1. A ccounting Principles, 6e Weygandt, Kieso, & Kimmel Prepared by Marianne Bradford, Ph. D. Bryant College John Wiley & Sons, Inc.

2. After studying this chapter, you should be able to: 1 Indicate the primary purpose of the statement of cash flows. 2 Distinguish among operating, investing, and financing activities. 3 Prepare a statement of cash flows using the indirect method. 4 Prepare a statement of cash flows using the direct method. 5 Analyze the statement of cash flows. CHAPTER 18 THE STATEMENT OF CASH FLOWS

3. PREVIEW OF CHAPTER 18 THE STATEMENT OF CASH FLOWS The Statement of Cash Flows: Purpose and Format    Purpose Meaning of “cash flows” Classifications Significant noncash activities     Format Usefulness Preparation Indirect & direct methods 

4. PREVIEW OF CHAPTER 18 OR Section 1: Indirect Method Determining net increase/decrease in cash Determining net cash provided/used by operating activities Determining net cash provided/used by investing and financing activities    Section 2: Direct Method    Determining net increase/decrease in cash Determining net cash provided/used by operating activities Determining net cash provided/used by investing and financing activities THE STATEMENT OF CASH FLOWS

5. PREVIEW OF CHAPTER 18 Analysis of the Statement of Cash Flows    Current cash debt coverage ratio Cash return on sales ratio Cash debt coverage ratio THE STATEMENT OF CASH FLOWS

6. STUDY OBJECTIVE 1 Indicate the primary purpose of the statement of cash flows.

7. PURPOSE OF THE STATEMENT OF CASH FLOWS  The primary purpose of the statement of cash flows (SCF) is to provide information about an entity’s cash receipts and cash payments during a period.  A secondary objective is to provide information about its 1) operating, 2) investing, and 3) financing activities of an entity during a period.  It provides answers to the following simple, but important, questions about an enterprise: 1 Where did the cash come from during the period? 2 What was the cash used for during the period? 3 What was the change in the cash balance during the period?

8. MEANING OF CASH FLOWS  The SCF is usually prepared using cash and cash equivalents as its basis.  Cash equivalents are short-term, highly liquid investments that are both: 1 readily convertible to known amounts of cash, and 2 so near to their maturity that their market value is relatively insensitive to changes in interest rates.

9. STUDY OBJECTIVE 2 Distinguish among operating, investing, and financing activities.

10. CLASSIFICATION OF CASH FLOWS Transactions and other events characteristic of each kind of activity are as follows: 1 Operating activities include the cash effects of transactions that create revenues and expenses. They thus enter into the determination of net income. 2 Investing activities include a) acquiring and disposing of investments and productive long-lived assets, and b) lending money and collecting the loans. 3 Financing activities include a) obtaining cash from issuing debt and repaying the amounts borrowed, and b) obtaining cash from stockholders and providing them with a return on their investment.

11. CLASSIFICATION OF CASH FLOWS  The category of operating activities is the most important because it shows the cash provided by company operations.  Note the following general guidelines: 1) Operating activities involve income determination (income statement) items, 2) Investing activities involve cash flows resulting from changes in investments and long-term asset items. 3) Financing activities involve cash flows resulting from changes in long-term liability and stockholders’ equity items.

12. ILLUSTRATION 18-1 BUSINESS ACTIVITIES SHOWN ON THE STATEMENT OF CASH FLOWS Operating Activities Investing Activities Financing Activities

13. ILLUSTRATION 18-1 TYPICAL RECEIPTS AND PAYMENTS CLASSIFIED BY ACTIVITY

15. SIGNIFICANT NONCASH ACTIVITIES  Not all of a company’s significant activities involve cash.  Examples of significant noncash activities are: 1 Issuance of common stock to purchase assets. 2 Conversion of bonds into common stock. 3 Issuance of debt to purchase assets. 4 Exchange of plant assets.  Significant financing and investing activities that do not affect cash are not reported in the body of the SCF.  Such activities are reported in either 1 a separate schedule at the bottom of the SCF or 2 in a separate note or supplementary schedule to the financial statements.

16. The general format of the SCF Is the 3 activities previously discussed – operating, investing, and financing – plus the significant noncash investing and financing activities. The general format of the SCF Is the 3 activities previously discussed – operating, investing, and financing – plus the significant noncash investing and financing activities. ILLUSTRATION 18-2 FORMAT OF STATEMENT OF CASH FLOWS

17. FORMAT OF THE STATEMENT OF CASH FLOWS Differences between net income and net cash provided by operating activities are illustrated by the following results from recent annual reports for the same fiscal year (all data are in millions of dollars).

18. USEFULNESS OF THE STATEMENT OF CASH FLOWS The information in the SCF should help investors, creditors and others assess the following aspects of the firm’s financial position: 1 The entity’s ability to generate future cash flows. 2 The entity’s ability to pay dividends and meet obligations. 3 The reasons for the difference between net income and net cash provided (used) by operating activities. 4 The cash investing and financing transactions during the period.

19. PREPARING THE STATEMENT OF CASH FLOWS The SCF is prepared differently from the 3 other basic financial statements. 1 It is not prepared from the adjusted trial balance. 2 The SCF deals with cash receipts and payments, so the accrual concept is not used in the preparation of the SCF. The information to prepare this statement usually comes from 3 sources: 1 Comparative balance sheet. 2 Current income statement. 3 Additional information.

20. ILLUSTRATION 18-3 THREE MAJOR STEPS IN PREPARING THE STATEMENT OF CASH FLOWS + or - The difference between the beginning and ending cash balances can be easily computed from comparative balance sheets. This step involves analyzing not only the current year’s income statement but also comparative balance sheets and selected additional data. XYZ Goods This step involves analyzing comparative balance sheet data and selected additional information for their effects on cash. For Sale InvestingFinancing Step 1: Determine the net increase/decrease in cash. Step 2: Determine net cash provided/used by operating activities. Step 3: Determine net cash provided/used by investing and financing activities.

21. USAGE OF INDIRECT AND DIRECT METHODS 98.3% Indirect Method 1.7% Direct Method In order to determine net cash provided/used by operating activities, the operating activities section must be converted from accrual basis to cash basis. This conversion may be accomplished by 1) the indirect method or 2) the direct method. The indirect method is used extensively in practice, as shown below. The indirect is favored by companies for 2 reasons: 1) it is easier to prepare and 2) it focuses on the differences between net income and net cash flow from operating activities.

22. STUDY OBJECTIVE 3 Prepare a statement of cash flows using the indirect method.

23. SECTION 1 STATEMENT OF CASH FLOWS INDIRECT METHOD  The transactions of the Computer Services Company for 2002 and 2003 are used to illustrate and explain the indirect method of preparing the SCF.  First Year of Operations – 2002 1 Computer Services Company started on January 1, 2002, when it issued 50,000 shares of $1 par value common stock for $50,000 cash. 2 The company rented its office space and furniture and rendered consulting services throughout the first year.

24. ILLUSTRATION 18-4 COMPARATIVE BALANCE SHEET, 2002, WITH INCREASES AND DECREASES The comparative balance sheets at the beginning and end of 2002 – showing increases and decreases – are shown below.

25. ILLUSTRATION 18-5 INCOME STATEMENT AND ADDITIONAL INFORMATION, 2002 The income statement and additional information for Computer Services Company are shown below.

26. ILLUSTRATION 18-6 NET INCOME VERSUS NET CASH PROVIDED BY OPERATING ACTIVITIES The indirect method starts with net income and converts it to net cash provided by operating activities. In other words, the indirect method adjusts net income for items that affect reported net income but do not affect cash. Noncash charges in the income statement are added back to net income. Likewise, noncash credits are deducted. The result is to calculate net cash provided by operating activities. Earned Revenues Net Income Incurred Expenses Accrual Basis of AccountingCash Basis of Accounting Adjustments to Reconcile Net Income to Net Cash Provided by Operations Net Cash Provided by Operating Activities Eliminate noncash revenues Eliminate noncash expenses

27. ILLUSTRATION 18-7 ANALYSIS OF ACCOUNTS RECEIVABLE  When accounts receivable increase during the year, revenues on an accrual basis are higher than are revenues on a cash basis.  In other words, operations of the period caused revenues to increase, but not all of these revenues resulted in an increase in cash.  Some of increase in revenues had to result in an increase in accounts receivable.  As shown below, Computer Services Company had $85,000 in revenues, but collected only $55,000 in cash.  Therefore, to convert net income into net cash provided by operating activities, the increase of $30,000 in accounts receivable must be deducted from net income.  When accounts receivable increase during the year, revenues on an accrual basis are higher than are revenues on a cash basis.  In other words, operations of the period caused revenues to increase, but not all of these revenues resulted in an increase in cash.  Some of increase in revenues had to result in an increase in accounts receivable.  As shown below, Computer Services Company had $85,000 in revenues, but collected only $55,000 in cash.  Therefore, to convert net income into net cash provided by operating activities, the increase of $30,000 in accounts receivable must be deducted from net income.

28. ILLUSTRATION 18-8 ANALYSIS OF ACCOUNTS PAYABLE  When accounts payable increase during the year, operating expenses on an accrual basis are higher than they are on a cash basis.  For Computer Services Company, operating expenses reported in the income statement were $40,000.  Since Accounts Payable increased $4,000, only $36,000 ($40,000 – $4,000) of the expenses were paid in cash.  To adjust net income to net cash provided by operating activities, the increase of $4,000 must be added to net income.  When accounts payable increase during the year, operating expenses on an accrual basis are higher than they are on a cash basis.  For Computer Services Company, operating expenses reported in the income statement were $40,000.  Since Accounts Payable increased $4,000, only $36,000 ($40,000 – $4,000) of the expenses were paid in cash.  To adjust net income to net cash provided by operating activities, the increase of $4,000 must be added to net income.

29. ILLUSTRATION 18-9 PRESENTATION OF NET CASH PROVIDED BY OPERATING ACTIVITIES, 2002 — INDIRECT METHOD  The changes in accounts receivable and accounts payable were the only changes in current assets and current liabilities during the year for Computer Services Company.  Therefore, any other revenues or expenses reported in the income statement were received or paid in cash.  The operating activities section of the SCF for Computer Services Company is shown below.  The changes in accounts receivable and accounts payable were the only changes in current assets and current liabilities during the year for Computer Services Company.  Therefore, any other revenues or expenses reported in the income statement were received or paid in cash.  The operating activities section of the SCF for Computer Services Company is shown below.

30. ILLUSTRATION 18-10 ANALYSIS OF RETAINED EARNINGS The reasons for the net increase of $20,000 in Retained Earnings are determined by analysis. 1 Net income increased Retained Earnings by $35,000. 2 The additional information below the income statement in Illustration 18-5 indicates that a cash dividend of $15,000 was declared and paid. The increase due to net income is reported in the operating activities section while the cash dividend paid is reported in the financing activities section. This analysis can also be made directly from the Retained Earnings account as shown below. The reasons for the net increase of $20,000 in Retained Earnings are determined by analysis. 1 Net income increased Retained Earnings by $35,000. 2 The additional information below the income statement in Illustration 18-5 indicates that a cash dividend of $15,000 was declared and paid. The increase due to net income is reported in the operating activities section while the cash dividend paid is reported in the financing activities section. This analysis can also be made directly from the Retained Earnings account as shown below.

31. ILLUSTRATION 18-11 STATEMENT OF CASH FLOWS, 2002 — INDIRECT METHOD Operating activities provided $9,000 cash, investing activities used $10,000 cash, while financing activities provided $35,000 cash.

32. ILLUSTRATION 18-12 COMPARATIVE BALANCE SHEET, 2003, WITH INCREASES AND DECREASES The comparative balance sheets at the beginning and end of 2003 – showing increases and decreases – are shown to the right.

33. ILLUSTRATION 18-13 INCOME STATEMENT AND ADDITIONAL INFORMATION, 2003 The income statement and additional information for 2003 for Computer Services Company are shown to the right.

34. ILLUSTRATION 18-14 ANALYSIS OF ACCUMULATED DEPRECIATION — EQUIPMENT  The increase in Accumulated Depreciation – Equipment was $3,000, which does not represent depreciation expense for the year since the account was debited $1,000 as a result a sale of some equipment.  Depreciation expense for 2003 was $4,000 ($3,000 + $1,000).  This amount is added to net income to determine net cash provided by operating activities.  The T-account below provides information about the changes that occurred in this account in 2003.  The increase in Accumulated Depreciation – Equipment was $3,000, which does not represent depreciation expense for the year since the account was debited $1,000 as a result a sale of some equipment.  Depreciation expense for 2003 was $4,000 ($3,000 + $1,000).  This amount is added to net income to determine net cash provided by operating activities.  The T-account below provides information about the changes that occurred in this account in 2003.

35. ILLUSTRATION 18-15 PRESENTATION OF NET CASH PROVIDED BY OPERATING ACTIVITIES, 2003 — INDIRECT METHOD Net cash provided by operating activities for 2003 is $218,000 as calculated below.

36. ILLUSTRATION 18-16 ANALYSIS OF EQUIPMENT Equipment increased $17,000, which was a net increase that resulted from 2 transactions: 1) a purchase of equipment of $25,000 and 2) the sale of equipment costing $8,000 for $4,000. These transactions are classified as investing activities and each should be reported separately. The purchase of equipment should therefore be reported as an outflow of cash for $25,000 and the sale should be reported as an inflow of cash for $4,000. The T-account below shows the reasons for the change in this account during the year. Equipment increased $17,000, which was a net increase that resulted from 2 transactions: 1) a purchase of equipment of $25,000 and 2) the sale of equipment costing $8,000 for $4,000. These transactions are classified as investing activities and each should be reported separately. The purchase of equipment should therefore be reported as an outflow of cash for $25,000 and the sale should be reported as an inflow of cash for $4,000. The T-account below shows the reasons for the change in this account during the year.

37. ILLUSTRATION 18-17 STATEMENT OF CASH FLOWS, 2003 — INDIRECT METHOD

39. The SCF prepared by the indirect method starts with net income. It then adds or deducts items not affecting cash to arrive at net cash provided by operating activities. The additions and deductions consist of: 1) changes in specific current assets and current liabilities and 2) noncash charges reported in the income statement. A summary of the adjustments for current assets and current liabilities is provided in Illustration 18-18. The SCF prepared by the indirect method starts with net income. It then adds or deducts items not affecting cash to arrive at net cash provided by operating activities. The additions and deductions consist of: 1) changes in specific current assets and current liabilities and 2) noncash charges reported in the income statement. A summary of the adjustments for current assets and current liabilities is provided in Illustration 18-18. ILLUSTRATION 18-18 ADJUSTMENTS FOR CURRENT ASSETS AND CURRENT LIABILITIES

40. ILLUSTRATION 18-19 ADJUSTMENTS FOR NONCASH CHARGES Adjustments for the noncash charges reported in the income statement are made as shown in Illustration 18-19.

41. STUDY OBJECTIVE 4 Prepare a statement of cash flows using the direct method.

42. SECTION 2 STATEMENT OF CASH FLOWS DIRECT METHOD  The transactions of Juarez Company for 2002 and 2003 are used to illustrate and explain the indirect method of preparing the SCF.  First Year of Operations – 2002 1 Juarez Company started on January 1, 2002, when it issued 300,000 shares of $1 par value common stock for $300,000 cash. 2 The company rented its office, sales space, and equipment.

43. ILLUSTRATION 18-20 COMPARATIVE BALANCE SHEET, 2002, WITH INCREASES AND DECREASES The comparative balance sheets at the beginning and end of 2002– showing increases and decreases – are shown to the right.

44. ILLUSTRATION 18-21 INCOME STATEMENT AND ADDITIONAL INFORMATION, 2002 The income statement and additional information for Juarez Company are shown below.

45. ILLUSTRATION 18-22 MAJOR CLASSES OF CASH RECEIPTS AND PAYMENTS From sales of goods and services to customers From receipts of interest and dividends on loans and investments Net cash provided by operating activities For interest and dividends For taxes For operating expenses To suppliers To employees Cash Receipts – Cash Payments = Net Cash Provided by Operating Activities

46. CASH RECEIPTS FROM CUSTOMERS  The income statement for Juarez Company reported revenues from customers of $780,000.  To determine the amount of cash receipts, the increase in accounts receivable is deducted from sales revenues.  Conversely, a decrease in accounts receivable is added to sales revenues, since cash receipts from customers exceed sales revenues.

47. ILLUSTRATION 18-23 COMPUTATION OF CASH RECEIPTS FROM CUSTOMERS For Juarez Company, accounts receivable increased $15,000, so that cash receipts from customers were $765,000, calculated as shown in Illustration 18-23.

48. ILLUSTRATION 18-24 ANALYSIS OF ACCOUNTS RECEIVABLE Cash receipts from customers may also be determined from an analysis of Accounts Receivable as shown in Illustration 18-24.

49. ILLUSTRATION 18-25 FORMULA TO COMPUTE CASH RECEIPTS FROM CUSTOMERS — DIRECT METHOD The relationships among cash receipts from customers, revenues from sales, and changes in accounts receivable are shown in Illustration 18-25. Cash receipts from customers Revenues from sales { + Decrease in accounts receivable or – Increase in accounts receivable =

50. ILLUSTRATION 18-26 COMPUTATION OF PURCHASES Juarez Company reported cost of goods sold on its income statement of $450,000. To determine purchases, cost of goods sold must be adjusted for the change in inventory. An increase (decrease) in inventory is added to (deducted from) cost of goods sold to arrive at purchases. In 2002, Juarez Company’s inventory increased $160,000. Purchases are calculated in Illustration 18-26.

51. Cash payments to suppliers are then determined by adjusting purchases for the change in accounts payable. An accounts payable increase (decrease) is deducted from (added to) purchases. Cash payments to suppliers are calculated in Illustration 18-27. ILLUSTRATION 18-27 COMPUTATION OF CASH PAYMENTS TO SUPPLIERS

52. Cash payments to suppliers may also be determined from an analysis of Accounts Payable as shown in Illustration 18-28. ILLUSTRATION 18-28 ANALYSIS OF ACCOUNTS PAYABLE

53. ILLUSTRATION 18-29 FORMULA TO COMPUTE CASH PAYMENTS TO SUPPLIERS — DIRECT METHOD Cash payments to suppliers = Cost of goods sold { + Increase in inventory or – Decrease in inventory { + Decrease in accounts payable or – Increase in accounts payable The relationship among cash payments to suppliers, cost of goods sold, changes in inventory, and changes in accounts payable is shown in Illustration 18-29.

54. Operating expenses of $170,000 were reported on Juarez’s income statement. To convert operating expenses to cash payments for operating expenses, the increase in prepaid expenses of $8,000 must be added to operating expenses. A decrease in prepaid expenses would be deducted from operating expenses. The increase in accrued expenses of $20,000 must be deducted, while a decrease would be added. Juarez Company’s cash payments for operating expenses are calculated in Illustration 18-30. ILLUSTRATION 18-30 COMPUTATION OF CASH PAYMENTS FOR OPERATING EXPENSES

55. ILLUSTRATION 18-31 FORMULA TO COMPUTE CASH PAYMENTS FOR OPERATING EXPENSES — DIRECT METHOD Cash payments for operating expenses = Operating expenses + Increase in prepaid expenses or - Decrease in prepaid expenses + Decrease in accrued expenses payable or - Increase in accrued expenses payable { {

56. ILLUSTRATION 18-32 OPERATING ACTIVITIES SECTION — DIRECT METHOD  All of the revenues and expenses in the 2002 income statement have now been adjusted to cash basis.  The operating activities section of the SCF is shown below.  All of the revenues and expenses in the 2002 income statement have now been adjusted to cash basis.  The operating activities section of the SCF is shown below.

57. ILLUSTRATION 18-33 ANALYSIS OF RETAINED EARNINGS The reasons for the net increase of $42,000 in Retained Earnings are determined by analysis. 1 Net income increased Retained Earnings by $112,000. 2 The additional information below the income statement in Illustration 18-21 indicates that a cash dividend of $70,000 was declared and paid. The increase due to net income is reported in the operating activities section while the cash dividend paid is reported in the financing activities section. This analysis can also be made directly from the Retained Earnings account as shown below. The reasons for the net increase of $42,000 in Retained Earnings are determined by analysis. 1 Net income increased Retained Earnings by $112,000. 2 The additional information below the income statement in Illustration 18-21 indicates that a cash dividend of $70,000 was declared and paid. The increase due to net income is reported in the operating activities section while the cash dividend paid is reported in the financing activities section. This analysis can also be made directly from the Retained Earnings account as shown below.

58. ILLUSTRATION 18-34 STATEMENT OF CASH FLOWS, 2002 — DIRECT METHOD The SCF for 2002 for Juarez Company shows that operating activities provided $9,000 cash, investing activities used $80,000 cash, while financing activities provided $230,000 cash.

59. ILLUSTRATION 18-35 COMPARATIVE BALANCE SHEET, 2003, WITH INCREASES AND DECREASES The comparative balance sheets at the beginning and end of 2003 – showing increases and decreases – are shown below.

60. ILLUSTRATION 18-35 COMPARATIVE BALANCE SHEET, 2003, WITH INCREASES AND DECREASES

61. ILLUSTRATION 18-36 INCOME STATEMENT AND ADDITIONAL INFORMATION, 2003 The income statement and additional information for 2003 for Juarez Company are shown.

62. Revenues from sales were $975,000. Cash receipts from customers were greater than sales revenues since accounts receivable decreased $3,000. Cash receipts from customers were $978,000, as calculated below. ILLUSTRATION 18-37 COMPUTATION OF CASH RECEIPTS FROM CUSTOMERS

63. Purchases are calculated using cost of goods sold of $660,000. The inventory decrease of $30,000 is deducted from cost of goods sold. Purchases are then adjusted by the accounts payable decrease of $8,000. Cash payments to suppliers are calculated in Illustration 18-38. ILLUSTRATION 18-38 COMPUTATION OF CASH PAYMENTS TO SUPPLIERS

64. ILLUSTRATION 18-39 COMPUTATION OF CASH PAYMENTS FOR OPERATING EXPENSES Operating expenses (exclusive of depreciation expense) was $176,000 for 2000. The $2,000 decrease in prepaid expenses is deducted and the $5,000 decrease in accrued expenses payable is added in determining cash payments for operating expenses, as shown in Illustration 18-39.

65. Income tax expense reported on the income statement was $36,000. The $12,000 increase in income taxes payable must be deducted from income tax expense to determine cash payments for income taxes. Cash payments for income taxes were $24,000 as shown in Illustration 18-40. ILLUSTRATION 18-40 COMPUTATION OF CASH PAYMENTS FOR INCOME TAXES

66. ILLUSTRATION 18-41 FORMULA TO COMPUTE CASH PAYMENTS FOR INCOME TAXES — DIRECT METHOD Cash payments for income taxes Income tax expense { + Decrease in income taxes payable or – Increase in income taxes payable = The relationships among cash payments for income taxes, income tax expense, and changes in income taxes payable are shown in the formula in Illustration 18-41.

67. ILLUSTRATION 18-42 ANALYSIS OF EQUIPMENT AND RELATED ACCUMULATED DEPRECIATION The comparative balance sheet shows that Equipment increased $160,000 in 2003. The additional information in Illustration 18- 36 that the increase resulted from 2 investing transactions: 1) equipment costing $180,000 was purchased for cash and 2) equipment costing $20,000 was sold for $17,000 cash when its book value was $18,000. For Juarez Company, the investing activities section will show: 1) the $180,000 purchase of equipment as an outflow of cash and 2) the $17,000 sale of equipment as an inflow of cash.

68. ILLUSTRATION 18-42 ANALYSIS OF EQUIPMENT AND RELATED ACCUMULATED DEPRECIATION

69. ILLUSTRATION 18-43 STATEMENT OF CASH FLOWS, 2003 — DIRECT METHOD

71. STUDY OBJECTIVE 5 Analyze the statement of cash flows.

72. ILLUSTRATION 18-45 THE GAP, INC. DATA USED IN CASH FLOW ANALYSIS The GAP, Inc. reported the following information in its 2000 annual report:

73. ILLUSTRATION 18-45 CURRENT CASH DEBT COVERAGE RATIO Net Cash Provided by Operating Activities Average Current Liabilities Current Cash Debt Coverage Ratio A disadvantage of the current ratio is that it employs year-end balances of current asset and current liability accounts. Such year-end balances may not be representative of the company’s current position during most of the year. The current cash debt coverage ratio partially corrects this problem and is calculated by dividing average current liabilities into net cash provided by operating activities. The current cash debt coverage ratio for The GAP, Inc. for 2000 is calculated below. $1,753 + $1,553 $1,478 ÷ ———————— =.89:1 2

74. ILLUSTRATION 18-46 CASH RETURN ON SALES RATIO The cash return on sales ratio is the cash based ratio that is the counterpart of the profit margin percentage. This ratio is calculated by dividing net sales into net cash provided by operating activities. The current return on sales ratio for The GAP, Inc. for 2000 is calculated below. Net Cash Provided by Operating Activities Cash Return on Sales Ratio Net Sales $1,478 ÷ $11,635 = 13%

75. ILLUSTRATION 18-47 CASH DEBT COVERAGE RATIO The cash basis measure of solvency is the cash debt coverage ratio – the ratio of net cash provided by operating activities to average total liabilities. This ratio demonstrates a company’s ability to repay its liabilities from net cash provided by operating activities, without having to liquidate the assets it employs. The cash debt coverage ratio for The GAP, Inc. for 2000 is calculated below. Net Cash Provided by Operating Activities Cash Debt Coverage Ratio Average Total Liabilities $2,956 + $2,390 $1,478 ÷ ———————— =.55:1 2

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77. CHAPTER 18 THE STATEMENT OF CASH FLOWS