21 Cashflow Statements Flashcards
What is the importance of cashflow statements
- Statements of cash flows are a useful addition to the financial statements because profit is not the only indicator of an entity’s performance.
- IAS 7 was introduced to assist users wanting to evaluate an entity’s ability to generate cash and to see how it spends its cash
What are the objectives of IAS 7
To provide information to the users of the financial statements about the entity’s:
* Ability to generate Cash and Cash Equivalents (CCE)
* Indicate the cash needs of the entity
* Classify cash flows
How can cashflows be classified
- Operating activities
- Investing activities
- Financing activities
What is cash
Cash on hand and demand deposits
What are cash equivalents
- Short-term (less than 3 months)
- Highly liquid investments that are readily convertible to known amounts of cash.
- Not equity shares.
What are cashflows
Cash flows = in/outflows of CCE
What are operating activities
- The principal revenue-producing activities of the entity.
- What they are known for
What are investing activities
Purchase/sale of non-current assets and other investments not included in CCE
What are financing activities
- Change the size/composition of the entity’s equity capital and borrowings.
- Therefore affect gearing
Share issues, dividend payments
What are the two methods under IAS 7
Direct method:
* Disclose major classes of gross cash receipts and payments
Indirect method:
* Adjust net profit for non-cash transactions
What is the direct method
- Reports cash inflows and outflows directly.
- Starts with the major categories of gross cash receipts and payments.
- Cash flows such as receipts from customers and payments to suppliers are stated separately within the operating activities.
- Provides more information about sources/uses of cash than indirect method.
- Shows operating cash receipts and payments.
- Possibly more useful in assessing future cash flows than indirect method
What is the indirect method
- Starts with profit before tax.
- Highlights differences between operating profit and net cash flow from operating activities.
- Indicates quality of earnings.
- Able to estimate future cash flows and adjust for accruals.
- Easier to prepare than direct method.
- Able to estimate future cash flow and adjust for accruals
- Explains how profit can be made but have no cash as there are many nonfinancial transactions that can make profit but not generate cash
How can you evaluate the cash generated from operations
- Interest cover
- Cash debt coverage
- Cash dividend coverage
o Do we have enough money to pay interest and dividends?
o Must pay interest, dividends are optional
How can you evaluate the investing activities cash flows
- Acquisitions
o Replacing
o Expanding - Can you afford to expand / can you afford not to expand
What does positive and negative cash flows from investing show
- Having a negative from investing activities is not always a bad thing as it shows investing in the future
- A positive for investing could suggest not investing enough in new assets
How can you evaluate the financing cash flows
- Extent to which investment has been financed.
- Does not assess the financing policy of the company.
- Does not assess whether the company would have done better to provide finance by improved control over its assets, e.g. working capital reduction
What does positive and negative cash flows from financing show
- For positive figure is not always good as need to break it down to understand if it has call come from issuing debt
o Which needs to be serviced - For negative not always bad as could be paying debtors or making dividend payments
What are the advantages of cash flow accounting
- The ability to generate cash is crucial to an entity’s survival – cash flow accounting directs attention to this.
o Nothing will kill a business faster than a lack of cash - Cash flow is more comprehensive than profit which is dependent on accounting conventions and concepts.
o Profit can be manipulated but cash is cash - Payables are more interested in an entity’s ability to pay them than profitability.
- Cash flow reporting provides a better means of comparing entities.
- Cash flow statements are easier to audit than accruals-based FS and more difficult to manipulate as they are not affected by accounting policies.
- Cash flows are more easily understood (particularly by non-accountants who do not understand the accruals concept).
What are the disadvantages of cash flow accounting
- Basically, the advantages of accruals accounting (income/expense matching) are the disadvantages of cash accounting.
o When buying a buying accrual accounting would expense it over its useful life where in cash it just goes through the statement - In practice, few businesses keep information in the form needed to prepare a cash flow statement and so this is the reason the indirect method (pulling from the FS) tends to be used rather than the direct method.
- The figures required for the direct method may not be readily available and so it would require additional record keeping.
What is the step method to preparing a statement of cash flows
Need to be able to run over the 4 steps and look at seminars for details
