Which of the following statements regarding the statement of cash flows is accurate? a. An increase in the balance of cash over time indicates that the cash generated from operating activities was positive. b. An increase in working capital assets causes cash to decline, all else being equal. c. A gain on the sale of a building is reported as an investing cash inflow on the statement of cash flows. d. Financing activities by a firm generally result in net cash inflows on the statement of cash flows. Explanation Choice “b” is correct. An increase in working capital assets (e.g., inventory, receivables) from the prior period represents a use of cash. What if you purchase inventory on credit? This doesn’t cause cash to decline, it may cause cash flow to decline, but not cash itself. Any thoughts?
if you purchase inventory on credit, the amount of A/P will increase by the same amount inventory increases -> working capital is not affected.
What about a purchase using Notes Payable?
the question says all else being equal, thus it implies a cash outflow. Notes payable have the same effect as A/P, liabilities go up (cf up) and purchase of WC assets push cf down - no effect.
You need to construct the formula for working capital and understand it’s components to understand the answer: Current Assets - Current Liabilities = Working Capital If you purchase on credit, both CA and CL will rise, thus leaving WC unchanged. If WC increased, the gap between CA and CL increases, which means that either (a) CA increases at a faster rate than CL, implying accumulation of accounts such as receivables or inventory (cash outflow), or (b) CL decreasing at a faster rate than CA, implying declining obligations resulting from paying down those obligations (again, cash outflow). It’s also important to know the reason the other answers are wrong: (a) An increase in cash over time may also come from Financing or Investing activities. © This one is kind of tricky. The investing section reports proceeds from a sale; no distinction for gains or losses is made. But what makes this answer ambiguous is that the procedure for determining cash flows from investing incorporates gains/losses from sale of property. For instance, we know that Beginning PPE + New Investments - Ending PPE = Historical Cost of the Asset Sold. Then we take Beginning Accumulated Depreciation + Depreciation Expense - Ending Accumulated Depreciation = Accumulated Depreciation on Asset Sold. Then, the Historical Cost - Accumulated Depreciation +/- Gains/Losses on Sale = Cash Flow from Sale, which is reported in CFI. So answer © is worded rather vaguely. (d) Posit the following scenario: what if the company began a strategy of paying down long term debt? If you can answer that question, then you’ll understand why this answer is wrong.