CHAPTER 12 Flashcards
Why is the cash flow statement necessary
Many small business owners (incorrectly) assume that cash and profit are the same thing, and that if they can sell their products at a profit then they will automatically have cash available to pay their debts. Unfortunately, this is not the case. Cash and profit are different measures of performance, and there are many possible reasons why a firm that is earning a profit can still suffer from a lack of cash. Given that cash and profit are different, it is important that the owner is provided with different information on both items.
Statement of receipts and payments
An accounting report that details cash received and paid during a Reporting Period, and the change in the firm’s bank balance over that period. By listing the sources of cash (cash receipts) and uses of that cash (cash payments), this report allows the owner to identify whether the firm’s cash balance has increased or
decreased, and the main reasons why this has occurred.
Cash surplus
an excess of cash receipts over cash payments, leading to an increase in the bank balance
Cash deficit
An excess of cash payments over cash receipts, leading to a decrease in the bank balance.
Cash flow statement
an accounting report that details all cash inflows and outflows from Operating, Investing and Financing activities, and the overall change in the firm’s cash balance. Information about cash is more useful for decision-making if it classifies common sources and uses of cash, and separately identifies their effect on the bank balance.
Operating activity
refers to all cash flows related to the firm’s day-to-day trading activities. Operating inflows may include cash sales, receipts from debtors, GST received, and any other cash revenues. Operating outflows may include all payments related to expenses (including interest), payments to creditors, GST paid, prepaid expenses, and any payments for expenses incurred in previous periods (such as accrued wages).
Investing activities
are cash flows relating to the purchase or sale of non-current assets. In practice this will mean there are only two possible Investing items: cash received from the sale of a non-current asset (Investing inflow) and cash paid for the purchase of a non- current asset (Investing outflow).
Financing activities
are cash flows that are the result of changes in the firm’s financial structure. In essence, this willmean only cash transactions that change|Dans and owner’s equity, such as receiving or repaying the principal of a loan, or cash contributions or drawings by the owner.
4 uses of the cash flow statement
Aid decision making
Assess performance in meeting targets
Assist planning
Facilitate calculation of financial indicators
Aid decision making
To aid decision-making about the firm’s cash activities by detailing the sources and uses of cash in a particular period. In particular, the owner would want to assess whether the business is generating enough cash from its Operating activities to fund its Investing and Financing activities. A firm with negative Net Cash Flows from Operations will be unable to meet its other payments without contributions from the owner or external finance.
Assess performance in meeting targets
The Cash Flow Statement can be compared against budgeted (or expected) performance, as shown in the Budgeted Cash Flow Statement, which would have been prepared in advance. This comparison will highlight where performance was better or worse than expected. Corrective action can then be taken.
Assist planning
By providing a basis for the next budget, the Cash Flow Statement will aid in the setting of targets for the future. This may include cash received from sales or debtors, payments for stock or expenses, cash purchases of non-current assets, cash drawings, and repayment of loans. (This will be explored in more detail in Chapter 17.)
Facilitate calculation of financial indicators
To facilitate the calculation of financial indicators for analysis and interpretation. These indicators can be used not only to uncover what has happened, but also to help explain why.
Cash vs profit
cash and profit are different resources, and business owners need to understand this difference in order to manage both effectively. The change in a firm’s bank balance is calculated by comparing cash inflows and cash outflows in a period, whereas profit is determined by comparing revenues earned and expenses incurred in that period and, as we have seen a number of times, these items are not necessarily the same.
Credit sales v receipts from debtors
SeJling goods on credit will increase profit immecliately, but may not involve a cash flow until much later. Conversely, when the cash is received from the debtor it will increase Bank, but it is not revenue. Thus, the dlfferent amounts reported as Credit Sales and receipts from debtors could explain why cash and profit are not the same.
If Cred t Sales is greater than receipts from debtors, the firm may have more profit than cash
If Credit Sales is less than receipts from debtors, the firm may very well have less profit than cash.
Cost of sales and payments for stock
The way stock is paid for can also mean that cash and profit are not the same. Cost of Sales represents the value of stock sold, but this may not be the same as the amount that has been paid for that stock (as cash purchases or payments to creditors). Remember, Cost of Sales represents a stock flow, not a cash flow.
If Cost of Sales is greater than payments for stock, it will reduce profit more than it reduces cash.
if Cost of Sales is less
than payments for stock, it will mean a greater reduction in cash than in profit.
Amount incurred v amount paid
Due to balance day adjustments, the amount paid for expenses is frequently dlfferent from the amount incurred. When expenses are paid in advance for the next Reporting Period, such as prepaid rent or prepaid insurance, the amount paid will be greater than
the amount fncurred, meanfng that cash decreases more than profit. On the other hand, if expenses are accrued at the end of the Reporting Period, the amount ncurred will be greater than the amount paid, meanfng profit decreases more than cash
Cash inflows that are not revenues
Capital contribution
Loan received
GST received (including GST refund)
Cash outflows that are not expenses
Cash drawings
Loan repayments
Cash payments for non-current assets GST paid (including GST settlement)
Revenues that are not cash inflows
Stock gain
Expenses that are not cash outflows
Bad debts
Depreciation
Stock loss
Cash flow statement template
(Business name) Cash Flow Statement for the (period) ended (date) CASH FLOW FROM OPERATING ACTIVITIES Cash Inflows Less Cash Outflows Net Cash Flows from Operations CASH FLOW FROM INVESTING ACTIVITIES Cash Inflows Less Cash Outflows Net Cash Flows from Investing Activities CASH FLOW FROM FINANCING ACTIVITIES Cash Inflows Less Cash Outflows Net Cash Flows from Financing Activities Net Increase (Decrease) in Cash Position Add Bank Balance at start (Date) Bank Balance at end (Date)
RULE FOR CASH FLOW STATEMENTS
Do not write the word CONTROL
Answering cash v profit question
Explain profit
Explain Cash Flows
Explain profit and cash flows in relation to the business
Cite relevant section of statement
E.g. Cash and Profit are two different resources.
A profit occurred because the total revenues earned were greater than the total expenses incurred. (1 mark), whereas the business had a negative Net Cash Flows from Operations as the total cash outflows from day-to-day trading activities were greater than the total cash inflows from day-to-day trading activities. (1 mark)
1 mark per identification of example from question
Net Cash Flows
Cash inflows less cash outflows
Explain to Alison, with the use of two examples, how the business’s bank account now has an overdraft balance even though the Income Statement reported a Net Profit for the same reporting period.
The business’s bank account now has an overdraft balance, as the total cash outflows were larger than the total cash inflows and opening bank balance combined. (1 mark) However, a profit occurred because the total revenues earned were greater than the total expenses incurred.
A contributing factor would be an assumption that Prepaid Rent Expense decreased the bank balance by a larger amount than the Rent Expense would decrease Profit. (1 mark)
Another example would be purchasing the Equipment for cash, decreasing the bank balance by a larger amount than the depreciation expense decreasing Profit. (1 mark)
Who is the fastest man alive
Barry Allen
Cash receipts different to revenue, why?
Cash receipts include GST collections but they are not reported in the Income Statement since GST collections are not revenue. Revenue is a transaction that leads to an increase in owner’s equity, excluding capital contribution. GST collections would increase cash assets and increase GST liabilities but they would not increase owner’s equity hence they are not revenue.
Using the above data only, comment on the firms cash position
Pic in favourites
The overdraft has increased from $16 700 to $17 700 over December which is an unfavourable trend. Stakeholders would be concerned that net operating activities were negative in December: this means the day-to-day cash inflows are not sufficient to cover the day-to-day cash outflows suggesting a poor cash position. There has been a decrease in the cash position of $2 000 due to investing activities. This means the business has had cash purchases of non current assets during December. These new non current assets may assist cash inflows in the future. Financing activities have contributed $4 000 which suggests capital injections and/or loan borrowings. This could be due to concern about the current cash position by the owner (why would the owner inject cash if she did not have too?) and the repayment of the loans will impact on both the current and future cash position.
Profit but cash decrease discuss how could be possible
Net profit is revenue earned less expenses incurred over the reporting period while the change in the cash balance is a function of cash receipts less cash payments over the period. In calculating net profit, revenue such as credit sales, which could have been greater than debtor receipts, stock gain and discount revenue may have been included even though they are not cash receipts. Cash may have decreased due to cash drawings, loan repayments, creditor payments and purchase of stock, which may be more than the cost of sales, cash purchase of non current assets, which is greater than depreciation of the non current assets, ATO settlement and GST payments all of which are reported as expenses for the period.
Two reasons why there could be difference in advertising
Accrued advertising
Advertising using stock
Cash increase but net loss, discuss possibility
Net loss is revenue earned less expenses incurred where expenses are greater than revenue while an increase in the cash balance is a function of cash receipts being greater than cash payments.
Expenses which are not reflected in the Cash Flow Statement include cost of sales (greater than cash paid to creditors or for stock purchases), bad debts, discount expense, deprecia- tion, stock loss, stock taken for advertising use and accrued expenses.
Cash increases which are not reflected in an increase in revenue include capital injections, loans, debtor receipts (greater than credit sales), GST collections and ATO refunds.
