CASH FLOW STATEMENTS

1
CHAPTER22

• CASH FLOW STATEMENTS

2
1THE NEED FOR A CASH FLOW STATEMENT

• Profit represents the increase in net assets in a
  business during an accounting period.
• This increase can be in
• ---Cash
• ---Non-current assets
• ---Receivables
• ---Inventory

3

• Or the liabilities of the business may have
  decreased ,i.e more cash has been spent this year
  in paying off suppliers than was the case last
  year.
• A cash flow statement is needed because of the
  differences between profits and cash. It achieves
  the following
• ---Provides additional information on business
  activities
• ---Helps to assess the current liquidity of
  the business.
• ---Allows the user to see the major types of
  cash flows into and out of the business
• ---Helps the user to estimate future cash flow
• ---Determines cash flows generated from
  trading transactions rather than other cash flows.

4

• 2 IAS 7 CASH FLOW STATEMENTS
• IAS 7 requires enterprises to present a cash flow
  statement as part of their financial statements.
• A cash flow statement can be presented in a
  number of ways
• ---As a summary of the cash receipts and
  payments of an enterprise (a summarized cash
  book)
• ---From the balance sheet and income
  statement, opening with a reconciliation between
  reported profit and operating cash flow.

5

• IAS 7 requires the cash flow statement to be
  presented using standard headings ,to ensure that
  cash flows are reported in a form that
• ---Highlights the significant components of
  cash flow.
• ---Facilitates comparison of the cash folw
  performance of different business.
• The standard leading shown n the statement are
• ---Operating activities
• ---Investing activities
• ---Financing activities
• Specimen format for a cash flow statement from
  IAS 7

6

• CASH FLOW STATEMENT FOR THE PERIOD ENDED
• 000
  000
• Cash flows from operating activities
• Net profit before taxation
  X
• Adjustments for
• Depreciation
  X
• Interest expense
  X
• Operating profit before working
• capital changes
  X
• (Increase)/decrease in trade receivables (X)/X
• (Increase)/decrease in inventories (X)/X
• (Increase)/decrease in trade payables X / (X)

7

• Cash generated form operations X
• Interest paid
  (X)
• Dividends paid
  (X)
• Income taxed paid
  (X)
• Net cash from operating activities
  X/(X)
• Cash flows from investing activities
• Purchase of property, plant and equipment (X)
• Proceeds of sale of equipment
  X
• Interest received
  X
• Net cash used in investing activities
  X
• 
  X/(X)

8

• Cash flows form financing activities
• Proceeds of issue of shares
  X
• Repayment of loans
  (X)
• Net cash used in financing activities
  X/(X)
• Net increase/(decrease) in cash and cash
  X/(X)
• equivalents
• Cash and cash equivalents at the beginning
• of the period
  X
• Cash and cash equivalents at the end of the
• period
  X

9

• Cash flows from operating activities begins with
  the profit before tax as shown in the income
  statement. The figures below are the adjustments
  necessary to convert the profit figure to the
  cash flow for the period.

Depreciation Added back to profit because it is a non-cash expense
Interest expense Added back because it is not part of cash generated from operations (the interest actually paid is deducted later)
Increase in trade receivables Deducted because this is part of the profit not yet realized into cash but tied up in receivables
10
Decrease in inventories Added on because the decrease in inventories liberates extra cash
Decrease in trade payables Deducted because the reduction in payables must reduce cash
Interest paid
Dividends paid These are the amount actually paid in the year
Income taxed paid
11

• Cash flows from investing activities cash spent
  on non-current assets, proceeds of sale of
  non-current assets and income from investments.
• Cash flows from financial activities the
  proceeds of issue of shares and long-term
  borrowing made or repaid.
• Net increase in cash and cash equivalents the
  overall increase9or decrease) in cash and cash
  equivalents during the year. Add the cash and
  cash equivalents at the beginning of the year to
  give the final balance of cash and cash
  equivalents at the end of the year.

12

• ---cashcash on hand and deposits available
  on demand.
• ---Cash equivalents' short-term highly
  liquid investments that are readily convertible
  to known amounts of cash and which are subject to
  an insignificant risk of changes in value usually
  excludes investments, unless they re readily
  convertible and with little or no risk of change
  in value).
• IAS 7 requires a note to the cash flow statement
  giving details of the make-up cash and cash
  equivalents

13

• Cash and cash equivalents
• At end of
  At
• year
  beginning
• 
  of year
• 000
  000
• Cash on hand and
• balance at banks X
  X
• Short-term investments X
  X
• X
  X

14

• 3 PREPARATION OF A CASH FLOW
• STATEMENT
• Direct method figure for the cash statement
  derived from the accounting records or form the
  other financial statements.
• Indirect method figures derived from the other
  financial accounting statements
• ---Balance sheets for the current year end and
  the previous period
• ---Income statement for the period.

15

• The alternative reconciliations are as follows

Direct method 000 Indirect method 000
Cash received from customers X Profit/(loss) before tax X/ (X)
Cash payments to suppliers (X) Depreciation charges X
Cash paid to and on behalf of employees (X) (Increase)/decrease (X)/X in inventories
Other cash payments (X) (Increase)/decrease (X)/X in receivables
(Increase)/decrease (X)/X in payables
Net cash inflow/(outflow) from operating activities X/ (X) Net cash inflow/(outflow) from operating activities X/ (X)
16

• Indirect method
• ---You are usually presented with two balance
  sheets for the end of the prior period and for
  the end of the current period. All the
  differences between the opening and closing
  balances are various types of cash flow, or are
  otherwise needed to produce the cash flow
  statement.
• ---To calculate the operating cash flow
• (1) Find the profit figure
• ?Take it from operating cash flow, or
• ?Calculate the increase in retain profit
  and
• add back the periods dividends
  and tax
• charge to arrive at profit before
  tax.

17

• (2)Adjust the profit figure for
• ? Non cash expenses like depreciation, and
• ? Movements in working capital items such as
  inventory, receivables and payables.
• (3)where there are sales of non- current assets
  you will need to find figures for additions or
  disposals, and depreciation on disposals.
• ? Set up three T accounts for non-current
  asset
• cost, aggregate depreciation and disposal
• ? Enter the opening and closing balances from
• the balance sheets.
• ? Do the double entry in the ledger accounts
  and the cash
• flow statements for all additional
  information given to you
• in the question
• ? The balancing figures will give you the
  figures you need

18

• (4) set up a format as follows, leaving plenty of
  space between the headings, then go through the
  given balance sheets from the top entering the
  differences in the correct positions in the
  format.

19
Cash flows from operating to give activities Net cash from operating X activities
Cash flows from investing to give activities Net cash used in investing X activities
Cash flows from financing to give activities Net cash used in financing X activities
Net increase in cash and cash equivalents X Net increase in cash and cash equivalents X
Cash and cash equivalents balance at beginning of year X (from prior period balance sheet) Cash and cash equivalents balance at beginning of year X (from prior period balance sheet)
Cash and cash equivalents balance at end of year X (agree to closing balance sheet) Cash and cash equivalents balance at end of year X (agree to closing balance sheet)
20

• Direct method
• ---Gross cash flows can be derived
• (1) from the accounting record total the
  cash
• receipts and payments directly, or
• (2) for net cash flow from operating
• activities, from the opening and
  closing
• balance sheets and income statements
  for
• the year by constructing summary
  control
• accounts for
• ? Sales (to derive cash received from
• customers)
• ? Purchases (to derive cash payments to
• suppliers)
• ? Wages( to derive cash paid to and on
• behalf of employees)

21

• (W1) Receivables ledger control
• 
  
• Balance b/d X Cash receipts (balancing
  X
• figure)
• Sales revenue X Balance c/d
  X
• X
  X
• (W2)Payables ledger control (excluding
  non-current asset purchases)
• 
  
• Cash paid (bal fig) X Balance b/d
  X
• Balance c/d X Purchases
• -Cost of sales
  X
• -Administration
  X
• X
  X

22

• (W3)Wages control
• 
  
• Net wages paid X Balance b/d
  X
• (bal fig) X Cost of sales
  X
• Balance c/d Administration
  X
• X
  X
• Alternatively, the figure for net cash flows from
  operating activities could be derived from the
  reconciliation shown above.
• A further working for non- current assets may be
  required.
• (W4) Non-current assets (NBV)
• 
  
• Balance b/d X Depreciation
  charge X
• Addition (bal fig) X Balance c/d
  X
• X
  X

23

• Whether you use the direct or the indirect
  method, here are the steps you should take in the
  exam.
• Step 1
• Allocate one or two pages to the cash flow
  statements so that easily identifiable cash flows
  can be inserted. Allocated a father page to
  workings.
• Step 2
• Go through the balance sheets and take the
  balance sheet movements to the cash flow
  statement or to workings as appropriate, Tick off
  the information in the balance sheets once it has
  been used.

24

• Step 3
• Go through the additional information provided
  and deal with as per Step2
• Step 4
• The amounts transferred to working can now be
  reconciled so that the remaining cash flows can
  be inserted on the statements.
• Step 5
• Complete the cash flow statement.

25

• 4 INTERPRETATION USING THE CASH FLOW STATEMENT
• The cash flow statement reveals
• ---Whether the overall activities reveal a
  positive cash flow
• ---Whether the operating activities yield a
  positive cash flow
• ---The manner in which capital expenditure has
  been financed (for example, whether it has come
  from internally-generated resources, borrowings,
  issue of shares or from cash balance)

26

• Cash flow statements allow users to evaluate
• ---How the enterprise generates and uses cash
  and cash equivalents.
• ---Changes in net assets, financial structure
  (including liquidity and solvency) and the
  ability of the enterprise to adapt to changing
  circumstances.
• ---The ability of the enterprise to generate
  cash
• ---Between different enterprises, because the
  effects of using different accounting treatments
  are eliminated
• ---Forecasts of future cash flows
• ---The accuracy of past assessments of future
  cash flows.