3. Measuring and reporting cash flows

Question 1

What does a cash flow statement show?

Answer 1

• Movements/ reasons in the cash balance of the company during the accounting period
• The manner in which cash has been generated and used during the year
• The effects on cash flows of an entity’s operating, investing and financing activities for a given period
• Provides information that assists in the assessment of liquidity, solvency and financial adaptability

Question 2

Definition of “cash flows”?

Answer 2

inflows and outflows of cash and cash equivalents

Question 3

Definition of “cash equivalents”?

Answer 3

short-term, highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value

Question 4

What is the relationship between statement of cash flows and statement of profit and loss (INCOME STATEMENT)?

Answer 4

the statement of P/L shows the profit, whereas the SCF shows the reasons for the change in cash. Profit is NOT the same as an increase in cash, it is only one source of cash

Question 5

What is the relationship between statement of cash flows and statement of financial position (BALANCE SHEET)?

Answer 5

the SFP is a list of the assets, liabilities and capital at the end of the year, whereas the SCF identifies the changes in assets, liabilities and capital during the year and the resulting effect on cash.

Question 6

Does every transaction impact profit and cash?

Answer 6

NO. A repayment on borrowings would not impact profit, but it would impact cash.

Question 7

What does the standard presentation of cash flow look like?

Answer 7

Question 8

What are “operating activities”?

Answer 8

Cash flows from operating activities are primarily made up of the net increase (or decrease) in cash that results from a company’s normal trading activities.

Question 9

What are “investing activities”?

Answer 9

Cash flows related to acquiring or disposing of long-term assets. eg. shares of another business, buildings, bonds

Question 10

What are “financing activities”?

Answer 10

Cash flows related to borrowing (short - or long-term) and stockholders’ equity.

Question 11

What are the two ways in which you can measure operating activities?

Answer 11

1. Direct method
2. Indirect method

Question 12

What is the “direct” method? (to measure operating activities)

Answer 12

Involves analysing the cash records of the business for the accounting period identifying all cash payments and receipts related to operating activities. It shows the cash received from customers, cash paid to suppliers, and cash paid in wages and for operating expenses.

Question 13

What is the “indirect” method? (to measure operating activities)

Answer 13

The indirect method involves adjusting the profit or loss before tax for:
- The effects of transactions of a non-cash nature, such as depreciation
- Cash receipts or payments related to the changes in working capital
- Items of income or expense associated with investing or financial cash flows

Question 14

What are some examples of “investing activities”?

Answer 14

the purchase/sale of financial assets

Question 15

What are some examples of “financial activities”?

Answer 15

This encapsulates cash received and paid to external providers of
finance in respect of the principal amounts of finance and the
payments required to service these principal amounts (interest and
dividends).
* The most common external providers of finance are equity
shareholders, preference shareholders, bank loans and bondholders
(borrowing direct from the public via issue of bonds).

Question 16

What are the uses of cash flows statement?

Answer 16

1. To enable users to see how the various activities have been
   financed.
2. To allow users to check the accuracy of past assessments.
3. To assist users in making judgements on the amount, timing
   and degree of certainty of future cash flows, and thus the
   ability of the entity to:
   (a) pay its debts (loans, payables, etc);
   (b) pay interest and dividends;
   (c) continue without the need for extra external finance.
4. To explain how there can be a profit but a decrease in cash (or
   vice versa), and thus why the dividend may be small.
5. To show the reasons for the difference between profit and its
   associated cash inflows and outflows.

Question 17

When drawing a cash flow statement. Why do we use “Profit before tax”?

Answer 17

We use profit before tax because a company doesnt pay ALL corporation tax, only 50%, so “taxation paid” refers to the actual tax that the company pays, they have to pay the remaining 50% the next year.

Question 18

Why is depreciation added back to the profit?

Answer 18

Because it is a non-cash expense

Question 19

Why do we add “interest payable”?

Answer 19

We add interest payable, because we HAVENT paid this yet. At the end we remove the actual interest we have paid. (Not ALL is paid..)

Question 20

What happens in the cash flow statement if “inventories” go up from one year to another?

Answer 20

IF the inventory increases from one year to another, the cash is subtracted as that extra inventory was “bought”

Question 21

What happens in the cash flow statement if “trade receivables” go up from one year to another?

Answer 21

If the trade receivables increases from one year to another, the cash goes down as the company hasnt been paid yet

Question 22

What happens in the cash flow statement if “trade payables” go up from one year to another?

Answer 22

If the trade payables increases from one year to another, the cash goes up as the company hasnt paid the expense yet, its delaying it