Statement of Cash Flows Flashcards
The need for the statement of cash flows (4)
Required by?
Cash flow is vital for?
Cash is more…?
Provides information about: (3)
- Required by IAS 7 Statement of Cash Flows
- Cash flow is vital for the survival of a company
- Cash more easily understood, less easily manipulated
- Provides information about liquidity, viability, and financial adaptability
Required by IAS 7, it is vital for the survival of a company.
What does cash flow represent in a business context?
Cash flow = Cash in – Cash out
It is vital for a business to maintain operations, including purchasing inventory and paying liabilities.
Cash flow examples (5 in, 5 out)
In:
- Capital introduced
- Cash sales
- Receipts from trade receivables
- Disposal of assets
- Rent income
- Cash loan
Out:
- Wages & salaries
- Cash purchases
- Payment to trade payables
- Cash rent payment
- Dividends, interest, tax
Profit versus cash flow
- Financial Statements are prepared under the __________ basis following the _____________ principle.
- As a result, the statement of comprehensive income shows ____________ ________ in a period not the ______ ____________ from ________.
- Similarly, it shows the ____________ ___________ in generating the __________ not the ______ ____________ ________.
- The cash flow statement ignores ___________ and simply looks at ______ __ ________ _________ _____.
- Financial Statements are prepared under the accruals basis following the matching principle.
- As a result, the statement of comprehensive income shows revenue earned in a period not the cash received from sales.
- Similarly, it shows the expenditure incurred in generating the revenue not the cash actually paid.
- The cash flow statement ignores accruals and simply looks at cash in versus cash out.
The format and preparation of the SoCF
What are the 2 methods permitted by IAS 7 (5,4 advantages and 3,3 disadvantages)
Direct:
- cash inflows and outflows as they occur e.g. receipts from customer, payments to suppliers
Advantages
- Provides detailed information about the sources and uses of cash.
- Displays operating cash receipts and payments.
- Assists in predicting future cash flows by providing specific information about past cash receipts and payments.
- Useful for assessing an entity’s ability to convert revenues to cash.
- Potentially more helpful for predicting bankruptcy or future liquidation.
Disdvantages
- May be more time-consuming and costly to prepare due to the detailed information required.
- Less commonly used, making comparisons with other companies more difficult.
- Preparers may prefer the indirect method, leading to potential resistance to implementation.
Indirect:
- starts with profit before tax and adjusts for
non-cash items.
Advantages
- Highlights differences between operating profit and net cash flow from operating activities, providing a measure of the quality of income.
- Easier and less costly to prepare compared to the direct method.
- Commonly used, making comparisons with other companies easier.
- Provides useful information about past accruals adjustments, which can help estimate future adjustments.
Disdvantages
- Lacks detailed information about specific cash receipts and payments.
- May not provide certain cash flow variables, which can be important for assessing creditworthiness.
- Less useful for predicting future cash flows compared to the direct method.
Cash equivalents
What are they?
What may they include?
- Cash equivalents – short term, highly liquid investments which are readily convertible into known amount of cash which are subject to an insignificant risk of changes in value.
- May include short term investments where the maturity date is <90 days e.g. a bank overdraft repayable on demand.
Statement of cash flows – value to users
- Statement of cash flows are needed to provide information about __________, ______________ and ___________ _______________.
- They are prepared from the statement of ____________ ___________ and the statement of __________ __ ______.
- Therefore ____ ____ information
- Highlights how the business has _________ _____ and _____ ____ ______ over the year
- To make more useful, breaks down cashflows arising from ____________ activities, _____________ activities and _____________ activities
- Statement of cash flows are needed to provide information about liquidity, viability and financial adaptability.
- They are prepared from the statement of financial position and the statement of profit or loss.
- Therefore not new information
- Highlights how the business has raised cash and paid out cash over the year
- To make more useful, breaks down cashflows arising from operating activities, investing activities and financing activities
WHY do we adjust for changes in working capital? (4)
- Accounts are prepared under the accruals basis following the matching principle
- Therefore statement of profit or loss shows revenue earned in a period, not the cash received from sales.
- Similarly, it shows the expenditure incurred in generating the revenue, not the cash actually paid
- The statement of cash flows ignores accruals and simply looks at cash in versus cash out
HOW do we adjust for changes in working capital?
Increases in inventory or receivables: (3)
Increases in payables: (2)
Increases in inventory or receivables:
- Increase in inventory means more cash has been spent on buying inventory therefore the company has less cash
- Increase in receivables means more of the revenue in the PoL has not been collected therefore the company has less cash
- an increase in inventory or receivables must be subtracted from operating profit (cash OUTflow)
Increases in payables:
- Increase in payables means more of the purchases in the PoL have not been paid therefore the company has more cash
- an increase in payables is added to operating profit (cash INflow)
HOW do we adjust for changes in working capital?
Increase during the year?
Decrease during the year?
Inventory
Receivables
Payables
Inventory
Increase during the year = Cash Outflow
Decrease during the year = Cash Inflow
Receivables
Increase during the year = Cash Outflow
Decrease during the year = Cash Inflow
Payables
Increase during the year = Cash Inflow
Decrease during the year = Cash Outflow
The importance of cash (4)
Cash flow is vital for the survival of a company
- Allows growth as opportunities can be taken
- Good relationship with suppliers and customers
You can be highly profitable but still go bust
- Overtrading – business runs out of cash due to rapid growth and poor cash management
Cash more easily understood
Cash less easily manipulated
Cash flows from operating activities, investing activities and financing activities (5,5,5)
Operating activities
- Shows users how much cash has been
- Generated from normal trading activities - Paid in tax and interest
- Useful to users
- Shows ability to generate sufficient cash to meet normal demands
Investing activities
- Shows users how much cash has been
- invested in resources - received from past investments
- Useful to users
- To predict future income and cash flow generation
Financing activities
- Shows users how much cash has been
- Used to repay debt - Received from new finance
- Useful to users
- To predict claims on future cash flow e.g. interest, dividends
Cash flow classification (picture)
Cash and cash equivalents at start of period
Where do we get this figure from?
Check current assets for the cash at bank figure and subtract the overdraft in the current liabilities
Cash flow question approach
- Calculate differences in SOFP and decide on classification:
Operating? Investing? Financing? - Identify relevant items in IS after operating profit (PBIT) and classify
- Identify any acquisitions, disposals and depreciation charges affecting cash flows
Tax paid formula with example question
Opening tax payable balance + tax charge from P&L - closing tax payable balance = tax paid
Sale Proceeds formula with example
NBV + profit / - loss = proceeds
Proceeds of share issue includes
Both increase in share capital and share premium added together
Cash paid to buy non current assets (NCA)
Not just the difference between the two Statement of Financial Position figures for non-current assets = purchases for the year:
because we have to allow for depreciation and disposals.
CV b/f + NCA additions - CV disposals - annual depreciation charge = CV c/f
NCA additions = CV c/f - CV b/f + CV disposals + Annual depreciation charge
Cash received from sale of non current assets(NCA)
P/L sale of NCA = sale proceeds - CV
Sale proceeds = CV + profit on sale (Deduct if loss on sale)
Interpreting the statement of cash flows
- What are operating activities
- Different…?
- Cash (2)
- Ratios you can use (3)
- What is the investing activities cash flow
- What is the financing activities cash flow
- No definition of operating activities
Includes all transactions not defined as investing or financing activities - Different classification of interest and dividends paid
- Cash generated from operations
Cash available from ongoing operations to service loans, pay tax, reinvest, pay dividends - Interest cover can be calculated from the IS and the SOCF
IS Interest cover = PBIT/interest
SOCF Interest cover = Cash generated from operations/Interest paid
Current cash debt coverage ratio
Cash generated from operations / average current liabilities - Investing activities cash flow
Acquisitions and disposal of non-current assets and investments
Replacement of existing assets or expansion
Free cash flow = net cash generated by operating activities less cash used to purchase non-current assets - Financing cash flows
Does not assess the financing policy of the company
