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Cash Flow Statements

Week 3

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Purpose of cash flow statement

IAS 7 requires enterprises to present a cash flow statement as part of their financial statements.

Helps users Assess company’s ability to generate

cash & cash equivalents Compare performance of companies for

cash flows not affected by accounting policies

Extrapolation of historic cash flows to future periods

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What is cash?

CASH: Cash at hand Demand deposits CASH EQUIVALENTS: Bank deposits with some notice for

withdrawals Money market investments with

minimally uncertain outcomes

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Reconciliation Recommended that there should

be a reconciliation between cash at start and at end of period

EG Increase in cash 92 Cash at start of period 104 Cash at end of period 196

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Objective of IAS 7

Objective of IAS 7 is to provide information on changes by cash and cash equivalents and to classify cash flow under three standard headings:

Operating activities Investing activities Financing activities

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Items under standard headings

Operating Activities Operating profit with adjustments for depreciation (non-

cash item) Profit and or losses on sale of non-current assets Interest paid Working capital changes i.e. increases or decreases in

inventories, receivables and payables. Also includes outflows as interest paid, dividends paid and

tax paid. Investing Activities Purchase of non-current assets and proceeds on sale of

such assets. Financing Activities Proceeds on the issue of shares and loan notes and the

redemption of certain classes of shares and loan notes.

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Bank Overdrafts - treatments

Negative element of cash flow

Financing Activity Increase = source of finance Decrease = repayment of

borrowing

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Cash flows from operating activities

Examples: Cash receipts from sales Cash receipts from royalties and fees Cash payments to suppliers Cash payments to and on behalf of

employees – salaries, PAYE tax, NICs etc

Cash payments of tax on profits

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Direct or Indirect The direct method shows each major class of

gross cash receipts and gross cash payments.

Cash receipts from customers xx,xxx Cash paid to suppliers xx,xxx Cash paid to employees xx,xxx Cash paid for other op exps xx,xxx Interest paid xx,xxx Income taxes paid xx,xxx   --------- Net cash from operating activities

xx,xxx   =====

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Direct or Indirect

The indirect method adjusts accrual basis net profit or loss for the effects of non-cash transactions.

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Indirect method basic rules

Profit before tax Add depreciation/amortisation Add Loss on sale of asset Subtract profit on sale of asset Add decrease in inventory Subtract increase in inventory Add decrease in receivables & prepayments Subtract increase in receivables &

prepayments Add increase in payables & accruals Subtract decrease in payables & accruals

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Cash flows from Investing activities Types of investing activity Cash payments (outflows) Cash to acquire property, plant &

equipment Cash to acquire intangible assets Cash paid for long term investment in

another entity Cash receipts (inflows) Cash receipts from sale of property, plant

& equipment Cash receipts from sale of intangibles

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Cash flows from Financing activities

Cash payments Payments to redeem/buy back shares Payments to repay loans or redeem

debt Cash payments to lessors under finance

lease agreement where payment reduces obligation

Cash receipts Proceeds from issue of shares Proceeds from loan or issue of debt

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Advantages of cash flow accounting – 1

Business survival depends on ability to generate cash

Cash flow accounting directs attention to this

Cash flow is more comprehensive than profit which depends on accounting conventions

Creditors are interested in entity’s ability to repay them

Cash flow reporting provides better means of comparing results of different companies than traditional profit reporting

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Advantages of cash flow accounting – 2

Satisfies needs of all users better Management – relevant costs for decision

making Shareholders & auditors – stewardship

accounting Creditors & employees Easier to prepare (& more meaningful) than

profit forecasts Can be audited more easily Forecasts easier to monitor by variance analysis Disadvantage – should cash equivalents be in

there?