Illustration 11-4 now gives them a rote approach to which they can revert.
Cases
Medieval Adventures Company is an armchair case intended to dramatize the difference between
operating cash flow and income.
Amerbran Company (A) illustrates preparation of the cash flow statement from the other two statements
and supplemental information.
Great Valu Variety Stores illustrates the potential drawback of defining funds as working capital, and the
importance of considering cash flows in conjunction with income statements. The origins of the case, the
W.T. Grant bankruptcy apparently influenced the FASB in changing the required definition of funds from
working capital to cash.
Problems
Problem 11-1

2003 sales...........................................................................................................................................................................
$8,743,000
Less: Change in accounts receivable..................................................................................................................................
(70,000)
Cash generated from sales during 2003..............................................................................................................................
$8,673,000
Problem 11-2
a. Issuance of a 12-month note in return for $2 million cash is a financing source of cash. Use of $2
million cash to purchase equipment is an investment use of cash.
b. Cash proceeds from the issuance of common stock is a financing source of cash. The use of cash to
retire mortgage bonds is a financing use of cash.
c. No cash effect.
d. No cash effect.
e. Cash proceeds from the sale of machinery is an investment source of cash.

Accounting: Text and Cases 12e Instructors Manual

Anthony/Hawkins/Merchant

The above responses assume the direct method is used to present its cash flow of statement.
Problem 11-3

Kidsn Caboodle
Statement of Cash Flows

Cash received from customers..........................................................................................................................

$155,000
Cash used in operations....................................................................................................................................
(146,900)
Cash from operations....................................................................................................................................
$8,100

Equipment........................................................................................................................................................
(10,500)
Cash used for investments.............................................................................................................................
(10,500)

Loan.................................................................................................................................................................
21,000
Cash from financing......................................................................................................................................
21,000

Increase in cash.............................................................................................................................................
$ 18,600
Problem 11-4

Net loss...............................................................................................................................................................
$(11,000)
Depreciation.......................................................................................................................................................
26,400
15,400
Accounts receivable (reduced)............................................................................................................................
17,600
Accounts payable (increased).............................................................................................................................
8,800
Accrued salaries (increased)...............................................................................................................................
3,300
Other accruals (increased)..................................................................................................................................
2,200

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

47,300

Investments.........................................................................................................................................................
0

Long-term debt (reduced)...................................................................................................................................

(29,700)

Change in cash................................................................................................................................................
17,600
Beginning cash................................................................................................................................................
4,400
Ending cash.....................................................................................................................................................
$22,000
Problem 11-5

Operating Activities
Cash received from customers.........................................................................................................................
$62,100
Interest received..............................................................................................................................................
345
Operating cash payments.................................................................................................................................
(54,165)
Interest payment..............................................................................................................................................
(1,035)
Net cash provided by operations.....................................................................................................................
7,245

Investing Activities
Sale of old machine.........................................................................................................................................
3,105
Down payment on new truck...........................................................................................................................
(3,450)

Net cash used in investing activities................................................................................................................

(345)

Financing Activities
Payment of debt...............................................................................................................................................
(3,450)

Net cash used in financing activities...............................................................................................................

(3,450)

2007 McGraw-Hill/Irwin

Chapter 11

Increase in cash..................................................................................................................................
3,450
Beginning cash...................................................................................................................................
3,450
Ending cash........................................................................................................................................
$ 6,900

Cases
Case 11-1 Medieval Adventures Company*
Note: This case is the same version that was in the Eleventh Edition.
Approach
This (obviously) is an armchair case, intended to show dramatically the difference between profit and
cash flow from operations. The case has mechanistic patterns built into it to help students see what is
going on: relatively rapid growth is causing cash to be tied up in receivables and inventories faster than it
is regenerated from collections. Although the case may seem trivial (at least after the calculations have
been made) because of these mechanistic patterns, in fact many businesses have had severe (sometimes
fatal) financial crises because management did not anticipate the basic phenomenon that this case
develops. The graph included herein can be used in class to help illustrate this phenomenon.

Medieval Adventures Company

600,000
500,000
Sales

400,000

Net Income
Net Operating Cash Flow

300,000

Cash Balance w /o Loan

Accounts Receivable

200,000
100,000
0
-100,000
Jan

Feb

March

April

May

June

July

Aug

Sep

Oct

Question 1
The required monthly statements are shown on the following pages. The peak need comes by the end of
July, when a $40,000 loan would be needed to maintain a zero cash balance. In August, cash generated by
operations finally turns positive, enabling partial repayments of the loan. Octobers $27,500 cash
*

This teaching note was prepared by Robert N. Anthony. Copyright Robert N. Anthony.

Accounting: Text and Cases 12e Instructors Manual

Anthony/Hawkins/Merchant

generated by operations enables making the final $15,000 loan repayment and ending the month with a
$12,500 cash balance.
Question 2
This question is the key one in terms of student insight from this case. The company has been paying its
costs currently, but allowing customers two months to pay. This, coupled with constant growth, causes
large net operating outflows for several months, which collectively eat up the firms initial capital. It is
important for students to understand why it is that this situation eventually turns around: the unit margin
is $20 and the monthly nonproduction costs are fixed at $10,000; thus, the continued unit sales growth
eventually (in August) causes the current inflows (from sales two months ago) to exceed the current
outflows (production costs for next months sales plus $10,000). In other words, as the income statement
shows, the firm is profitable, and eventually those profits get realized in cash.
This need could have been avoided by projecting the cash flow figures that the students have developed
after the fact. Then the company could have arranged the necessary line of credit. Banks are happy to
provide such funds for companies that anticipate the need because that anticipation reflects good financial
management. On the other hand, banks are hesitant to lend to a firm that has been taken by surprise by a
cash shortage. Of course, a no-cost method to avoid the problem was also probably feasible. The
company could have arranged credit with vendors to help finance the inventory, and could have been
more aggressive in collecting from its customers in accord with the stated 30-day terms. If the company
delayed its payments by 30 days and accelerated receivable collections from 60 to 30 days (thus
shortening its cash cycle by 60 days), the operating cash flow would have turned positive in March and
no cash crisis would have occurred.
Question 3
The purpose of this question is to give students practice in deriving a cash flow statement from the
income statement and balance sheets. Because of the work done in question 1, where cash flows were
dealt with directly, students can gain some confidence in these derivation procedures before they apply
the procedures in more complex and realistic cases. The statements are as follows (in somewhat
simplified format, befitting this introductory problem):

March
May
July
Net income...................................................................................................................................................................................................................
$30,000
$50,000
$70,000
Increase in accounts receivable....................................................................................................................................................................................
(55,000)
(55,000)
(55,000)
Increase in inventory....................................................................................................................................................................................................
(17,500)
(17,500)
(17,500)
Cash from operations...................................................................................................................................................................................................
(42,500)
(22,500)
(2,500)
Proceeds of debt...........................................................................................................................................................................................................
-022,500
2,500
Cash increase (decrease)..............................................................................................................................................................................................
(42,500)
0
0
Beginning of month cash balance................................................................................................................................................................................
72,500
0
0
End of month cash balance...........................................................................................................................................................................................
$30,000
$0
$0
OPERATING BUDGET
Jan.
Feb.
Mar.
Apr.
May
June
July
Aug.
Sept.
Sales.............................................................................................................................................................................................................................
$55,000
$82,500
$110,000
$137,500
$165,000
$192,500
$220,000
$247,500
$275,000
Cost of Sales.................................................................................................................................................................................................................
35,000
52,500
70,000
87,500
105,000
122,500
140,000
157,500
175,000
Gross Margin................................................................................................................................................................................................................
20,000
30,000
40,000
50,000
60,000
70,000
80,000
90,000
100,000
Other Expenses.............................................................................................................................................................................................................
10,000
10,000
10,000
10,000
10,000
10,000
10,000
10,000
10,000
Net Income...................................................................................................................................................................................................................
10,000
20,000
30,000
40,000
50,000
60,000
70,000
80,000
90,000
CASH BUDGET
Cash lnflows:
Cash forwarded............................................................................................................................................................................................................
$146,250
$111,250
$ 72,500
$ 30,000
$-0$-0$-0$-0$-0Collections....................................................................................................................................................................................................................
27,500
41,250
55,000
82,500
110,000
137,500
165,000
192,500
220,000
Loan from bank.........................................................................................................................................................................................................
------2,500
22,500
12,500
2,500
----Total......................................................................................................................................................................................................................
$173,750
$152,500
$127,500
$115,000
$132,500
$150,000
$167,500
$192,500
$220,000
Cash Outflows:
Costs & expenses.........................................................................................................................................................................................................
$ 62,500
$ 80,000
$ 97,500
$115,000
$132,500
$150,000
$167,500
$185,000
$202,500
Loan payback............................................................................................................................................................................................................
--------------7,500
17,500
Cash balance.........................................................................................................................................................................................................
$111,250
$ 72,500
$ 30,000
$0
$0
$0
$0
$0
$0
Memo:
Net operating cash flow................................................................................................................................................................................................
$(35,000)
$(38,750)
$(42,500)
$(32,500)
$(22,500)
$(12,500)
$(2,500)
$ 7,500
$ 17,500
Cash balance w/o loan..................................................................................................................................................................................................
$111,250
$ 72,500
$ 30,000
$ (2,500)
$(25,000)
$(37,500)
$(40,000)
$(32,500)
$(15,000)

Oct.
$302,500
192,500
110,000
10,000
100,000

$-0247,500
--$247,500
$220,000
15,000
$ 12,500
$ 27,500
$ 12,500

Accounting: Text and Cases 12e Instructors Manual

Dec.
31st

Jan.
31st

Anthony/Hawkins/Merchant

Feb.
28th

BALANCE SHEET
Mar
Apr.
31st
30th

May
31st

June
30th

July
31st

Aug.
31st

Sept.
30th

0ct.
31st

Assets:
Cash...........................................................................................................................................................................................................................
$146,250
$111,250
$ 72,500
$ 30,000
$0
$0
$0
$0
$0
Accounts Receivable.................................................................................................................................................................................................
68,750
96,250
137,500
192,500
247,500
302,500
357,500
412,500
467,500
Inventory...................................................................................................................................................................................................................
35,000
52,500
70,000
87,500
105,000
122,500
140,000
157,500
175,000
Total.......................................................................................................................................................................................................................
$250,000
$260,000
$280,000
$310,000
$352,500
$425,000
$497,500
$570,000
$642,500

$0
522,500
192,500
$715,000

$ 12,500
577,500
210,000
$800,000

Liabilities and Equity:

Note Payable.............................................................................................................................................................................................................
$ --$ --$ --$ --$ 2,500
$ 25,000
$ 37,500
$ 40,000
$ 32,500
Common Stock..........................................................................................................................................................................................................
250,000
250,000
250,000
250,000
250,000
250,000
250,000
250,000
250,000
Retained Earnings.....................................................................................................................................................................................................
_______
10,000
30,000
60,000
100,000
150,000
210,000
280,000
360,000
Total..........................................................................................................................................................................................................................
$250,000
$260,000
$280,000
$310,000
$352,500
$425,000
$497,500
$570,000
$642,500

$ 15,000
250,000
450,000
$715,000

$ --250,000
550,000
$800,000

2007 McGraw-Hill/Irwin

Chapter 11

Case 11-2 Amerbran Company (A)*

Note: This case is unchanged from the Eleventh Edition.
Approach
This case is based on actual financial statements of American Brands, Inc. Although the numbers have
been changed from those reported, the magnitudes and relationships have been preserved. This case
provides additional practice in preparing a statement of cash flows. Since specific information is not
given on cash collections and operating disbursements, it is expected that students will use the indirect
approach in developing the cash generated by operations amount. The statements in Exhibit I also provide
the raw data for the (B) case, which is a ratio analysis case that appears in Chapter 13.
Answer to Question
The required cash flow statement appears below. The explanatory notes to the statement are as follows:
Note 1 This is the net of the following components:

Increase in accounts receivable .......................................................................................................................

$(68,827)
Increase in inventories .....................................................................................................................................
(19,510)
Decrease in prepaid expenses ..........................................................................................................................
1,027
Increase in accounts payable ...........................................................................................................................
33,075
Increase in accrued expenses payable .............................................................................................................
194,728
$ 140,493
Note 2. The two components of this acquisition, as given in the case, could be shown separately.
Note 3. The decrease in long-term debt is less than the decrease in long-term liabilities because the latter
also includes deferred taxes.
Note 4. Lacking specific information to the contrary, it is assumed that reissuance of treasury stock for
bonuses generated no cash. The stock dividend was, in effect, a 2-for-1 stock split. The only
difference is that if it were a stock split, the total shown for common stock at par would have
remained $161,417 rather than doubling to $322,834.
Note 5. The three major categories of cash flows generated a net of $11,785 of cash. Since the increase to
be explained is only $4,960, miscellaneous activities must have used $6,825 of cash. Some
students may include this line in operating activities, rather than as a fourth category; if they do,
the net cash flow from operations becomes $567,303.

AMERBRAN COMPANY
Statement of Cash Flows
For the year ended December 31, 20x1
(in thousands)
Net cash flow from operating activities:
Net income......................................................................................................................................................................
$328,773
Noncash items included in income:
Depreciation and amortization.....................................................................................................................................
115,974
Deferred taxes..............................................................................................................................................................
(17,548)
*

This teaching note was prepared by Robert N. Anthony. Copyright Robert N. Anthony.

Accounting: Text and Cases 12e Instructors Manual

Anthony/Hawkins/Merchant

Net change in receivables, inventories, and payables (Note 1)................................................................................................

140,493
Write-off of obsolete equipment...............................................................................................................................................
66,046
Income from subsidiary............................................................................................................................................................
(59,610)
Net cash flow from operating activities.......................................................................................................................................
(574,128)
Cash flows from investing activities:
Acquisitions of property, plant, and equipment...........................................................................................................................
(260,075)
Proceeds from disposals...............................................................................................................................................................
33,162
Acquisition of Company X (Note 2)............................................................................................................................................
(133,721)
Net cash used by investing activities........................................................................................................................................
(360,634)
Cash flows from financing activities:
Increase in short-term debt...........................................................................................................................................................
79,664
Decrease in long-term debt (Note 3)............................................................................................................................................
(34,606)
Dividends paid.............................................................................................................................................................................
(216,158)
Purchase of treasury stock (Note 4).............................................................................................................................................
(30,609)
Net cash used by financing activities........................................................................................................................................
(201,709)
Cash flows from miscellaneous activities (Note 5).........................................................................................................................
(6,825)
Net increase in cash.........................................................................................................................................................................
4,960
Cash at beginning of year................................................................................................................................................................
23,952
Cash at end of year..........................................................................................................................................................................
$ 28,912

Case 11-3: Great Value Variety Stores*

Note: A new case for the Twelfth Edition.
Approach
The premise motivative to case is that traditional ratio analysis and the definition of funds as working
capital used in many finance classes may not reveal a companys liquidity crisis as early as would a
careful analysis of the firms cash flows.
This case requires two class sessions. Trying to use it for only one session is likely to result in student
confusion and frustration unless the instructor provides handouts before class with all of the ratio analysis
and conversion of working capital flow to cash flow calculations done for the students.
My two-day approach involves six steps: (l) Calculate the ratios for just one year, being sure the students
understand what each ratio indicates (a few ratios have not yet been formally presented in the text, but
students seem to catch on to them quickly). (2) Use a transparency spreadsheet with all of the ratios for all
of the years, and discuss trends. (3) Discuss the working capital concepts of funds and how it differs from
the cash concept. (4) Do the conversion from working capital to cash for at least one year. (5) Use a
transparency to compare net income, working capital, and cash flow generated by operations, as well as
financing and investing activities, for the 10-year period. (6) Give a brief post mortem along the lines
mentioned below. Note the year 2007 is included in these handouts, the instructor may not want to show
2007 letting the students predict what 2007 may look like.

This teaching note was prepared by James S. Reece. Copyright James S. Reece.

Question 1

2007 McGraw-Hill/Irwin

Chapter 11

Ratios are shown in Exhibit A. Graphs of groups of related ratios are also shown below. Although the
case calls for calculation for days receivables, in the accompanying graph of turnover ratios that ratio has
been converted to receivables turnover, so it could readily be graphed using the same scale as for
inventory and asset turnover. (Receivables turnover is simply 365 divided by days receivables.) It should
be noted that profitability ratios were gradually declining through FY2005, but the big fall did not start
until 1963. Similarly, turnover ratios were gradually deteriorating (the improvement in 2007 is
deceptiveprimarily the result of crisis management). Liquidity declined over the decade and solvency
ratios also began to deteriorate in 2001.
Question 2.
The primary cause of student problems in answering Question 2 is that the changes in working capital
components at the bottom of the statement of changes in financial position have the opposite signs from
those needed for question 2. For example, an increase in inventory causes an increase in working capital,
and thus is shown as a positive amount in the bottom section of the SCFP; but an inventory increase is a
use of cash that must be subtracted in making the adjustments called for in question 2. I warn the students
of this complication on the assignment sheet. This is, of course, an ideal case for use of a spreadsheet; the
instructor may wish to make the data in Exhibits 1 and 2 available to the student as spreadsheet files to
facilitate all of their calculations.
The results of these calculations are graphed below, along with net income and working capital generated
by operations. This graph vividly demonstrates the premise: a cash flow analysis would have revealed Big
Values developing problem two or three years sooner than either net income or working capital
generated by operations signaled it. Indeed, over the decade, Big Value had positive operating cash flow
in only three years. The $100 million borrowings in 2004 and 2006 were needed to compensate for the
lack of cash generated by operations, as receivables and inventories ballooned.
Post Mortem
This is a disguised case based on the W.T. Giant bankruptcy.
The above analysis shows that net income was relatively flat through FY2005, yet sales doubled over the
period. Nevertheless, the year-end FY2005 stock price was double that of year-end FY1998. Until 2006,
Big Values p/e ratio (20) exceeded that of similar variety chains. The company was showing increased
sales and had paid dividends since 1906; apparently this overwhelmed the fact that the growth was
profitless.
Big Value filed for Chapter XI bankruptcy on October shortly after the case and was liquidated soon
thereafter.

EXHIBIT A
Big Value Variety Stores
1998
1999
2000
2001
2002
2003
2004
2005
2006
Selected Ratios
Profit Margin........................................................................................................................................................................................
0.038
0.034
0.034
0.035
0.035
0.029
0.023
0.021
0.006
Return on equity...................................................................................................................................................................................
0.164
0.149
0.137
0.136
0.144
0.131
0.106
0.116
0.037
Return on assets...................................................................................................................................................................................
0.078
0.062
0.060
0.061
0.059
0.049
0.036
0.034
0.009
Days receivables.................................................................................................................................................................................
75.2
91.3
101.5
104.2
111.0
104.3
108.4
104.0
106.7
Inventory turnover................................................................................................................................................................................
3.82
3.62
3.65
3.55
3.68
3.24
3.12
2.82
2.85
Asset turnover......................................................................................................................................................................................
2.07
1.80
1.78
1.76
1.71
1.68
1.57
1.59
1.55
Current ratio.........................................................................................................................................................................................
2.61
2.05
2.06
1.93
1.71
1.56
1.75
1.53
1.58
Quick ratio...........................................................................................................................................................................................
1.47
1.23
1.26
1.19
1.09
0.93
1.05
0.85
0.89
Total Liability Equity...........................................................................................................................................................................
1.113
1.415
1.292
1.221
1.431
1.695
1.947
2.423
3.054
Debt Capitalization...............................................................................................................................................................................
0.267
0.248
0.206
0.134
0.109
0.104
0.302
0.295
0.428

2007
-0.101
-1.557
-0.164
89.3
3.20
1.63
1.23
0.68
8.502
0.655

EXHIBIT B
Big Value Variety Stores
1990
1999
2000
2001
2002
2003
2004
2005
2006
Cash Flow From Operations
Working capital from operations..........................................................................................................................................................
38.8
39.2
40.3
45.4
49.2
43.6
40.4
45.3
23.1
Accounts receivable decrease (increase)..............................................................................................................................................
(53.7)
(57.3)
(42.1)
(40.3)
(55.5)
9.9
(49.9)
(60.3) (72.2)
Inventory decrease (increase)...............................................................................................................................................................
(10.6)
(23.2)
(9.1)
(24.9)
(13.5)
(38.4)
(38.2)
(100.8) (51.1)
Other current assets decrease(increase)................................................................................................................................................
0.0
(4.2)
0.2
(0.4)
(0.6)
(0.3)
0.0
(1.4)
(0.6)
Accounts payable increase (decrease)..................................................................................................................................................
(2.5)
(1.4)
6.2
15.6
7.5
9.8
14.0
(15.9)
(2.8)
Other current liabilities increase (decrease)..........................................................................................................................................
17.6
26.3
9.4
15.4
9.9
(17.8)
6.9
18.8
l0.4
Cash flow from operations...................................................................................................................................................................
(10.4)
(20.6)
4.9
10.8
(3.0)
6.8
(26.8)
(114.3) (93.2)
Note: 2007 figures are not in the case.

2007
(179.7)
109.6
43.2
0.7
(8.1)
(51.0)
(85.3)

2007 McGraw-Hill/Irwin

Chapter 11

Profitability Ratios
0.2
0.1
0
-0.1
-0.2
-0.3
-0.4
-0.5
-0.6
-0.7
-0.8
-0.9
-1
-1.1
-1.2
-1.3
-1.4
-1.5
-1.6
1998

1999

2000

2001

2002

Profit Margin

2003

2004

2005

ROE

2006

2007

ROA

Turnover Ratios
5
4.8
4.6
4.4
4.2
4
3.8
3.6
3.4
3.2
3
2.8
2.6
2.4
2.2
2
1.8
1.6
1.4
1998

1999

2000

2001

2002

Rcvbis

2003
Invent

11

2004

2005

2006
Assets

2007

Accounting: Text and Cases 12e Instructors Manual

Anthony/Hawkins/Merchant

Liquidity Ratios
2.7
2.6
2.5
2.4
2.3
2.2
2.1
2
1.9
1.8
1.7
1.6
1.5
1.4
1.3
1.2
1.1
1
0.9
0.8
0.7
0.6
1998

1999

2000

2001

2002

2003

2004

2005

Current Ratio

2006

2007

2006

2007

Quick Ratio

Solvency Ratios
9
8
7
6
5
4
3
2
1
0
1998

1999

2000

2001

2002

Liab/Equity

2003

2004

2005

Debt/Capital

12

2007 McGraw-Hill/Irwin

Chapter 11

Income and Funds Flows

60
40
20
0
-20
-40
-60
-80
-100
-120
-140
-160
-180
1998

1999

2000

Net Income

2001

2002

2003

Opns Wkg Cap

13

2004

2005

2006

Opns Cash

2007