acc5502: module 5 statement of cash flows. shows an entity: what money came in (cash inflows e.g....
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ACC5502: Module 5
Statement of Cash Flows
Statement of Cash Flows
shows an entity: what money came in (cash inflows
e.g. sales receipts; loans) and what money went out (cash outflows
e.g. wages; electricity). The difference between the two is
called net cash flow.
What is cash?
Cash on hand Cash Equivalents
Highly liquid assets Short periods to maturity
Cash on Hand
Cash Equivalents
Examples:
•Notes and coins held
•Deposits held at call with a financial institution
Highly liquid investments
•With short periods to maturity
•Readily convertible to cash on hand at the investor’s option; and
•Subject to an insignificant risk of change in value
Short term borrowings
•That are integral to the cash management functions; and
•Not subject to a term facility
Examples:
•Banks and non-bank bills
•Money market deposits with 3 months or less maturity
Example:
Money market funds or bank overdraft repayable on demand
Cash
Purpose
To give information about the cash receipts and payments and net changes in cash
Cash is the most liquid asset Therefore integral to assessing an entity’s
financial position
Importance of cash
Entities can be quite profitable yet still fail due to poor cash mananagement techniques
An entity needs to ensure it has enough cash on hand to meet its financial commitments in a timely fashion (workers don’t like waiting to be paid their wages)
So how much cash should an entity have on hand?
Disadvantages of having too much cash on hand
There are costs involved in this: May have to pay unnecessary interest
to bank for loans Missed investment opportunities
So the trick is to have an equilibrium of cash to commitments
Cash Flow Management
Cash from sales Credit policy and debt collection Paying bills Alternative credit Progress payments Buyer’s terms Inventory control Surplus cash Cash planning Supplier relationships
Some methods to improve cash flow
Credit and debt collection policies Use trade/alternative credit (e.g. Visa) Progress payments/buyer terms Inventory control Develop good supplier relationships Cash planning Invest surplus cash wisely
Reminder -The Accrual Accounting System
Measuring income as earned and matching to expenses incurred in same period = Accrual Accounting
Under accrual accounting: Net profit or loss for the period
MAY NOT BE THE SAME AS Net cash inflows or outflows for the period
Accrual accounting used for Income StatementAccounts for credit transactions
Accrual V Cash
P&L is based on an accrual system focused on when a transaction takes place (not
when the payment for the transaction occurs) SCF is based on cash
Focused on the actual receipts and payments (not the underlying transaction)
It gives users of GPFRs additional information to the Balance Sheet and Profit & Loss Statement
Balance Sheet What the entity owns and owes at a set point in time
Income Statement A flow report that shows revenues, expenses and
profit/loss for a particular period Statement of Cash Flows
Shows a flow of actual receipts and payments for a particular period
Relationship to other financial reports
Relationship to other financial reports
CFS gives users of GPFRs information on cash receipts, cash payments and the
net changes in cash during a period. Cash is an entity’s most liquid asset and it
is an integral component in assessing an entity’s financial position.
Relationship to other financial reports (cont.) Sometimes a company can be quite
profitable and yet still fail because of poor cash management
Accounting is based on an accrual system. The statement of cash flow is concerned with the actual receipts and payments and not the timing of the underlying transaction
Relationship to other financial reports (cont.)
CFS gives additional information to assist decision makers in assessing
an entity’s ability to generate cash flows meet its financial commitments as they fall
due fund changes in the scope and/or nature of
its activities obtain external finance.
Relationship to Other Financial Reports
It gives additional information to the Balance Sheet and Profit & Loss Statement
Balance Sheet What the entity owns and owes at a set point in time
Profit & Loss Statement A flow report that shows revenues, expenses and
profit/loss for a particular period Statement of Cash Flows
Shows a flow of actual receipts and payments for a particular period
How do these financial statements connect?
Make-a-BuckIncome Statement
For the year ended 30 June 2007
RevenueService Fees 20,000ExpensesWages 17,000Electricity 500 17,500
Profit/Loss 2,500
Make-a-BuckCash Flow Statement
for the year ended 30 June 2007
Cash Inflows 11,500
Cash Outflows 8,500
Net flows for the period 3,000
Beginning Balance 2,000
Ending Balance 5,000
Make-a-BuckStatement of Changes in EquityFor the year ended 30 June 2007
Opening Balance of Capital 5,500Add: additional funds contributed by owner 1,500
7,000Minus: drawings (500)
Add: Profit (or deduct loss) 2,500
Equals: Closing balance of capital (owner’s equity) 9,000
Make-a-BuckBalance Sheet
As at 30 June 2007
ASSETS 2007 2006
Cash 5,000 2,000 Trade Debtors 6,000
11,000Machinery 9,000
20,000LIABILITIESTrade Creditors 6,000Bank Loan 5,000
11,000
EQUITYCapital 9,000
TOTAL LIABILITIES & EQUITY 20,000
NOTE: Remember the accounting equation
ASSETS = LIABILITIES + EQUITY
Format (direct method)
Example: Ansell Ltd
Operating Activities Investing Activities Financing Activities
Cash at Beginning Cash at EndLtd
http://www.ansell.com/en/About/Investor-Center/Annual-Review-2014.aspx
Ansell Ltd (direct method)
operating
investing
financing
CashBalances
Comparative figures
Cash flows:
Balance Sheet 2014
Consolidated Income St 2014
Classification The Statement of Cash Flows is divided into 3 main sections –
1. operating activities – day-to-day activities including receipts and payments (NB: dividend receiptsare considered inflows)
Cash Inflows Receipt of cash from sale of goods or services Receipt of interest or dividends
Cash Outflows Payments to suppliers Payment of salaries and wages Payment of tax and interest
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Operating Activities Activities relating to provision of goods and services
and other activities that are neither investing or financing activities
Activities reported in the income statement are adjusted from accrual to cash basis
Cash from operating activities shows ability to: generate cash meet short term obligations continue as a going concern expand
Classification cont.
2. investing activities – relate to the acquisition and/or disposal of non-current assets, and investments, (e.g. securities). Relates to the asset section of the balance sheet
Cash Inflows Sale of property, plant and equipment Receipt of loan payments Sale of equity in other entities
Cash Outflows Purchase of property, plant and equipment Making loans Purchase of equity in other entities
These items allow users to analyse future directions of the entity by studying major asset acquisitions and disposals
Classification cont.3. financing activities – activities that relate to
changing the size and/or composition of the financial structure of the entity (e.g. equity and borrowings). Relates to the non-current liability and equity section in the balance sheet
Cash Inflows: Borrowing cash Proceeds from share issues
Cash Outflows: Repayment of borrowed cash Payments to acquire or redeem the entity’s shares
Simple Example Revisited – Teresa’s carpets
Teresa’s Carpets and Rugs
Balance Sheet as at 30 April
Assets Liabilities
Current Current
Cash $78 750 Accounts Payable $35 000
Inventory $15 000 Non-current
Non-current Loan $50 000
Lease Prepaid $10000Less amortisation $ 167 $ 9 833
Equity
Shop Fixtures $20000Less accum deprec$ 334 $19 666
Capital Contrib $20 000+Retain Profit $18 249 $38 249
$123 249 $123 249
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Assets Liabilities
Current Current
Cash $78 750 Accounts Payable $35 000
Inventory $15 000
Non-current
Non-current Loan $50 000
Lease Prepaid $10000Less amortisation $ 167 $ 9 833
Equity
Shop Fixtures $20000Less accum deprec$ 334 $19 666
Capital Contrib $20 000+Retain Profit $18 249 $38 249
$123 249 $123 249
Income Statement for May
Sales $100 000
Less COGS
Beginning Inventory $15,000
+Purchases $50 000
$65 000
-End Inventory $10 000 $ 55 000
Gross Profit $ 45 000
Other Expenses
Depreciation $ 334
Interest $ 250
Marketing $ 5 000
Lease Prepaid $ 167
Lease Rent Payment $ 1 000 $ 6 751
Net Profit $ 38 249
Income Statement for April and May
Sales $140 000
Less COGS
Beginning Inventory $0
+Purchases $85 000
$85 000
-End Inventory $10 000 $ 75 000
Gross Profit $ 65 000
Other Expenses
Depreciation $ 668
Interest $ 500
Marketing $ 5 000
Lease Prepaid $ 334
Lease Rent Payment $ 2 000 $ 8 502
Net Profit $ 56 498
Teresa’s Carpets and Rugs
Balance Sheet as at 31 May
Assets Liabilities
Current Current
Cash $78 750 Accounts Payable $35 000
Inventory $15 000 Non-current
Non-current Loan $50 000
Lease Prepaid $10000Less amortisation $ 167 $ 9 833
Equity
Shop Fixtures $20000Less accum deprec$ 334 $19 666
Capital Contrib $20 000+Retain Profit $18 249 $38 249
$123 249 $123 249
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Assets Liabilities
Current Current
Cash $117 500 Accounts Payable $50 000
Accounts receivable $20 000 Non-current
Inventory $10 000 Loan $50 000
$147,500 Total liabilities $100 000
Non-current
Lease Prepaid $10000Less amortisation $ 334 $ 9 666
Equity
Shop Fixtures $20000Less accum deprec$ 668 $19 332
Capital Contrib $20 000+April Profit $18 249 +May Profit $38 249
$76 498
$28 998
TOTAL ASSETS $176 498 TOTAL L + OE $176 498
30
Relationship to other financial statements Classified into three main sections
reflecting the major cash flow activities Operating activities Investing activities Financing activities
Non-current liabilities and equity in the balance sheet
Income statement revenue and
expenses; Current assets and
liabilities in the balance sheet
Non-current assets in the balance sheet
Teresa’s Carpets and Rugs
Cash Flow Statement For the period of April and May Cash flows from operating activitiesReceipts from customers ($40 000 + $80 000) $Payments to suppliers and employees ($35 000 + $2 000 + $5000) ($ )Dividends receivedInterest receivedInterest paid ($ )Income taxes paidNet Cash from operating activities $ Cash from Investing ActivitiesPayments for property, plant and equipment ($10 000 + $20 000) ($ )Proceeds from sale of property, plant and equipmentNet Cash from Investing Activities ($ )Cash from financing activitiesProceeds from issue shares/capital introduced $Proceeds from borrowings $Repayment of borrowingsDistributions PaidNet Cash flow from financing activities $
Net increase/decrease in cash for the year $Cash at the beginning of the financial year $Cash at the end of the financial year $
Teresa’s Carpets and Rugs - CFS SolutionCash Flow Statement For the period of April and May
Cash flows from operating activities
Receipts from customers ($40 000 + $80 000) 120,000
Payments to suppliers and employees ($35 000 + $2 000 + $5000) (42,000)
Dividends received 0
Interest received 0
Interest paid (500)
Income taxes paid 0
Net Cash from operating activities 77,500
Cash from Investing Activities
Payments for property, plant and equipment ($10 000 + $20 000) (30,000)
Proceeds from sale of property, plant and equipment 0
Net Cash from Investing Activities (30,000)
Cash from financing activities
Proceeds from issue shares/capital introduced 20,000
Proceeds from borrowings 50,000
Repayment of borrowings 0
Distributions Paid 0
Net Cash flow from financing activities 70,000
Net increase/decrease in cash for the year 117,500
Cash at the beginning of the financial year 0
Cash at the end of the financial year 117,500
Net cash flow..
Net Cash Flow versus Gross Cash Flow If positive, ‘net cash provided by ***
activities If negative, ‘net cash used in *** activities
Reconciliation
Standards require a reconciliation of cash flow from operating activities to the operating profit
Presented as a note to the accounts Called the ‘indirect method’ In Australia required to present ‘direct’ and
‘indirect’ (in notes) International standards give a choice
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Reconciliation
Profit must be reconciled to net cash provided/used by operations
Allows users to see the changes in operating accounts brought about by use of accrual versus cash basis of accounting
Reconciliation must be disclosed in financial statements as a note to the accounts
JB Hi-Fi direct method 2014
Example of Indirect Method
Ansell Ltd (indirect method)
Summary of Indirect Method
This method not emphasised in course
Analysis & Evaluation
The evaluation of the Statement of Cash Flows includes an ‘eyeball’ analysis as well as the use of trend and ratio analysis.
“Eyeball”: You would expect operating activities to be positive (that is
their core activity) Normally you would expect investing activities to be
negative (shows investment in assets that will hopefully bring in cash from operations)
Normally you would expect financing activities to be positive (loans, etc. to help finance asset purchases)
Reconciliation can show inefficient management of working capital (current assets and current liabilities)
Evaluation (cont.)
Trend and ratio analysis Eg. Cash flow ratio (liquidity), debt coverage ratio
(solvency), cash flow to sales ratio (profitabiltity)
Capital adequacy ratio (Cash from operations/capital expenditure + dividends paid)
Liquidity ratio – cash flow ratio (Cash from operating activities/current liabilities)
Solvency ratio – the debt coverage ratio (NC liabilities/cash from operating activities) and
Profitability ratio – the cash flow to sales ratio (cash from operating activities/net sales).
Free cash flow Represents the free cash an entity has
available to repay debt, pay dividends and expand operations
Capital investments for PPE to maintain existing operations
Free cash flowCash from operating activities
–=
The Working Capital Cycle
Raw Materials
Work in Process
Finished Goods
Trade Debtors
Cash
Trade Creditors
What is Working Capital?
Current Assets less Current Liabilities
Current AssetsCurrent Assets Current LiabilitiesCurrent Liabilities
CashCash Trade CreditorsTrade Creditors
Trade DebtorsTrade Debtors
InventoriesInventories
Analysis
The statement of cash flow can provide warning signals Cash received compared to cash paid Operating outflow Cash from operations compared to after tax
profit Proceeds from share capital, investments and
borrowings Loss of cash on a continual basis
What does this table illustrate?
Source: Montgomery, R. 2011, Eureka Report, p.25.
p.303
Basic finance is relevant at all levels
If the US Government was a family, they would be making $58,000 a year, spending $75,000 a year, and have $327,000 in credit card debt. They are currently proposing BIG spending cuts to reduce their spending to $72,000 a year. These are the actual proportions of the federal budget and debt, reduced to a level that we can understand.” Wesley LeGrand, Grand Private Equities, July 2011.
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