4 Cash Flows

Question 1

What is meant by cash?

Answer 1

Cash comprises of cash on hand and demand deposits.

Question 2

How do we recognise on the cash flow statement?

Answer 2

Cash equivalents are 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.

e.g. short term government bonds, marketable securities, commercial papers etc.

Question 3

What are the two ways of approaching cash flow statements?

Answer 3

Direct and indirect.

Question 4

What is the direct approach to cash flows?

Answer 4

Shows major classes of gross cash receipts and payments

Question 5

What is the indirect approach to cashflows?

Answer 5

Starts with profit or loss before tax and adjusts for non-operating items, non-cash items and changes in working capital. Provides useful information about management of working capital.

Question 6

Consideration that must be made for the direct method

Answer 6

If the direct method is chosen, reconciliation of profit/loss before tax to cash flows from operating activities is disclosed.

Question 7

Working capital formula

Answer 7

Working Capital = current assets - cash - (current liabilities - short term debt)

Question 8

Indirect method approach to inventory

Answer 8

An increase in inventory represents an outflow of cash as more money will have been spent on acquiring this additional inventory.

Question 9

Indirect method approach to receivables

Answer 9

An increase in receivables means additional sales have been recognised in the income statement, but cash has not been received from this additional income.

Question 10

Indirect method approach to trade payables

Answer 10

An increase in trade payables means you have not spent money on paying your suppliers.

Question 11

Direct method approaches to all cash flows

Answer 11

Categorise them into: operating, investing, and financing.

Question 12

How are cash flow statements prepared?

Answer 12

Constructed at the end of the period using the cash account in the ledger.

Cash is an asset

Thus, each transaction is either an increase (source of cash) or a decrease (use of cash)

Identify each increase or decrease as either operating, investing or financing → re-arrange to obtain the direct method statement.

Question 13

Accurals: cash flow vs. economic effects

Answer 13

Accruals record economic effects of transactions:

• Recording cash flows that have related cash flows in the future
• Balance sheet and income statements reflect the effects of those accruals

But… accrual accounting focuses on the economic meaning of the transaction rather than its cash effects.

Question 14

What does de-accural mean?

Answer 14

• Adds increases in liabilities
• Decrease in assets
• Subtract decreases in liabilities and increases in assets
• Add non-cash expenses and subtract non-cash revenues.

Question 15

De-accural in practice

(6)

Answer 15

+ Depreciation and amortisation expense

• Change in Accounts Receivable
• Change in Inventories

and

+ Change in Accounts Payable

• Change in Prepaid expenses

+ Change in other payables

= Net cash provided by operating activities.

Question 16

What are operating cash flows?

Answer 16

Operating cash flows - result of trading activities. For example, cash received from customers, or cash paid to supplier or employees.

Question 17

What might a positive operating cash flow indicate?

Answer 17

A positive operating cash flow is a good sign - indicating that the cash received from business activity exceeds the cash expended on business operation.

Question 18

What are investing cash flows?

Answer 18

Investing cash flows - long-term assets. The purchase of land, equipment and buildings is an investing cash flow.

Question 19

What might a negative (and positive) investing cash flow indicate?

Answer 19

A negative investing cash flow is indicative of business expansion as more long-term assets are bought, a positive flow indicates the reverse.

Question 20

What are financing cash flows?

Answer 20

Financing cash flows - long-term finance. For example, cash received from issuing new shares or cash paid out to redeem a bank loan.

Question 21

What might a positive financing cash flow indicate?

Answer 21

Positive: finance in. Negative: finance out.

Interpreting this cash flow is never unambiguous. The reason for which finance is being taken out or paid for is not shown on the cash flow and thus cannot indicate the nature of financial decisions.

Question 22

Operating cash flows compared to the rest

Answer 22

Operating cash flows involve changes in wealth, whereas investing and financial cash flows can be viewed as wealth-neutral.

Question 23

What should we consider when analysing cash flow statements?

Answer 23

Follow the cash flow.

Take into context (industry and life stage)

What might financial statement users be looking for?

Question 24

Define depreciation

Answer 24

An accounting method of allocating the cost of a tangible asset over its useful life to account for declines in value over time

Question 25

Define amortisation

Answer 25

An accounting technique used to periodically lower the book value of a loan or an intangible asset over a set period of time