CASH FLOWS Flashcards
CASH
Comprises cash on hand and demand deposits.
CASH EQUIVALENTS
Short term, highly liquid investment that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value.
STATEMENT OF CASH FLOWS
IAS 7 para 10:
The statement of Cash Flows shall report cash flows during the period classified by operating, investing and financing activities.
Headings are standard and cannot be altered.
OPERATING ACTIVITIES
The principal revenue-producing activities of the entity and other activities that are not investing or financing activities.
INVESTING ACTIVITIES
The acquisition and disposal of long-term assets and other investments not included in cash equivalents.
FINANCING ACTIVITIES
Activities that result in changes in the size and composition of the contributed equity and borrowings of the entity.
Inconsistencies of treatment in IAS 7
IAS 7 allows interest paid and dividends paid to be shown under either financing activities or operating activities.
These items would fall more naturally under financing activities - as they relate to the cost of obtaining finance.
IAS 7 takes the view that inclusion under operating activities allows users to judge the company’s ability to pay interest and dividends out of operating cash flows.
The inconsistency of treatment can be confusing and cause problems with comparability
An entity shall report cash flows from operating activities using either:
IAS 7 para 18
a) the DIRECT method
b) the INDIRECT method
DIRECT METHOD
WHEREBY MAJOR CLASSES OF GROSS CASH RECEIPTS AND GROSS CASH PAYMENTS ARE DISCLOSED
INDIRECT METHOD
Whereby profit or loss is adjusted for the affects of transaction of a non-cash nature, any deferrals or accruals of past or future operating cash receipts or payments, and items of income or expense associated with investing or financing cash flows.
Direct method v indirect method
DIRECT METHOD:
- Shows operating cash receipts and payments
- Easier for non-experts to follow
- Possibly more useful in assessing future cash flows
- Useful in failure prediction models
INDIRECT METHOD:
- Starts with profit before tax & makes adjustments
- Highlights differences between operating profit and net cash flow from operating activities
Which operating cash flow method is encouraged?
Both permitted, total operating cash flow will be the same.
IAS para 19:
“Entities are encouraged to report cash flows from operating activities using the direct method..”
What are the headings for the indirect method?
Take profit before tax (per IS) and adjust for non-cash items on the IS e.g. depreciation, investment income, investment expense, any foreign exchange gain/loss, gain/losses on sale of assets etc.
Profit before tax Adjustments for: Depreciation Investment Income Interest Expense Gain/loss on disposal of equipment
expense are +, income -
next adjust for movements on the SoFP (i.e. difference between year 1 and year 2) for working capital items.
Increase in inventories
Increase in trade receivables
Increase in trade payables
Cash generated from operations
Interest paid
Income taxes paid
Net cash from operating activities
Cash flows from investing activities Purchase of non-current assets - Proceeds from sale of NCAs + Interest received + Net cash used in investing activities
Cash flows from financing activities
Proceeds from issue of share capital (share capital + share premium) +
Proceeds from long term borrowing (increase in LT loan) +
Dividends paid -
Net cash from financing activities
Cash and cash equivalents at the start of period
Cash and cash equivalents at end of period
Need a note to show split between cash and cash equivalents
(for year 1 and year 2)
Cash on hand & balances with banks
Short term investments
Cash and cash equivalents
INTEREST PAID
interest paid = op. unpaid interest + interest (per IS) - cl. unpaid interest
TAXES PAID
op. unpaid tax + charge for year - cl. unpaid tax
Headings for direct method
Start with gross cash receipts and payments
Shows operating cash receipts and payments.
Cash flows from operating activities: Cash receipts from customers Cash paid to suppliers and employees Cash paid for administrative and selling expenses Cash generated from operations
How is information about major classes of gross cash receipts and gross cash payments obtained?
IAS 7 para 19:
Under the direct method, information about major classes of gross cash receipts and gross cash payments may be obtained either:
a) from accounting records of the entity
b) by adjusting sales, cost of sales and other items in the statement of comprehensive income for:
1) changes during the period in inventories and operating receivables and payables
2) other non-cash items
3) other items for which the cash effects are investing or financing cash flows.
CASH RECEIPTS FROM CUSTOMERS (direct method)
Revenue + op. receivables - cl. receivables = cash receips
CASH PAID TO SUPPLIERS AND EMPLOYEES (direct method)
- Cos - op. inventory + closing inventory = purchases
2. Purchases + op. trade receivables - cl. trade receivables = cash paid
CASH PAID FOR ADMINISTRATIVE AND SELLING EXPENSES
Use the figure in the income statements
Interpretation of cash flows
- no benefit to having a positive cash flow for its own sake
- every business should aim to have sufficient cash to meet any contingencies or to provide a fund in case any opportunities crop up unexpectedly
- if the business had to much cash to begin with then it should aim for a net outflow during the year
- if more cash is needed, care should be taken to ensure that it has been raised from the most appropriate sources e.g. long term funding for non-current assets.
Management of cash flows
- management prepare forward looking cash flows to try and predict any cash shortages in advance.
- Looking ahead to predict future cash flows is potentially more useful
- Knowing that the business is likely to run out of cash is not necessarily a problem if it predicted well in advance,
- Banks are likely to be sympathetic to a loan application that is made in good time and supported by a detailed proposal.
