STATEMENT OF CASH FLOWS: REPORTING THE EFFECTS OF OPERATING, INVESTING, AND FINANCING ACTIVITIES ON CASH FLOWS T4-X
4.30 a. continued.
c.Cash flow from operations exceeded net income during Year 2 because of the addbacks for depreciation and other noncurrent liabilities. Changes in current assets just slightly exceeded changes in current liabilities, suggesting effective working capital management. Cash flow from operations was insufficient to fund expenditures on property, plant, and equipment. The firm primarily used long-term debt to finance the shortfall from operating cash flows in acquiring these fixed assets.
Net income declined between Year 2 and Year 3 but cash flow from operations increased significantly. The increased cash flow from operations, however, results primarily from increases in accounts payable and other current liabilities. The firm had insufficient cash to pay its suppliers and therefore stretched the payment time. The firm increased substantially its purchase of property, plant, and equipment during Year 3, financing its purchases with cash flow from operations and additional long-term debt. The use of operating cash flows to finance purchases of fixed assets is generally undesirable if it occurs as it does in this case from stretching short-term suppliers.
Net income turns negative in Year 4, primarily because of a substantial increase in depreciation expense from purchases of depreciable assets in the current and prior years. Cash flow from operations is positive because of the addback for depreciation expense and the continued stretching of accounts payable suppliers. Flight Training Corporation again spent significant amounts on property, plant, and equipment, financing the purchases in part with additional long-term debt and in part with issuances of common stock.
d.The cash flow problems of Flight Training Corporation trace to expanding fixed assets too rapidly, relative to increases in sales, and to