FAC Cash Flow Management 2 — Questions and Answers
Question 1: Which method of preparing the cash flow statement starts with net income and adjusts for non-cash items?
- Direct method
- Indirect method (Correct answer)
- Modified cash basis
- Accrual reconciliation method
Correct answer: Indirect method
The indirect method begins with net income and adjusts for non-cash items like depreciation and changes in working capital.
Question 2: A company collects $50,000 from customers but recorded $60,000 in sales. Which statement best explains the $10,000 difference?
- Revenue was overstated
- Accounts receivable increased by $10,000 (Correct answer)
- Accounts payable decreased by $10,000
- Depreciation reduced cash by $10,000
Correct answer: Accounts receivable increased by $10,000
When collections are less than sales, accounts receivable increases by the difference.
Question 3: Under US GAAP, where is interest paid classified on the cash flow statement?
- Investing activities only
- Financing activities only
- Operating activities (Correct answer)
- Either operating or financing activities
Correct answer: Operating activities
Under US GAAP, interest paid is classified as an operating activity, unlike IFRS which allows financing classification.
Question 4: A firm has net income of $100,000, depreciation of $20,000, and an increase in inventory of $15,000. What is operating cash flow?
- $105,000 (Correct answer)
- $135,000
- $85,000
- $95,000
Correct answer: $105,000
Operating cash flow = $100,000 + $20,000 (add back depreciation) – $15,000 (inventory increase uses cash) = $105,000.
Question 5: What does a negative cash flow from investing activities most commonly indicate?
- The company is losing money on operations
- The company is paying down debt
- The company is investing in long-term assets (Correct answer)
- The company has excess inventory
Correct answer: The company is investing in long-term assets
Negative investing cash flow typically signals capital expenditures or acquisitions, which represent investment in growth.
Question 6: Which ratio measures a company's ability to cover capital expenditures using operating cash flow?
- Current ratio
- Cash coverage ratio
- Capital expenditure coverage ratio (Correct answer)
- Quick ratio
Correct answer: Capital expenditure coverage ratio
The capital expenditure coverage ratio equals operating cash flow divided by capital expenditures.
Question 7: A business purchases equipment worth $80,000 by issuing a note payable. How is this reported on the cash flow statement?
- $80,000 outflow in investing activities
- $80,000 inflow in financing activities
- Disclosed as a non-cash investing and financing activity (Correct answer)
- Not reported anywhere on the cash flow statement
Correct answer: Disclosed as a non-cash investing and financing activity
Non-cash transactions must be disclosed as supplemental information rather than included in the statement body.
FAC Cash Flow Management 2
Which method of preparing the cash flow statement starts with net income and adjusts for non-cash items?