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Chapter 5-7

ACTG 2010 Chapter Notes - Chapter 5-7: Cash Flow Statement, Free Cash Flow, Cash Flow

Course Code
ACTG 2010
Douglas Kong

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ACTG Chapter 5
Cash cycle: The cycle of investing cash in resources, providing goods and services to
customers, and collecting cash from customers.
Cash lag: The delay between the expenditure and receipt of cash.
Inventory conversion period: The average length of time between receiving
inventory from a supplier and selling it to the customer.
Payables deferral period: Average number of days between receipt of goods and
services from a supplier to payment of the supplier.
Receivable conversion period: Average length of time between delivery of goods to a
customer and receipt of cash.
Inventory self-financing period: Average number of days between the date the
inventory is paid for and the date that the inventory is sold to a customer. Same as
the cash lag.
Self-financing: Time paid since supplier was paid till when cash was collected.
i). Unit of measure: Currency in which all an entity’s activities are classified. E.g., U.S
dollar or even Canadian Dollar. Drawbacks of unit of measure include; it may not
consider inflation, and human capabilities.
ii). Entity concept: If there is a separate entity, there should be information that is
provided for that entity alone. However, there are situations where owners of the
entity can record their private personal transaction that do not relate to the
business entity to affect the overall credibility of financial statements. Stakeholders
may make wrong assumptions. Anil Chopra’s Nashco and Dimension Hospitality vs.
his personal transactions (e.g., India Ticket) that are included in the same financial
iii). Going concern (A business will continue running): An entity that will be
continuing its operations for the foreseeable future. In the event that an entity exists
for a certain known duration of time (or is at risk of going out of business), all assets
and liabilities become current. Creditors will demand loan repayment or supply
payment in the current period (not the original long term commitment, they won’t
allow payment deferrals on inventory).
iv). Periodic reporting assumption: The entity reports financial information over
periods of time that are shorter than the entities life (quarterly, annually). You now
where an entity is headed based on these reports and the information is more useful
for stakeholders if it is reported frequently.

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Cash flow statement can also be known as the changes in financial position.
-Cash from operations: Any cash that an entity generates or uses from its day-to-
day business activities. Cash involving current assets and current liability accounts.
Cash from financing activities: Is that cash an entity raises from and pays to equity
investors and lenders. Involving long-term assets.
-Cash from investing activities: The cash an entity spends on buying capital assets
and other long-term assets (also the cash that the entity receives from selling those
assets). Cash involved with long-term liability and equity.
-All three of these activities combine to create net cash flow.
-Cash and cash equivalents include:
i). Cash on hand and cash in bank accounts.
ii). Short-term liquid investment: Investments that are easily converted to known
amounts of cash with little risk that the amount of cash to be received would not
change. These are investments maturing within 3 months. Government T-bills,
money market fund (bank needs money to meet its deposits, very short term paper
for borrowing where some interest is paid), commercial paper (entities like Loblaws
need money for a short duration of time which would be paid back with interest).
NOTE: Equity investments (Royal Bank Shares) cannot be included in cash or cash
equivalents because their market values fluctuate.
iii). Bank overdraft is a liability to the bank created when an entity has $20000 in its
bank account and it writes cheque amounts exceeding the balance in its bank
account. Line of credit is a loan amount provided by the bank at interest which
becomes a liability for the institution owing the money. Cash and cash equivalents
includes the money available from having a line of credit (included as a negative
-Repurchasing common shares from investors is when an entity (corporation)
purchases shares back from investors for the purposes of
-IFRS states that interest paid out can be treated as either operating activity or
financing activity. Dividends are always financing activities.
-Cash flow statements only reports statements involving cash.
Cash flow from operations can be calculated in 2 ways:
i). Indirect method: Adjusting net income for non-cash amounts and for operating
flows not included in the calculation for net income. Used more widely by
company’s even though IFRS allows the direct method. The method highlites the
difference between income and cash flow.

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ii). Direct method: Cash collections and cash disbursements related to operations
during a period. Only considers cash inflows and outflows.
-When examining the indirect method, there are two types of adjustments that need
to be made:
i). Remove transactions and economic events that are included in the calculation of
net income but do not effect the cash flow. Essentially taking out all the non-cash
transactions. E.g., depreciation which does not involve cash, it’s just allocating the
cost of a depreciating item to expense over its life. Since depreciation is a non-cash
expense subtracted from net income, it must be added back to net income to
eliminate it when calculating CFO. Hence non-cash items must be subtracted when
calculating net income then must be added back when reconciling from net income
to CFO.
ii). Adjusting accrual revenue and expenses so that only cash flows are reflected. We
can change accrual revenues and expenses to cash by adjusting for changes over a
period in the non-cash working capital accounts on the balance sheet (A/R, A/P,
W/P, essentially the current assets and liabilities.
-Increasing depreciation expense would not increase CFO because you already
subtracted depreciation when calculating net income. To reconcile from net income
to CFO, you are adding the amount of depreciation which balances out depreciation
to 0.
-Gains: The amount by which the selling price of an asset is greater than its net book
value. These are subtracted from net income to determine CFO.
-Losses: The amount by which the selling price of an asset is less than its net book
value. These are added to net income to determine CFO.
-Future (deferred) income taxes: Differences between how taxes are calculated for
accounting purposes versus how they are calculated for taxation authorities These
are added/subtracted from net income to determine CFO.
-Writeoffs or writedowns of assets: Occurs when an asset’s book value is decreased
to reflect a decline in market value that is not supported by a transaction. These are
added to net income to determine CFO. Value of a Sony Bravia TV for example,
bought for 5000 but three years later is worth only $800.
-Liquidity is the ability to convert short-term assets into cash. It is important to
evaluate to see whether an entity can meet its current operations. Current assets,
current liabilities and shares of public companies.
-Solvency is the ability of the entity to pay its debts as they come due. You should be
able to meet your obligations as they fall due (it is a long-term concept).
-CFO if regular and predictable, is an important source of liquidity because it
represents a reliable source of cash for meeting obligations.
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