(19) Here are the cash flow summaries for two companies – a manufacturer (MFR) a
ID: 2765745 • Letter: #
Question
(19) Here are the cash flow summaries for two companies – a manufacturer
(MFR) and an online retailer:
Cash from Operations $75,000 $15,000
Cash from Financing 50,000 75,000
Cash from Investing <75,000> <25,000>
Net Free Cash Flow $50,000 $65,000
MFR ONLINE RETAILER
Of the two companies, which one has higher “quality of cash flow?” Explain
why.
(20) What is the difference between the Direct Method and Indirect Method
for calculating Cash Flow? Explain how the two methods are reconciled.
(21) If a company decides to increase its ratio of total debt / total assets
from 30% to 50% as a means of increasing its return on equity (ROE), and it
is able to maintain a 7.5% return on assets(ROA), what is the return on
equity (ROE) with the two different total debt/total asset ratios?
Explanation / Answer
(19)
Manufacturing company has Higher quality of Cash flow than an Online retailer.
Because The cash flow from Operations are more in a manufacturing company which implies that susstantial part of cash inflows are from operating the business, even though net cash flow is lower than an onliner retailer.
Cash Flow from Operations: This is the key source of a company's cash generation. It is the cash that the company produces internally as opposed to funds coming from outside investing and financing activities.
Cash Flow from Investing: For the most part, investing transactions generate cash outflows, such as capital expenditures for plant, property and equipment, business acquisitions and the purchase of investment securities.
Cash Flow from Investing: For the most part, investing transactions generate cash outflows, such as capital expenditures for plant, property and equipment, business acquisitions and the purchase of investment securities.
(20)
The main difference between the direct method and the indirect method involves the cash flows from operating activities, the first section of the statement of cash flows. (There is no difference in the cash flows reported in the investing and financing activities sections.)
Under the direct method, the cash flows from operating activities will include the amounts for lines such as cash from customers and cash paid to suppliers. In contrast, the indirect method will show net income followed by the adjustments needed to convert the total net income to the cash amount from operating activities.
The direct method must also provide a reconciliation of net income to the cash provided by operating activities. (This is done automatically under the indirect method.)
Nearly all corporations prepare the statement of cash flows using the indirect method.
Reconciliation Process:
Because the direct method solely focuses on cash transactions, the cash flow statement does not have an obvious link to the income statement with this method. Therefore, companies must reconcile the cash flow statement to the income statement through an adjustment and reconciliation process. Under the direct method, reconciliation occurs when a company shows how net income from its income statement translates into the net cash it generated during the same accounting period. After making all the required adjustments, the net income, or net loss, reconciliation must equal the net cash from operating activities shown on the cash flow statement.
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