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Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
CHAPTER 10Cash flow statements
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Contents Introduction – The cash flow statement Usefulness of cash flow information Cash flow cycles Format and structure of the cash flow statement Cash flow from operating activities Cash flows from investing and financing activities Direct and indirect method for operating cash
flows Constructing a cash flow statement Disposal of fixed assets Presentational differences
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Cash flow statement A cash flow statement presents
information about the cash flows associated with the company’s main operations and those associated with its investing and financing activities of the period
A cash flow statement functions in conjunction with both the income statement (performance dimension) and the balance sheet (financial position)
IAS 7 Cash Flow Statements
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Usefulness of cash flow information
Ability to generate adequate cash flows is a significant performance dimension
Cash flow information clarifies the dynamics of short-term liquidity and long-term solvency
Cash flow information is an essential input for economic decision models
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Cash flow versus profit Cash flow and profit are different economic
phenomena But linked through the mechanisms of accrual
accounting! Cash flows are factual details of incoming
and outgoing flows of cash, while the balance sheet and income statement emanate from professional judgement and are not a direct projection of objective economic data
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Liquidity/solvency and cash flows
Liquidity- Relates to “nearness to cash” of the structure of assets- Determined by capacity to convert current assets into cash
Solvency- Relates to future availability of cash in order to settle
financial liabilities on due date- Determined by timing and uncertainty of expected future
cash payments and cash receipts Liquidity and solvency ratios are determined
on static financial position data, while cash flows reflect changes in financial position
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Relationship with BS and IS Income statement
BS at start Cash flow BS at end
A cash flow statement reflects both “profit related” and “non-profit related” activities (investing and financing) with an impact on available cash over the period covered in the income statement
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Related questions1. From which sources did the company raise
cash last year? How was this cash used? 2. Were the normal operating activities capable
of satisfying its need for cash during the year?3. If not, is the shortage of cash compensated by
new borrowings, issuing new share capital or by selling fixed assets?
4. Is a surplus of cash used for repayment of debt, for investments or for distribution of dividends?
5. Why has the balance of cash available decreased, knowing that the company’s operations have been profitable?
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Cash conversion cycles Cash flows through the company
continuously in a series of short-term and long-term conversion cycles
The ST - cash conversion cycle (operating cycle) relates to the main business operations = OPERATING ACTIVITIES
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Cash conversion cycles (cont.)
The LT- cash conversion cycles relate to the acquisition, renewal and disposal of intangible and tangible infrastructure and the long-term sourcing of funds Productive capacity acquired for cash and
subsequently consumed during several ST-operating cycles
Acquisition and disposal of infrastructure = INVESTING ACTIVITIES
External sourcing of funds = FINANCING ACTIVITIES
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Fig. 10.1 Long-term and short-term cash flow cycles
Inventory
Work in Progress Sales
ReceiptsPayments
Procurement
Current payables Inventory Current receivables
Cash and cash equivalents
Main operations
External financingInvesting/ Productive
infrastructure
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Format and structure of the cash flow statement
Cash flows from operating activities
+ Cash flows from investing activities
+ Cash flows from financing activities Net change in cash during period+ Beginning cash balance Ending cash balance
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Cash flows from operating activities
Operating activities are primarily the revenue-generating activities of a company
“Operating cash flow” is conceptually most near to “net profit”
Main differences:1. Non-cash expenses and non-cash revenues (f.i.
depreciation expense)2. Non-operating items (f.i. gain on disposal of
tangible fixed assets)3. Timing differences between net profit and
underlying cash flow (f.i. changes in the level of inventories, receivables, creditors, etc.)
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Operating cash flows: Examples
Receipts from sale of goods and rendering of services (cashing in of receivables included)
Receipts from taxes on sales and VAT Receipts from royalties, fees, commissions,
… Payments to suppliers (payment of creditors
included) Payments to employees Payments of taxes, VAT, fines, …
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Operating cash flows – Direct versus indirect method
2 methods for identifying and presenting the operating cash flow:
Direct method: engenders the presentation of the most important categories of gross operating cash inflows and cash outflows
Indirect method: net operating cash flow is determined by adjusting the (net) profit figure for the 3 types of differences
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Direct method - Example
Cash receipts from customers 30,150
Cash paid to suppliers and employees (27,600)Cash generated from main operations 2,550
Income taxes paid (1170)
Net cash flow from operating activities 1,380
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Indirect method - ExampleNet profit before tax 3,350Adjustments for:Depreciation 490Investment income (100)
3,740
Working capital changes:Increase in trade and other receivables (500)Decrease in inventories 1,050Decrease in trade payables (1,740)Cash generated from main operations 2,550Income taxes paidNet cash flow from operating activities
(1170) 1,380
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Cash flow proxy
Net profit or loss after tax xxxxxxxxxxxxxxAdd back: Depreciation charge for the
year xxxxxxxxxxxxxxxProvisions created in year xxxxxxxxxxxxxxxDeduct:
Provisions released in year(xxxxxxxxxxxx
xx)‘Cash flow proxy’ xxxxxxxxxxxxxx
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Cash flow proxy (bis)Net profit or loss after tax xxxxxxxxxxxxAdd back: Depreciation for the year xxxxxxProvisions created in year xxxDeduct:Provisions released (xxxx)Gain on asset disposal (xxxxx)Net change in non-cash working capital (xxxxx)‘Cash flow proxy’ xxxxxxxxxxxx
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Cash flows from investing activities
Investing activities relate to the acquisition and disposal of long-term tangible and intangible assets and other investments
Cash flows from investing activities are an indication of the expansion or downsizing of operating capacity
Examples: Payments for newly acquired equipment Receipts from the disposal of a building Payments for new investments
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Cash flows from financing activities
Financing activities relate to changes in the size and composition of contributed capital and financial debt of the company
Examples: Receipts from issuing new shares or bonds Receipts from new bank loan Payments for buy-back of shares Repayments of loans Payments of interest and dividend
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Constructing a cash flow statement
1. Determine the net change in cash Compare beginning and ending balance
2. Identify all transactions of the period leading to a change in cash
Direct: analyze movements in the accounts of cash (equivalents) transaction by transaction
Indirect: explain net change of cash by analyzing all other accounts, knowing that each transaction with an impact on cash also affects a non-cash account
3. Use the information (of step 1 and 2) to construct a cash flow statement according to the formal rules
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Applying step 2 Information for operating cash flow is primarily
derived from balances in the IS, while information for the two other principal categories comes from the Balance Sheet (and details in the Notes)
Movements in the accounts indicate a change in financial position and further examination is needed to determine if they had a cash impact
Check if balances have been impacted by “accrual-based adjustments” or other “non-cash activities”
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Fig. 10.2 Classifying balance sheet movements as inflows or outflows of cash
Assets Equity/liabilities
Increase Outflow Inflow
Decrease Inflow Outflow
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Illustration - Constructing a CFS (1)
X2 X1 ∆ Outflow Inflow
Assets
Fixed assets (at cost) 980 740 240 240 Acc. depreciation -350 -265 85 85 Inventories 180 171 9 9 Trade receivables 115 98 17 17 Cash 92 110 18 18 1017 854
Financing
Equity Share capital 600 600 __ Reserves 90 90 __ X2 profit 50 __ 50 50 Liabilities Trade payables 62 59 3 3 LT debt 215 105 110 110 1017 854 266 266
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Illustration - Constructing a CFS (2)
Operating activities Net profit after tax 50 Add back depreciation 85 135 Changes in non-cash working capital –23 Net cash flow from operations (A) 112 Investing activities Purchase of fixed assets (B) –240 Financing activities New LT debt (C) 110 Net change in cash (A+B+C) –18 Cash balances At beginning of year 110 At balance sheet date 92 Difference –18
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Disposal of fixed assets - Example
Disposal of equipment:Acquisition cost 275
- Accum. depreciation- 200Net carrying value = 115 Net carrying value = 115 Sale at 135 Sale at 135
Result (gain) on disposal = 135 - 115= 20Result (gain) on disposal = 135 - 115= 20
Incoming cash flow = 135, composed of a decrease in Incoming cash flow = 135, composed of a decrease in net carrying value of equipment in the BS (115) and net carrying value of equipment in the BS (115) and gain on disposal in the IS (20)gain on disposal in the IS (20)
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Disposal of fixed assetsNet profit after tax xxxxxxxxxxx
xAdd back: Depreciation xxxxxxProvisions created xxxxxxLoss on disposal of assets xxxxxxDeduct:Provisions released xxxxxxGain on asset disposal xxxxxx+/- Change in non-cash working capital xxxxxx
Net cash flow from operating activities xxxxxxxxxxxx
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Incoming cash flowsCash +
Other assets =
Liabilities +
Owners’equity
(1) + -
(2) + +
(3) + +
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Outgoing cash flowsCash +
Other assets =
Liabilities +
Owners’equity
(1) - +
(2) - -
(3) - -
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Presentational choices Interest paid can be classified under either
operating or financing activities Interest and dividends received can be
included in either operating or investing cash flows
Starting from net profit or operating profit under the indirect method (with implications for the adjustments to be made)
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
IAS 7 - Direct Method (Extract)
Source: IAS 7 – Cash Flow Statements, Appendices
20X2 Cash flows from operating activities Cash receipts from customers 30,150 Cash paid to suppliers and employees (27,600) Cash generated from operations 2,550 Interest paid (270) Income taxes paid (900) Net cash from operating activities 1,380 Cash flows from investing activities Acquisition of subsidiary X, net of cash acquired (550) Purchase of property, plant and equipment (350) Proceeds from sale of equipment 20 Interest received 200 Dividends received 200 Net cash used in investing activities (480) Cash flows from financing activities Proceeds from issue of share capital 250 Proceeds from long-term borrowings 250 Payment of finance lease liabilities (90) Dividends paid* (1,200)
Net cash used in financing activities (790) Net increase in cash and cash equivalents 110 Cash and cash equivalents at beginning of period 120 Cash and cash equivalents at end of period 230 * This could also be shown as an operating cash flow.
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
IAS 7 - Direct Method (Extract)
Source: IAS 7 – Cash Flow Statements, Appendices
20X2 Cash flows from operating activities Cash receipts from customers 30,150 Cash paid to suppliers and employees (27,600) Cash generated from operations 2,550 Interest paid (270) Income taxes paid (900) Net cash from operating activities 1,380 Cash flows from investing activities Acquisition of subsidiary X, net of cash acquired (550) Purchase of property, plant and equipment (350) Proceeds from sale of equipment 20 Interest received 200 Dividends received 200 Net cash used in investing activities (480)
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
IAS 7 - Direct Method (Extract- cont.)
Source: IAS 7 – Cash Flow Statements, Appendices
Cash flows from financing activities Proceeds from issue of share capital 250 Proceeds from long-term borrowings 250 Payment of finance lease liabilities (90)
Dividends paid* (1,200)
Net cash used in financing activities (790) Net increase in cash and cash equivalents 110 Cash and cash equivalents at beginning of period 120 Cash and cash equivalents at end of period 230 * This could also be shown as an operating cash flow.
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
IAS 7 - Indirect Method (Extract) 20X2 Cash flows from operating activities Profit before taxation 3,350 Adjustments for: Depreciation 450 Foreign exchange loss 40 Investment income (500) Interest expense 400 3,740 Increase in trade and other receivables (500) Decrease in inventories 1,050 Decrease in trade payables (1,740) Cash generated from operations 2,550 Interest paid (270) Income taxes paid (900) Net cash from operating activities 1,380 Cash flows from investing activities Acquisition of subsidiary X net of cash acquired (550) Purchase of property, plant and equipment (350) Proceeds from sale of equipment 20 Interest received 200 Dividends received 200 Net cash used in investing activities (480) Cash flows from financing activities Proceeds from issue of share capital 250 Proceeds from long-term borrowings 250 Payment of finance lease liabilities (90) Dividends paid* (1,200) Net cash used in financing activities (790) Net increase in cash and cash equivalents 110 Cash and cash equivalents at beginning of period 120 Cash and cash equivalents at end of period 230 * This could also be shown as an operating cash flow.
Source: IAS 7 – Cash Flow Statements, Appendices
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
IAS 7 - Indirect Method (Extract) 20X2 Cash flows from operating activities Profit before taxation 3,350 Adjustments for: Depreciation 450 Foreign exchange loss 40 Investment income (500) Interest expense 400 3,740 Increase in trade and other receivables (500) Decrease in inventories 1,050 Decrease in trade payables (1,740) Cash generated from operations 2,550 Interest paid (270) Income taxes paid (900) Net cash from operating activities 1,380
Source: IAS 7 – Cash Flow Statements, Appendices
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
IAS 7 - Indirect Method (Extract – cont.) 20X2 Cash flows from investing activities Acquisition of subsidiary X net of cash acquired (550) Purchase of property, plant and equipment (350) Proceeds from sale of equipment 20 Interest received 200 Dividends received 200 Net cash used in investing activities (480) Cash flows from financing activities Proceeds from issue of share capital 250 Proceeds from long-term borrowings 250 Payment of finance lease liabilities (90) Dividends paid* (1,200) Net cash used in financing activities (790) Net increase in cash and cash equivalents 110 Cash and cash equivalents at beginning of period 120 Cash and cash equivalents at end of period 230 * This could also be shown as an operating cash flow. Source: IAS 7 – Cash Flow Statements, Appendices