chapter22-cash flow statements

8/6/2019 Chapter22-Cash Flow Statements

1/26

CHAPTER22CHAPTER22

CASH FLOWCASH FLOW

STATEMENTSSTATEMENTS


2/26

1THE NEED FOR A CASH FLOW1THE NEED FOR A CASH FLOWSTATEMENTSTATEMENT

Profit represents the increase in netassets in a business during anaccounting period.

This increase can be in :

---Cash

---Non-current assets

---Receivables---Inventory


3/26

Or the liabilities of the business may havedecreased ,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 achievesthe following:

---Provides additional information on businessactivities

---Helps to assess the current liquidity of thebusiness.

---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 tradingtransactions rather than other cash flows.


4/26

2 IAS 7 CASH FLOW STATEMENTS2 IAS 7 CASH FLOW STATEMENTS

IAS 7 requires enterprises to present acash flow statement as part of theirfinancial statements.

A cash flow statement can be presented ina number of ways:

---As a summary of the cash receipts andpayments of an enterprise (a summarizedcash book)

---From the balance sheet and incomestatement, opening with a reconciliationbetween reported profit and operating cashflow.


5/26

IAS 7 requires the cash flow statement tobe presented using standard headings ,to

ensure that cash flows are reported in aform that:---Highlights the significant components ofcash flow.---Facilitates comparison of the cash folwperformance of different business.

The standard leading shown n thestatement are:---Operating activities

---Investing activities---Financing activities

Specimen format for a cash flow statementfrom IAS 7


6/26

CASH FLOW STATEMENT FOR THEPERIOD ENDED

$000 $000 Cash flows from operatingactivities

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)


7/26

Cash generated form operations X

Interest paid (X)

Dividends paid (X)

Income taxed paid (X)

Net cash from operating activities X/(X)

Cash flows frominvestingactivities

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)


8/26

Cash flows form financingactivities

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


9/26

Cash flows from operatingactivities :beginswith the profit before tax as shown in the income

statement. The figures below are the adjustmentsnecessary to convert the profit figure to the cashflow for the period.

Depreciation Added back to profit because it

is a non-cash expenseInterestexpense

Added back because it is notpart of cash generated fromoperations (the interest actuallypaid is deducted later)

Increase intradereceivables

Deducted because this is part ofthe profit not yet realized intocash but tied up in receivables


10/26

Decrease ininventories

Added on because the decrease ininventories liberates extra cash

Decrease intrade payables

Deducted because the reduction inpayables must reduce cash

Interest paid

Dividends paid These are the amount actually

paid in the year

Income taxedpaid


11/26

Cash flows frominvestingactivities :cash spent

on non-current assets, proceeds of sale of non-current assets and income from investments.

Cash flows from financial activities: theproceeds of issue of shares and long-termborrowing made or repaid.

Netincreaseincashandcashequivalents :theoverall increase9or decrease) in cash and cashequivalents during the year. Add the cash and cashequivalents at the beginning of the year to give the

final balance of cash and cash equivalents at theend of the year.


12/26

---cashcash on hand and deposits available ondemand.

---Cashequivalents': short-term highly liquidinvestments that are readily convertible to knownamounts of cash and which are subject to aninsignificant risk of changes in value usually

excludes investments, unless they re readilyconvertible and with little or no risk of change invalue).

IAS 7 requires a note to the cash flow statement

giving details of the make-up cash and cashequivalents:


13/26

CashandcashequivalentsCashandcashequivalents

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


14/26

3 PREPARATION OF A CASH FLOW

STATEMENT

Directmethod :figure for the cashstatement derived from theaccounting records or form the other

financial statements. Indirectmethod: figures derived

from the other financial accountingstatements:

---Balance sheets for the current yearend and the previous period

---Income statement for the period.


15/26

Thealternative reconciliationsareas follows

Direct method $000 Indirect method $000

Cash received fromcustomers 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)


16/26

Indirectmethod

---You are usually presented with two balance

sheets: for the end of the prior period and for theend of the current period. All the differencesbetween the opening and closing balances arevarious types of cash flow, or are otherwiseneeded 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.


17/26

(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 tofind figures for additions or disposals, and depreciation ondisposals.

Set up three T accounts for non-current assetcost, aggregate depreciation and disposal

Enter the opening and closing balances fromthe balance sheets.

Do the double entry in the ledger accounts and the cashflow statements for all additional information given to youin the question

The balancing figures will give you the figures you need


18/26

(4) set up a format as follows, leavingplenty of space between the headings,then go through the given balancesheets from the top entering the

differences in the correct positions inthe format.


19/26

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

activitiesNet 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)


20/26

Directmethod---Gross cash flows can be derived:

(1) from the accounting record: total the cashreceipts and payments directly, or(2) for net cash flow from operating

activities, from the opening and closingbalance sheets and income statements for

the year by constructing summary controlaccounts for:

Sales (to derive cash received fromcustomers)

Purchases (to derive cash payments tosuppliers)

Wages( to derive cash paid to and onbehalf of employees)


21/26

(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 (excludingnon-currentasset purchases)

$ $

Cash paid (bal fig) X Balance b/d X

Balance c/d X Purchases

-Cost of sales X

-Administration X

X X


22/26

(W3)Wagescontrol

$ $

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 shownabove.

A further working for non- current assets may be required.

(W4) Non-currentassets(NBV)

$ $

Balance b/d X Depreciation charge X

Addition (bal fig) X Balance c/d X

X X


23/26

Whether you use the direct or the indirect method,here are the steps you should take in the exam.

Step 1Allocate one or two pages to the cash flowstatements so that easily identifiable cash flowscan be inserted. Allocated a father page to

workings.Step 2

Go through the balance sheets and take thebalance sheet movements to the cash flowstatement or to workings as appropriate, Tick offthe information in the balance sheets once it hasbeen used.


24/26

Step 3

Go through the additional information provided

and deal with as per Step2Step 4

The amounts transferred to working can now bereconciled so that the remaining cash flows can be

inserted on the statements.Step 5

Complete the cash flow statement.


25/26

4 INTERPRETATION USING THE CASH4 INTERPRETATION USING THE CASHFLOW STATEMENTFLOW STATEMENT

The cash flow statement reveals:

---Whether the overall activities reveal a positivecash flow

---Whether the operating activities yield a positivecash flow

---The manner in which capital expenditure hasbeen financed (for example, whether it has comefrom internally-generated resources, borrowings,

issue of shares or from cash balance)


26/26

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 ofthe enterprise to adapt to changing circumstances.

---The ability of the enterprise to generate cash---Between different enterprises, because theeffects of using different accounting treatmentsare eliminated

---Forecasts of future cash flows---The accuracy of past assessments of future cashflows.

chapter22-cash flow statements

Documents