CASH FLOWS & LIQUIDITY PREPARING AND INTERPRETING STATEMENT OF CASH FLOWS

Question 1

What are the types of items included in the statement of cash flows?

Answer 1

Cash: On hand, Demand deposit, Overdraft (repayable on
demand)
Cash Equivalents: Short term < 3 month maturity, Highly liquid, Readily convertible, Not held for investment

Question 2

What 3 sections does the SoCF include?

Answer 2

Regular cash flow Cash generated/(used) by
1. operating activities
One-off cash flow Cash generated/(used) by
2. investing activities
Cash generated/(used) by
3. financing activities

Question 3

What are the special consideration items in the SoCF?

Answer 3

• Interest received = investing cash inflow
• Dividend received = investing cash inflow
• Interest paid = operating cash outflow
• Dividend paid = financing cash outflow

Question 4

What are the 5 benefits of the SoCF?

Answer 4

• Objectivity
• Comparability
• Predictive
• Understandable
• Liquidity focus

Question 5

What does the SoCF tell you about your operating activities?

Answer 5

How good you are at turning your business ideas into cash. May be an early warning sign of a problem with the business if levels fluctuate considerably.

Question 6

What does the SoCF tell you about your investing activities?

Answer 6

Ability to maintain performance & finance expansion
needs from internal sources.
Free cash flow

Question 7

What does the SoCF tell you about your financing activities?

Answer 7

Debt : Equity

Risk & Return

Question 8

Name and describe the formulas for two liquidity ratios.

Answer 8

– CURRENT RATIO
Current assets : Current liabilities
Bench mark 2:1 but varies by industry
– QUICK RATIO (ACID TEST)
Current assets (excluding inventory): Current liabilities
Bench mark 1:1 but varies by according to repayment date of current liabilities

Question 9

Name and describe the formulas for three efficiency ratios.

Answer 9

Indicates efficiency of inventory management
Objective – to have minimum possible levels of inventory but sufficient always available to meet customer demand
INVENTORY HOLDING PERIOD
Average inventory x 365 / Cost of sales
Measures average number of day elapsing between acquiring inventory and selling/using it
OR
INVENTORY TURNOVER
Cost of sales / Average inventory
Measures average number of times inventory is ‘turned over’ during the year
– TRADE RECEIVABLES COLLECTION PERIOD
Measures average number of day elapsing between making a credit sale and receiving payment
Insights into credit policy – increases may indicate deliberate decision to offer better than industry norm terms to attract customers or, conversely, inefficient credit control systems
Average trade receivables x 365 / Credit sales (or revenue)
– TRADE PAYABLES PAYMENT PERIOD
Measures average number of day elapsing between making a credit purchase and making payment
Insights into cash management – increases may indicate difficulties in making payments with associated risks to credit rating
Average trade payables x 365 / Credit purchases (or cost of sales)