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
