Cash Flow Flashcards
What are the 3 types of activities that businesses engage in?
- Financing activities
- Investing activities
- Operating activities
How are the 3 types of business activities reported?
They are reported in a set of four financial statements.
- Statement of Financial Position
- Statement of Profit or Loss or Loss and Other Comprehensive Income
- Statement of Changes in Equity
- Statement of Cash Flows.
What information does Cash Flow Statement provide?
- It provides better insight on a company’s current financial condition.
- It recognizes effects of transactions and other events, as cash or cash equivalents are received or paid.
- Presents cash inflows and outflows from operating, investing and financing activities from the business.
- We can see how a company uses its cash.
- We can assess how much of the company’s reported net income, as recorded under the Accrual basis of accounting, is actually in cash.
- We will be able to assess:
1. The capacity of an enterprise to pay its employees and suppliers.
2. The capacity to make interest payments and repay loans.
3. The capacity to make distributions to owners.
4. Whether the enterprise is able to raise additional finance.
5. What the investing activities are and how these are financed.
What are operating activities?
These are the principal revenue-producing activities of a company.
Cash flows from operating activities generally result from the transactions and other events that enter into the determination of profit or loss.
Operating activities affects the profit or loss.
Some examples of cash inflows under operating activities:
- Cash receipts from sale of goods and rendering of services.
- Cash receipts from royalties, fees, commissions, and other revenue.
- Cash receipts from contracts held for dealing or trading purposes.
Some examples of cash outflows under operating activities:
- Cash payments to suppliers for goods and services
- Cash payments to and on behalf of employees.
- Cash payments for contracts held for dealing or trading purposes.
- Cash payments for income taxes.
How to analyze cash flows from operating activities?
Operating cash flow is an important indicator of liquidity of the company.
The operating cash flow ratio measures the extent to which cash flow generated from the company’s operating activities covers its current liabilities.
This ratio = ‘Cash flow from operations’ / ‘Current liabilities’
This is an indicator of the company’s ability to pay maturing liabilities, interests and dividends.
The higher this ratio is, the better the ability of the company to pay off what needs to be paid.
What are investing activities?
These are activities that are intended to bring about future economic benefits for the enterprise.
Total receipt or payment from these activities are presented.
Note that most of the investing activities are about long-term assets or equity investments.
Some examples of cash inflows under investing activities:
- Cash receipts from sale of PPE, intangibles, and other long-term assets.
- Cash receipts from sale of investments in shares (FVPL or FVOCI) or debt instruments.
- Cash receipts from repayments of advances and loans made to others.
Some examples of cash outflows under investing activities:
- Payments to purchase PPE, intangibles and other long-term assets.
- Cash payments to acquire investment in shares (FVPL or FVOCI) or debt instruments of other companies.
- Cash advances and loans to other parties.
What are financing activities?
These are transactions that a company engages in for funding purposes, including transactions with debt holders and shareholders, and are useful in predicting future cash flows.
Some examples of cash inflows under financing activities:
- Proceeds from issuance of ordinary/preference shares (equity financing)
- Cash proceeds from issuing bonds, obtaining loans, and other borrowings (debt financing)
- Decrease in fixed deposit pledged.
Some examples of cash outflows under financing activities:
- Payments to shares buyback. Payment of dividends.
- Cash payments of borrowed amounts.
- Increase in fixed deposits pledged.
How should we classify interest and dividends paid and interest and dividends received? In other words, should we put them under ‘operating’, ‘investing’ or ‘financing’ activities?
It all depends on how the interest/dividends paid or received are incurred.
Most of the time, interest and dividends received are classified as investing cash flows as these are returns on investment. However, in the case of banks, making investments is their primary business. Hence, the interest and dividends received may be classified as operating activities.
SFRS require that cash flows arising from interest and dividends received or paid be disclosed separately in the Statement of Cash Flows.
–> These should be classified in a consistent manner from period to period as either operating, investing or financing activities.
What do we need for the preparation of the Statement of Cash Flows?
- Comparative statements of Financial Positions for the current and prior year.
- Statement of Profit or Loss for the current year
- Additional information on selected accounts.
What are the 2 methods in reporting cash flows from operating activities of an enterprise?
- Direct method
- Indirect method
Direct method (Method in reporting cash flows from operating activities)
Major classes of gross cash receipts and gross cash payments are presented in the form of a cash-basis income statement.
Indirect method (Method in reporting cash flows from operating activities)
The section on operating activities begins with profit before tax.
Net cash flow from operating activities is determined by adjusting (adding or subtracting) for the effects of transactions of a non-cash nature, items of income or expenses associated with investing or financing activities, and any deferrals or accruals of past or future operating cash receipts and payments.
What needs to be separately presented on the face of the statement?
- Cash flows arising from taxes on income
- Interest and dividends received and paid
Indirect method Structure
- Profit before taxes
- Adjustments - All items are from the statement of profit or loss. Usually there will be 2 types of adjustments (additions and subtractions). –> Non-cash operating expenses like depreciation/amortization/impairment loss AND –> Gains and losses that are associated with investing or financing activities like gain or loss on IP, investment in shares (FVLP), and interest income and dividend income.
- Working Capital Changes. (Changes in working capital)
Adjustments for the effects of deferrals or accruals of past or future operating cash receipts and payments. –> All these adjustments involve changes of accounts in the Statement of Financial Position.
These changes involves the current asset and current liability account balance.
Direction indicates whether revenues and expenses increased or decreased. Since these items do not involve cash, we need to exclude them.
Changes can be in form of:
- Non-cash expense
- Non-cash revenue
- Cash outflows not included in profit before tax
- Cash inflows not included in profit before tax.
When do we add back losses and deduct gains?
Depreciation and amortization expenses reduces profit before tax. To reconcile profit before tax with operating cash flows, we add back these non-cash expenses.
THE AIM TO ACHIEVE WHAT IS THE PROFIT BEFORE THE TAX.
–> Add back losses
–> Deduct gains.
Example of common gains to be deducted:
- Gain on revaluation of PPE
- FV gain on IP
- FV gains of investment in shares (FVPL)
- Recovery of impairment of non current assets held for sale
Example of common losses to be added back:
- Loss on revaluation of PPE
- FV loss on IP
- Impairment losses on PPE, IP, intangible assets, non-current assets
- FV loss on investment in shares (FVPL).
