Accounting Business Reporting for Decision Making

CHAPTER 7 Statement of cash flows 307

Ratio Calculation Harvey Ltd

Debt coverage ratio

(solvency)

Non-current liabilities

Cash from operating activities

$350

$23

= 15.22 times or 152.1%

Cash flow to sales

ratio (profitability)

Cash from operating activities

Net sales

$23

$368

= 0.062 times or 6.25%

• The cash adequacy ratio shows that the cash from operating activities funded 8 per cent of the
  expansion and dividend payout.


• The cash flow ratio shows that the cash from operating activities covers 21.1 per cent of the cur-
  rent liabilities.


• The debt coverage ratio shows that it will take 15.22 years at the current operating level to pay
  off the long-term debt.


• The cash flow to sales ratio reveals that, at the current operating level, every sales dollar achieved
  resulted in 6.25 cents in cash flows from operating activities.


• Generally, the cash flow data reveal a low performance and a watchful eye is needed. Although
  the ratios reveal some information about Harvey Ltd’s operation, it is best to trace the ratios over
  time and to compare them to industry norms.

Comprehension questions

7.4 What is meant by the term ‘cash’? LO3

7.5 What is the purpose of a statement of cash flows? LO1

7.6 Which of the following are not disclosed in a statement of cash flows? LO2

a. Cash outflows from operating activities

b. The cash on hand at the beginning of the reporting period

c. The amount of depreciation for a reporting period

d. The payment of a long-term debt

7.7 Outline the format of a statement of cash flows, identifying each of the activity

classifications. LO2

7.8 ABC Company had a positive net cash flow for the year, but its statement of profit or loss

reported a loss for the period. Explain. LO1

7.9 Outline some cash flow warning signals. LO4

7.10 Fill in the blanks in the following statement by choosing the words from those in the

brackets that best complete the statement. LO3

Changes in non-current liabilities and equity would usually be classified as cash flows from

(operating, financing or investing) activities, and changes in non-current assets would usually

be classified as cash flows from (operating, financing or investing) activities.

7.11 Choose the correct response. LO1

The primary purpose of a statement of cash flows is to provide relevant information about:

a. an entity’s ability to meet future obligations.

b. the differences between profit and associated cash receipts and payments.

c. the ability of an entity to generate future cash flows.

d. the cash receipts and cash payments of an entity during a reporting period.

7.12 Outline the difference between the direct method and the indirect method of reporting

cash flows. Why is it necessary to present the cash flows using both methods? LO2

7.13 List four ratios that could help evaluate an entity’s cash adequacy, liquidity, solvency and

profitability. LO4

7.14 Outline the difference between the cash and accrual bases of accounting. LO1