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CASH FLOW Statement -Study Notes
Table of Contents
1.0 MEANING OF CASH FLOW AND CASH FLOW STATEMENT.................................................................... 1
2.0 FORMS OF CASH................................................................................................................................ 1
3.0 OBJECTIVES OF CASH FLOW STATEMENT.......................................................................................... 1
4.0 PURPOSES OF CASH FLOW STATEMENT.............................................................................................. 1
5.0 IMPORTANCE OF CASH FLOW STATEMENT......................................................................................... 1
6.0 COMPONENT OF CASH FLOW STATEMENT......................................................................................... 2
6.1 CASH FLOW FROM OPERATING ACTIVITIES..................................................................................... 2
6.2 CASH FLOW FROM INVESTING ACTIVITIES....................................................................................... 2
6.0 CASH FLOW FROM FINANCING ACTIVITIES...................................................................................... 2
7.0 PREPARATION OF CASH FLOW STATEMENT........................................................................................ 3
CASH FLOW STATEMENT
1.0 MEANING OF CASH FLOW AND CASH FLOW STATEMENT
A Cash Flow statement is a simple report that explains the various sources of cash and how the
business puts this cash into use.
Cash flow statement is a primary final financial statement that reports the movement of cash and
cash equivalents that is inflows and outflows of the company accounts during a particular
financial year.
2.0 FORMS OF CASH
Cash comprises of cash in hand and demand deposits with banks.
Cash Equivalents are short-term, highly liquid investments that are readily convertible into
known amount of cash and which are subject to an insignificant risk of change in value. An
investment normally qualifies as cash equivalent only when it has a short maturity
i. Treasury bills,
ii. Commercial paper,
iii. Money market funds and
iv. Investments in preference shares and redeemable within three months can also be taken as
cash equivalents if there is no risk of the failure of the company.
3.0 OBJECTIVES OF CASH FLOW STATEMENT
The objectives of cash flow statement are:
i. To ascertain the sources from activities (i.e., operating/investing/financing activities) from
which cash and cash equivalents were generated by an enterprise.
ii. To ascertain the uses by activities (i.e., operating/investing/financing activities) for which
cash and cash equivalents were used by an enterprise.
iii. To ascertain the net change in cash or cash equivalents indicating the difference between
sources and uses from or by the three activities between the dates of two Balance Sheets.
4.0 PURPOSES OF CASH FLOW STATEMENT
i. Forecast future cash flows
ii. Evaluate management decisions
iii. Determine the ability to pay dividends to stockholders’ and payments to creditors
iv. Show the relationship of net income to the business’s cash flows
5.0 IMPORTANCE OF CASH FLOW STATEMENT
i. To identify the sources from where cash inflows have arisen within a particular period
and also shows the various activities where in the cash was utilized.
ii. It is significant to management for proper cash planning and maintaining a proper
matching between cash inflows and outflows.
iii. Shows efficiency of a firm in generating cash inflows from its regular operations.
iv. Reports the amount of cash used during the period in various long-term investing
activities, such as purchase of fixed assets.
v. Reports the amount of cash received during the period through various financing
activities, such as issue of shares, debentures and raising long-term loan.
6.0 COMPONENT OF CASH FLOW STATEMENT
It should prepared in accordance to the Revised Accounting Standard ( IAS 7) on cash flow
statement. The standard requires that cash flow be classified and shown in the cash flow
statement under three heads, namely:
i. Cash Flow from Operating Activities
ii. Cash Flow from Investing Activities
iii. Cash Flow from Financing Activities.
6.1 CASH FLOW FROM OPERATING ACTIVITIES
Operating activities are accounting items which indicates the money a company brings in from
ongoing, regular business activities, such as manufacturing and selling goods or providing a
service. Cash flow from operating activities does not include long-term capital or investment
costs. It does include earnings before interest and taxes plus depreciation minus taxes.
These are both normal and core daily activities within a business that generate cash inflows and
outflows which includes:
i) Cash received from customers
ii) Cash paid to suppliers of goods and services
iii) Cash paid to employees
6.2 CASH FLOW FROM INVESTING ACTIVITIES
Investing activities are items on the cash flow statement that reports the aggregate change in a
Financing Activities
Loans obtained
Loans repaid
Net cash flow from financing activities
Net cash flow
Add cash b/d
Cash c/f
h
(i
) XX
XX
a _
j _
Note : It can be seen from the above illustration that the cash flow statement is just a rearrangement of cashbook entries. However, the classifications are rigid; each item can only belong in one category. This classification must be fully understood. The items falling into each category are governed by paragraphs 10 – 17 of IAS7. However the first category that is operating activities cash flows can be arrived at by two methods; i. The direct method – whereby major classes of gross cash receipts and gross cash payments are disclosed; or ii. The indirect method – whereby the net profit or loss is adjusted for the effects of transactions of a non-cash nature and accruals/prepayments Format for cash flow statement (using direct cash flow method) Operating activities Sh Sh Cash receipts from customers X Cash paid to suppliers and employees (X) Cash generated from operations X Interest paid/received (X) Income taxes paid (X) Net cash flow from operating activities X Investing activities Purchase of property plant and equipment Proceeds on disposal of equipment
(X)
X_
Net cash flow from investing activities X Financing activities Proceeds from issuance of share capital X Redemption and purchase of share capital (X) Proceeds from long- term borrowings X Repayments on long-term borrowings (X) Payments on finance lease obligations (X) Dividends paid (X) Net cash flow from financing activities X_ Net change in cash and cash equivalents X Cash and cash equivalents b/f X_ Cash and cash equivalents c/f XX Format for cash flow statements (using indirect cash flow method) Sh Sh Net profit before tax X Adjustment for items not involving movement of cash Depreciation X Profit and losses on fixed asset disposals X_ X Adjustment for working capital items
(Increase)/Decrease in stocks X (Increase)/Decrease in debtors X (Decrease)/Increase in creditors X. Cash generated from operations X Tax paid (X) Net cash inflow from operating activities X Investing Activities Purchase of property plant and equipment Proceeds on disposal of equipment (^) X_
(X)
Net cash flow from investing activities X Financing Activities Proceeds from issuance of share capital X Redemptions and purchase of share capital (X) Proceeds from long-term borrowings X Repayments on long-term borrowings (X) Payments on finance lease obligations (X) Dividends paid (X) Net cash flow from financing activities X_ Net change in cash and cash equivalents X Cash and cash equivalents b/f X_ Cash and cash equivalents c/f XX A Good Example The balance sheet of Eco Link Ltd for the years ended 31 December, 2012 and 31 December 2013 were summarised and shown below: 2013 2012 Fixed assets (at written down values) £ £ Premises 10,000 10, Fixtures 17,000 11, Vehicles 12,500 8, Current assets Stock 17,000 14, Debtors 8,000 6, Bank and cash 23,000 29, 87,500 78, Ordinary shares of £1 per share 60,000 50, Reserves Profit and Loss Creditors due in less than one year
Trade creditors 4,000 2, Taxation 1,500 1, Proposed dividends 2,000 1,
Opening balance b/d Receipts from debtors Receipts from fixed asset disposals – vehicles Ordinary share issue Transfer from cash pening balances b/d 21,300 1700 Solution (refer only to cash book for 1 st^ solution) Eco- Link Limited Cash flow statement for the year ended 31 December 2013 (Direct Method) Operating activities £ £ Cash receipts from customers (30500 + 3750) 34, Cash paid to suppliers and employees (23250 + 700 + 900) (24,850) Other cash payments (2400 + 1200) (3,600) Cash generated from operations 5, Tax paid (1,000) Debenture interest paid (2,000) Net cash inflow from operating activities 2, Investing activities Payments to acquire fixtures (7,000) Payments to acquire vehicles (8,000) Proceeds on disposal of vehicles 1, Net cash outflow from investing activities (13,300) Financing Activities Ordinary share issue 10, Redemption of debentures (5,000) Dividends paid (1,000) 4, Net change in cash and cash equivalents Cash and cash equivalents b/f (25,300 + 4,200)
29,500_
Cash and cash equivalents c/f (21,300 + 1,700) 23, _ _ Closing balances c/d 21,300 1, 71,650 8,450 71,650 8,
Note:
- When all cash movements have been brought in, the opening cash is added thereon to generate the closing cash
- Under the direct method, the cash flow statement has been drawn up from the cash book only.
- The term “cash and cash equivalents” refers to: Cash in hand Cash at bank Short-term investments For the solution using the indirect method, no reference to the cash book is made. Information provided to enable preparation of the cash flow statement under this method consists:
- Beginning of the year balance sheet
- End of year balance sheet
- A profit and loss account for the year
- Additional information Thus accounts need reconstruction to obtain required values for the cash flow statement to be drawn up. Eco Link Limited Cash flow statement for the year ended 31 December 2013 (Indirect method) Operating activities £ £ Net profit before tax 4, Adjustment for items not involving movement of funds Depreciation 3, Profit on disposal of vehicles (700) 7, Adjustment for working capital items Increase in stock (3,000) Increase in debtors (2,000) Increase in creditors (trade) 1, Cash generated from operations 3, Taxation paid (1,000) Net cash inflow from operating activities 2, Investing activities Payments to acquire fixtures (7,000) Payments to acquire vehicles (8,000) Proceeds on disposal of vehicles 1, Net cash outflow from investing activities Financing activities
Ordinary share issue 10,
