Principle of Accounting

Chapter 11

Statements of Cash Flows

BA. in International BusinessForeign Trade University

Outline

The role of the statement of cash flows

Classification of cash flowsThe concept of cashThe format of the statement of cash

flowsPreparing a statement of cash flowsCash flows and decision making

The role of the statement of cash flows

The statement of cash flows concentrates on movements of cash in and out of the business entity.

It provides information relating to areas:The net cash inflows generated by trading

operationsThe firm’s ability to meet obligations to

creditors and bankersThe firm’s long-term capital and debt

arrangementsCash flows resulting from investing

activities.

Classification of cash flowsOperating activities examine the

cash flows resulting from revenues and expenses.

Investing and financing activities highlight the changes in items reported in the statement of financial position.

Operating activitiesCash inflows

Cash salesReceipts from customers

Cash outflowsPayments to suppliersPayments to employeesPayments for operating expensesPayments for taxPayments for interest

Investing activitiesCash inflows

Sale of non-current assetsSale of investments

Cash outflowsPurchase of non-current assetsPurchase of investments

Financing activitiesCash inflows

Cash contribution by ownerProceeds from loan

Cash outflowsCash drawings by ownerRepayment of loan (principal)

Examples of cash flows by classification

Activity Examples Effect on cash

Related B/S a/c

Operating Collection from customers Inflow Debtors

Payment to suppliers Outflow Creditors

Payment of wages Outflow Wages payable

Investing Purchase of non-current assets Outflow Plant, equipment

Sales of non-current assets Inflow Plant, equipment

Financing Capital contributions of cash Inflow Capital

Withdrawal of cash by owner Outflow Drawings

Taking out loans Inflow Loan payable

Loan repayments Outflow Loan payable

The concept of cashCash includes all cash on hand and any

other cash equivalents held by a firm.The definition of cash means cash on hand,

cash at bank and cash held with non-banking financial institutions on an at-call basis.

Cash equivalents extends this definition to include items such as short-term cash deposits, bills receivable and other short-term investments (bank bills, treasury bills).

Short-term investments can include investments with a maturity ranging from at-call up to two or three months.

Overdrafts should also be included under the definition of cash and cash equivalents.

The format of the statement of cash flows

Grech’s Sports Store: Statement of cash flows for year ended 31.12.05

Cash flows from operating activities

Receipts from customers 100,000

Payments to suppliers and employees (73,000)

Net cash provided by operating activities 27,000

Cash flows from investing activities

Proceeds from sale of shop fittings 1000

Payments for shop fittings (5,000)

Net cash used in investing activities (4,000)

The format of the statement of cash flows (cont’d)

Cash flows from financing activities

Loan from bank 10,000

Repayments of loan (5,000)

A. Grech – cash withdrawals (29,500)

Net cash used in financing activities (24,500)

Net increase (decrease) in cash held (1,500)

Cash held at the beginning of the year 2,000

Cash held at the end of the year 500

Preparing a statement of cash flows

A statement of cash flows can be prepared from either the two cash journals or a statement of receipts and payments.

Both journals and the statement of receipts and payments provide a summary of all cash flow transactions for the period.

Cash flows are classified under the heading operating, investing and financing.

Cash flows and decision making

The statement of cash flows provides management with information that demonstrates the effects of its decision-making on the cash resources of the firm.

A statement of cash flows can be compared with previous result, therefore statement of cash flows for consecutive periods are often prepared.

This allows for easy comparison and highlights changes in various activities and identifies trends.

Practice questionsExercise 11.1Exercise 11.2Exercise 11.3

HomeworkExercise 11.4Exercise 11.5Exercise 11.6Exercise 11.7