FIN 461 EXAM 2 QUESTIONS AND
ANSWERS (GRADED A+)
What are the three categories of cash flows? - Answer- Operating activities, investing
activities, financing activities.
What is the significance of cash in a company? - Answer- Positive net income is
insignificant unless a company can translate earnings into cash; 'Cash is king.'
What are the four parts of preparing a Statement of Cash Flows? - Answer- Cash,
operating activities, investing activities, financing activities.
What are cash inflows from operating activities? - Answer- Cash from sales of goods or
services, returns on equity securities (dividends), returns on interest-earning assets
(interest).
What are cash outflows from operating activities? - Answer- Payments for purchase of
inventory, payments for operating expenses, payments to lenders (interest), payments
for taxes.
What inflows are associated with investing activities? - Answer- Cash from sales of
PP&E, cash from collections from loans (principal) to others, cash from sales of debt or
equity securities.
What outflows are associated with investing activities? - Answer- Purchases of PP&E,
loans (principal) to others, purchases of debt or equity securities of other entities.
What inflows are associated with financing activities? - Answer- Proceeds from
borrowing, proceeds from issuing own equity securities.
What outflows are associated with financing activities? - Answer- Repayments of debt
principal, repurchase of firm's own shares, payment of dividends.
How is the change in cash calculated? - Answer- Total inflows less total outflows.
What are the steps to prepare a Statement of Cash Flows? - Answer- Calculate
changes in balance sheet accounts, list changes as inflows or outflows, categorize
flows, calculate total inflows less total outflows.
, What indicates a cash inflow in terms of asset and liability accounts? - Answer-
Decrease in asset account, increase in liability account, increase in equity account.
What indicates a cash outflow in terms of asset and liability accounts? - Answer-
Increase in asset account, decrease in liability account, decrease in equity account.
What is the direct method of cash flow from operating activities? - Answer- Shows cash
collected from customers, interest and dividends collected, and cash paid to suppliers.
What is the indirect method of cash flow from operating activities? - Answer- Starts with
net income and adjusts for deferrals, accruals, noncash items, and non-operating items.
What adjustments are made in the indirect method? - Answer- Add back depreciation,
amortization, changes in deferred tax liability, changes in operating assets and
liabilities.
What does the analysis of the Statement of Cash Flows help determine? - Answer-
Ability to generate cash flows in the future, capacity to meet cash obligations, future
external financing needs.
What can cause a firm to be profitable but unable to pay dividends? - Answer- High
accounts receivable, inventory management issues, or cash flow problems.
What is 'cookie jar accounting'? - Answer- A practice where a firm reserves earnings in
good years to make bad years look better.
What is the impact of a cash shortfall? - Answer- It can lead to borrowing and
operational difficulties, potentially leading to bankruptcy.
What does the income statement not show about a firm? - Answer- It does not reflect
issues like lower-quality customers or inventory management problems.
What is the common size income statement? - Answer- An income statement where
each line item is expressed as a percentage of net sales.
What is the equity method in accounting? - Answer- Investment income is recognized
based on ownership percentage in another company.
What is the significance of retained earnings in cash flow? - Answer- Changes come
from net income less payments of dividends; declaration without payment does not
affect cash.
What does a firm need to satisfy creditors and investors? - Answer- Sufficient cash flow
to cover obligations and investments.
ANSWERS (GRADED A+)
What are the three categories of cash flows? - Answer- Operating activities, investing
activities, financing activities.
What is the significance of cash in a company? - Answer- Positive net income is
insignificant unless a company can translate earnings into cash; 'Cash is king.'
What are the four parts of preparing a Statement of Cash Flows? - Answer- Cash,
operating activities, investing activities, financing activities.
What are cash inflows from operating activities? - Answer- Cash from sales of goods or
services, returns on equity securities (dividends), returns on interest-earning assets
(interest).
What are cash outflows from operating activities? - Answer- Payments for purchase of
inventory, payments for operating expenses, payments to lenders (interest), payments
for taxes.
What inflows are associated with investing activities? - Answer- Cash from sales of
PP&E, cash from collections from loans (principal) to others, cash from sales of debt or
equity securities.
What outflows are associated with investing activities? - Answer- Purchases of PP&E,
loans (principal) to others, purchases of debt or equity securities of other entities.
What inflows are associated with financing activities? - Answer- Proceeds from
borrowing, proceeds from issuing own equity securities.
What outflows are associated with financing activities? - Answer- Repayments of debt
principal, repurchase of firm's own shares, payment of dividends.
How is the change in cash calculated? - Answer- Total inflows less total outflows.
What are the steps to prepare a Statement of Cash Flows? - Answer- Calculate
changes in balance sheet accounts, list changes as inflows or outflows, categorize
flows, calculate total inflows less total outflows.
, What indicates a cash inflow in terms of asset and liability accounts? - Answer-
Decrease in asset account, increase in liability account, increase in equity account.
What indicates a cash outflow in terms of asset and liability accounts? - Answer-
Increase in asset account, decrease in liability account, decrease in equity account.
What is the direct method of cash flow from operating activities? - Answer- Shows cash
collected from customers, interest and dividends collected, and cash paid to suppliers.
What is the indirect method of cash flow from operating activities? - Answer- Starts with
net income and adjusts for deferrals, accruals, noncash items, and non-operating items.
What adjustments are made in the indirect method? - Answer- Add back depreciation,
amortization, changes in deferred tax liability, changes in operating assets and
liabilities.
What does the analysis of the Statement of Cash Flows help determine? - Answer-
Ability to generate cash flows in the future, capacity to meet cash obligations, future
external financing needs.
What can cause a firm to be profitable but unable to pay dividends? - Answer- High
accounts receivable, inventory management issues, or cash flow problems.
What is 'cookie jar accounting'? - Answer- A practice where a firm reserves earnings in
good years to make bad years look better.
What is the impact of a cash shortfall? - Answer- It can lead to borrowing and
operational difficulties, potentially leading to bankruptcy.
What does the income statement not show about a firm? - Answer- It does not reflect
issues like lower-quality customers or inventory management problems.
What is the common size income statement? - Answer- An income statement where
each line item is expressed as a percentage of net sales.
What is the equity method in accounting? - Answer- Investment income is recognized
based on ownership percentage in another company.
What is the significance of retained earnings in cash flow? - Answer- Changes come
from net income less payments of dividends; declaration without payment does not
affect cash.
What does a firm need to satisfy creditors and investors? - Answer- Sufficient cash flow
to cover obligations and investments.
