Unit-III - Cash Flow

8/2/2019 Unit-III - Cash Flow

1/27

CASHFLOWSTATEMEN

TS


2/27

Mar-12

Links Balance Sheet and Income Statementelements to change in cash position.

Integral part of holy trinity of financial

statements shows the ability of the firm togenerate cash (given normal assumptions likecontinuity, stability etc.)

Undoes some accrual accounting adjustments

underlying the income statement. Presents cash flows logically organized by

source or type of activity generating the cashflows.

2


3/27

Profit represents the increase in net assets in a businessduring an accounting period.

This increase can be in :

---Cash

---Non-current assets

---Receivables

---Inventory

Mar-12 3


4/27

Or the liabilities of the business may have decreased ,i.emore cash has been spent this year in paying off suppliersthan was the case last year.

A cash flow statement is needed because of thedifferences between profits and cash. It achieves thefollowing:

---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 intoand out of the business

---Helps the user to estimate future cash flow

---Determines cash flows generated from tradingtransactions rather than other cash flows.

Mar-12 4


5/27

2 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 cashbook)

---From the balance sheet and income statement,opening with a reconciliation between reportedprofit and operating cash flow.

Mar-12 5


6/27

IAS 7 requires the cash flow statement to bepresented using standard headings ,to ensure thatcash flows are reported in a form that:

---Highlights the significant components of cash flow.---Facilitates comparison of the cash flow performanceof different business.

The standard leading shown n the statement are:---Operating activities

---Investing activities---Financing activities Cash flow from operations

Cash generated by selling goods & services

Cash flow from investing activities

Cash used/generated by changes in long-term assets Cash flow from financing activities

Cash used/generated by changes in equity & debt.

Specimen format for a cash flow statement from IAS 7

Mar-12 6


7/27

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 changesX

(Increase)/decrease in trade receivables

(X)/X (Increase)/decrease in inventories

(X)/X

(Increase)/decrease in trade payables

X / (X)Mar-12 7


8/27

Cash generated form operationsX

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)Mar-12 8


9/27

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 equivalentsX/(X)

Cash and cash equivalents at the beginning of the periodX

Cash and cash equivalents at the end of the period X

X X

Mar-12 9


10/27

Cash flows from operating activities :begins with theprofit before tax as shown in the income statement. Thefigures below are the adjustments necessary to convert theprofit figure to the cash flow for the period.

Depreciation Added back to profit because itis a non-cash expense

Interestexpense

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

Mar-12 10


11/27

Decrease in

inventories

Added on because the decrease in

inventories liberates extra cashDecrease 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

Mar-12 11


12/27

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 duringthe year. Add the cash and cash equivalents at thebeginning of the year to give the final balance of cash andcash equivalents at the end of the year.

Mar-12 12


13/27

---cashcash on hand and deposits available ondemand.

---Cash equivalents': short-term highly liquid investmentsthat are readily convertible to known amounts of cash andwhich are subject to an insignificant risk of changes invalue 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:

Mar-12 13


14/27

Cash and cash equivalents

At end of At

yearbeginning

of year

$000 $000

Cash on hand and balance at banks X

X

Short-term investments X

X

X X

Mar-12 14


15/27

3 PREPARATION OF A CASH FLOW

STATEMENT

Direct method :figure for the cash statement derived fromthe accounting records or form the other financialstatements.

Indirect method: figures derived from the other financialaccounting statements:

---Balance sheets for the current year end and the previousperiod

---Income statement for the period.

Mar-12 15


16/27

The alternative reconciliations are as 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)Mar-12 16


17/27

Indirect method

---You are usually presented with two balance sheets: forthe end of the prior period and for the end of the currentperiod. All the differences between the opening and closingbalances are various 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 taxcharge to arrive at profit before tax.

Mar-12 17


18/27

(2)Adjust the profit figure for:

Noncash expenses like depreciation, and

Movements in working capital items such as inventory, receivablesand 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 cashflow statements for all additional information given to youin the question

The balancing figures will give you the figures you need

Mar-12 18


19/27


20/27

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

activities

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)

Mar-12 20


21/27

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 closingbalance sheets and income statements for

the year by constructing summary controlaccounts 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)

Mar-12 21


22/27

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

Step 1

Allocate one or two pages to the cash flow statements sothat easily identifiable cash flows can be inserted.Allocated a father page to workings.

Step 2

Go through the balance sheets and take the balance sheetmovements to the cash flow statement or to workings asappropriate, Tick off the information in the balance sheetsonce it has been used.

Mar-12 22


23/27

Step 3

Go through the additional information provided and dealwith as per Step2

Step 4

The amounts transferred to working can now be reconciledso that the remaining cash flows can be inserted on thestatements.

Step 5

Complete the cash flow statement.

Mar-12 23


24/27

Mar-12

Non-cash items (depreciation, amortization) areexpenses that do not have to be paid to outside

entities. Hence they are not a use of cash in the directmethod. In the indirect method, depreciation has

already been subtracted to compute net income, so wemust add it back to compute cash from operations.Hence non-cash items are informally called sourcesof cash. This does not mean more deprecitation

expense increases the cash balance.

24


25/27

Mar-12

In general, increases in assets is a use of cash increases incurrent assets represent a use of cash in operations. Decreasesin current assets are sources of cash from operations.

In general increases in liabilities is a source of cash increases incurrent liabilities represent a source of cash from operations.Decreases in current liabilities are uses of cash from operations.

25


26/27

4 INTERPRETATION USING THE CASH FLOWSTATEMENT

The cash flow statement reveals:

---Whether the overall activities reveal a positive cash flow

---Whether the operating activities yield a positive cashflow

---The manner in which capital expenditure has beenfinanced (for example, whether it has come from internally-generated resources, borrowings, issue of shares or fromcash balance)

Mar-12 26


27/27

Cash flow statements allow users to evaluate:

---How the enterprise generates and uses cash and cashequivalents.

---Changes in net assets, financial structure (includingliquidity and solvency) and the ability of the enterprise toadapt to changing circumstances.

---The ability of the enterprise to generate cash

---Between different enterprises, because the effects ofusing different accounting treatments are eliminated

---Forecasts of future cash flows

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

Mar-12 27

Documents

Unit-III - Cash Flow