CHAPTER 10
Cash flow statements
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
2005 Peter Walton and Walter Aerts
Contents
Introduction The cash flow statement
Usefulness of cash flow information
Cash flow cycles
Format and structure of the cash flow statement
Cash flow from operating activities
Cash flows from investing and financing activities
Direct and indirect method for operating cash
flows
Constructing a cash flow statement
Disposal of fixed assets
Presentational differences
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
2005 Peter Walton and Walter Aerts
Cash flow statement
A cash flow statement presents
information about the cash flows
associated with the companys main
operations and those associated with its
investing and financing activities of the
period
A cash flow statement functions in
conjunction with both the income
statement (performance dimension) and
the balance sheet (financial position)
IAS 7 Cash Flow Statements
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
2005 Peter Walton and Walter Aerts
Usefulness of cash flow
information
Ability to generate adequate cash
flows is a significant performance
dimension
Cash flow information clarifies the
dynamics of short-term liquidity and
long-term solvency
Cash flow information is an essential
input for economic decision models
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
2005 Peter Walton and Walter Aerts
Cash flow versus profit
Cash flow and profit are different economic
phenomena
But linked through the mechanisms of accrual
accounting!
Cash flows are factual details of incoming
and outgoing flows of cash, while the
balance sheet and income statement
emanate from professional judgement and
are not a direct projection of objective
economic data
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
2005 Peter Walton and Walter Aerts
Liquidity/solvency and cash
flows
Liquidity
-
Solvency
-
Relates to nearness to cash of the structure of assets
Determined by capacity to convert current assets into cash
Relates to future availability of cash in order to settle
financial liabilities on due date
Determined by timing and uncertainty of expected future
cash payments and cash receipts
Liquidity and solvency ratios are determined
on static financial position data, while cash
flows reflect changes in financial position
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
2005 Peter Walton and Walter Aerts
Relationship with BS and IS
Income statement
BS at start
Cash flow
BS at end
A cash flow statement reflects both profit related
and non-profit related activities (investing and
financing) with an impact on available cash over the
period covered in the income statement
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
2005 Peter Walton and Walter Aerts
Related questions
1.
2.
3.
4.
5.
From which sources did the company raise
cash last year? How was this cash used?
Were the normal operating activities capable of
satisfying its need for cash during the year?
If not, is the shortage of cash compensated by
new borrowings, issuing new share capital or
by selling fixed assets?
Is a surplus of cash used for repayment of
debt, for investments or for distribution of
dividends?
Why has the balance of cash available
decreased, knowing that the companys
operations have been profitable?
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
2005 Peter Walton and Walter Aerts
Cash conversion cycles
Cash flows through the company
continuously in a series of short-term
and long-term conversion cycles
The ST - cash conversion cycle
(operating cycle) relates to the main
business operations
=
OPERATING ACTIVITIES
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
2005 Peter Walton and Walter Aerts
Cash conversion cycles
(cont.)
The LT- cash conversion cycles relate to
the acquisition, renewal and disposal
of intangible and tangible infrastructure
and the long-term sourcing of funds
Productive
capacity acquired for cash and
subsequently consumed during several SToperating cycles
Acquisition and disposal of infrastructure
= INVESTING ACTIVITIES
External sourcing of funds = FINANCING
ACTIVITIES
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
2005 Peter Walton and Walter Aerts
Fig. 10.1 Long-term and short-term
cash flow cycles
Main operations
Inventory
Procurement
Work in Progress
Sales
Current payables
Inventory
Current receivables
Payments
Cash and cash
equivalents
Receipts
Investing/
Productive
infrastructure
External financing
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
2005 Peter Walton and Walter Aerts
Format and structure of the
cash flow statement
Cash flows from operating
activities
+ Cash flows from investing
activities
+ Cash flows from financing
activities
Net change in cash during
period
+ Beginning cash balance
Ending cash balance
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
2005 Peter Walton and Walter Aerts
Cash flows from operating
activities
Operating activities are primarily the revenuegenerating activities of a company
Operating cash flow is conceptually most near
to net profit
Main differences:
1.
Non-cash expenses and non-cash revenues (f.i.
depreciation expense)
2.
Non-operating items (f.i. gain on disposal of
tangible fixed assets)
3.
Timing differences between net profit and
underlying cash flow (f.i. changes in the level
of inventories, receivables, creditors, etc.)
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
2005 Peter Walton and Walter Aerts
Operating cash flows:
Examples
Receipts from sale of goods and rendering of
services (cashing in of receivables included)
Receipts from taxes on sales and VAT
Receipts from royalties, fees, commissions,
Payments to suppliers (payment of creditors
included)
Payments to employees
Payments of taxes, VAT, fines,
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
2005 Peter Walton and Walter Aerts
Operating cash flows
Direct versus indirect method
2 methods for identifying and presenting
the operating cash flow:
Direct method: engenders the presentation of
the most important categories of gross
operating cash inflows and cash outflows
Indirect method: net operating cash flow is
determined by adjusting the (net) profit figure
for the 3 types of differences
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
2005 Peter Walton and Walter Aerts
Direct method - Example
Cash receipts from customers
30,150
Cash paid to suppliers and employees
(27,600)
Cash generated from main operations
2,550
Income taxes paid
(1170)
Net cash flow from operating activities
1,380
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
2005 Peter Walton and Walter Aerts
Indirect method - Example
Net profit before tax
Adjustments for:
Depreciation
Investment income
3,350
490
(100)
3,740
Working capital changes:
Increase in trade and other receivables
(500)
Decrease in inventories
1,050
Decrease in trade payables
Cash generated from main operations
Income taxes paid
Net cash flow from operating activities
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
2005 Peter Walton and Walter Aerts
(1,740)
2,550
(1170)
1,380
Cash flow proxy
Net profit or loss after tax
Add back:
Depreciation charge for the
year
Provisions created in year
Deduct:
Provisions released in year
Cash flow proxy
xxxxxxxxxxxxxx
xxxxxxxxxxxxxxx
xxxxxxxxxxxxxxx
(xxxxxxxxxxxx
xx)
xxxxxxxxxxxxxx
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
2005 Peter Walton and Walter Aerts
Cash flow proxy (bis)
Net profit or loss after tax
xxxxxxxxxxxx
Add back:
Depreciation for the year
Provisions created in year
Deduct:
Provisions released
xxxxxx
xxx
(xxxx)
Gain on asset disposal
(xxxxx)
Net change in non-cash working capital
(xxxxx)
Cash flow proxy
xxxxxxxxxxxx
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
2005 Peter Walton and Walter Aerts
Cash flows from investing
activities
Investing activities relate to the acquisition
and disposal of long-term tangible and
intangible assets and other investments
Cash flows from investing activities are an
indication of the expansion or downsizing
of operating capacity
Examples:
Payments for newly acquired equipment
Receipts from the disposal of a building
Payments for new investments
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
2005 Peter Walton and Walter Aerts
Cash flows from financing
activities
Financing activities relate to changes in the
size and composition of contributed capital
and financial debt of the company
Examples:
Receipts from issuing new shares or bonds
Receipts from new bank loan
Payments for buy-back of shares
Repayments of loans
Payments of interest and dividend
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
2005 Peter Walton and Walter Aerts
Constructing a cash flow
statement
1.
2.
3.
Determine the net change in cash
Compare beginning and ending balance
Identify all transactions of the period leading to a
change in cash
Direct: analyze movements in the accounts of
cash (equivalents) transaction by transaction
Indirect: explain net change of cash by
analyzing all other accounts, knowing that each
transaction with an impact on cash also affects
a non-cash account
Use the information (of step 1 and 2) to construct a
cash flow statement according to the formal rules
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
2005 Peter Walton and Walter Aerts
Applying step 2
Information for operating cash flow is primarily
derived from balances in the IS, while information
for the two other principal categories comes from
the Balance Sheet (and details in the Notes)
Movements in the accounts indicate a change in
financial position and further examination is
needed to determine if they had a cash impact
Check if balances have been impacted by accrualbased adjustments or other non-cash activities
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
2005 Peter Walton and Walter Aerts
Fig. 10.2 Classifying balance sheet
movements as inflows or outflows of
cash
Assets
Equity/liabiliti
es
Increase
Outflow
Inflow
Decrease
Inflow
Outflow
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
2005 Peter Walton and Walter Aerts
Illustration - Constructing a CFS
(1)
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
2005 Peter Walton and Walter Aerts
Illustration - Constructing a CFS
(2)
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
2005 Peter Walton and Walter Aerts
Disposal of fixed assets Example
Disposal of equipment:
Acquisition cost
275
- Accum. depreciation
- 200
Net carrying value = 115
Sale at 135
Result (gain) on disposal = 135 - 115= 20
Incoming cash flow = 135, composed of a decrease in
net carrying value of equipment in the BS (115) and
gain on disposal in the IS (20)
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
2005 Peter Walton and Walter Aerts
Disposal of fixed assets
Net profit after tax
Add back:
Depreciation
Provisions created
Loss on disposal of assets
Deduct:
Provisions released
Gain on asset disposal
+/- Change in non-cash working capital
xxxxxxxxxxx
x
xxxxxx
xxxxxx
xxxxxx
xxxxxx
xxxxxx
xxxxxx
xxxxxxxxxxx
Use with Global
Financial
Accounting and Reporting
ISBN 1-84480-265-5
Net cash flow
from
operating
activities
2005 Peter Walton and Walter Aerts
x
Incoming cash flows
Cash
+
(1)
(2)
(3)
Other assets
=
Liabilities
+
Ownersequi
ty
+
+
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
2005 Peter Walton and Walter Aerts
Outgoing cash flows
Cash
+
(1)
(2)
(3)
Other assets
=
Liabilities
+
Ownersequi
ty
+
-
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
2005 Peter Walton and Walter Aerts
Presentational choices
Interest paid can be classified under either
operating or financing activities
Interest and dividends received can be
included in either operating or investing
cash flows
Starting from net profit or operating profit
under the indirect method (with
implications for the adjustments to be
made)
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
2005 Peter Walton and Walter Aerts
IAS 7 - Direct Method (Extract)
Source: IAS 7 Cash Flow Statements, Appendices
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
2005 Peter Walton and Walter Aerts
IAS 7 - Direct Method (Extract)
Source: IAS 7 Cash Flow Statements, Appendices
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
2005 Peter Walton and Walter Aerts
IAS 7 - Direct Method (Extract- cont.)
Source: IAS 7 Cash Flow Statements, Appendices
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
2005 Peter Walton and Walter Aerts
IAS 7 - Indirect Method (Extract)
Source: IAS 7 Cash Flow Statements, Appendices
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
2005 Peter Walton and Walter Aerts
IAS 7 - Indirect Method (Extract)
Source: IAS 7 Cash Flow Statements, Appendices
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
2005 Peter Walton and Walter Aerts
IAS 7 - Indirect Method (Extract cont.)
Source: IAS 7 Cash Flow Statements, Appendices
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
2005 Peter Walton and Walter Aerts
