CHAPTER22CHAPTER22

CASH FLOW CASH FLOW STATEMENTSSTATEMENTS

1THE NEED FOR A CASH FLOW 1THE NEED FOR A CASH FLOW STATEMENT 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

• 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 in

to and out of the business ---Helps the user to estimate future cash flow ---Determines cash flows generated from trading transa

ctions rather than other cash flows.

2 IAS 7 CASH FLOW STATEMENTS2 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.

• 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 fro

m IAS 7

• 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)

• 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)

• 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

• 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

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

• 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.

---‘cash’ ： cash 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:

Cash and cash equivalentsCash 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

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.

• 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 onbehalf of employees (X)

(Increase)/decrease (X)/Xin inventories

Other cash payments (X) (Increase)/decrease (X)/Xin receivables

(Increase)/decrease (X)/Xin payables

Net cash inflow/(outflow) from operating activities X/ (X)

Net cash inflow/(outflow) from operating activities X/ (X)

• 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 period’s dividends and tax

charge to arrive at profit before tax.

(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

• (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.

Cash flows from operating to giveactivities

Net cash from operating Xactivities

Cash flows from investing to giveactivities

Net cash used in investing Xactivities

Cash flows from financing to giveactivities

Net cash used in financing Xactivities

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 end of year X(agree to closing balance sheet)

• 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)

(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

(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

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.

Step 3 Go through the additional information provided and

deal with as per Step2Step 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.

4 INTERPRETATION USING THE CASH 4 INTERPRETATION USING THE CASH FLOW STATEMENTFLOW 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)

• 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.