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					 CHAPTER22

 CASH FLOW
STATEMENTS
1THE NEED FOR A CASH FLOW
 STATEMENT
• Profit represents the increase in net
  assets in a business during an
  accounting period.
• This increase can be in :
  ---Cash
  ---Non-current assets
  ---Receivables
  ---Inventory
• Or the liabilities of the business may have
  decreased ,i.e more cash has been spent this year
  in paying off suppliers than was the case last year.
• A cash flow statement is needed because of the
  differences between profits and cash. It achieves
  the following:
  ---Provides additional information on business
  activities
  ---Helps to assess the current liquidity of the
  business.
  ---Allows the user to see the major types of cash
  flows into and out of the business
  ---Helps the user to estimate future cash flow
  ---Determines cash flows generated from trading
  transactions rather than other cash flows.
2 IAS 7 CASH FLOW STATEMENTS
• IAS 7 requires enterprises to present a
  cash flow statement as part of their
  financial statements.
• A cash flow statement can be presented in
  a number of ways:
  ---As a summary of the cash receipts and
  payments of an enterprise (a summarized
  cash book)
  ---From the balance sheet and income
  statement, opening with a reconciliation
  between reported profit and operating cash
  flow.
• IAS 7 requires the cash flow statement to
  be presented using standard headings ,to
  ensure that cash flows are reported in a
  form that:
  ---Highlights the significant components of
  cash flow.
  ---Facilitates comparison of the cash folw
  performance of different business.
• The standard leading shown n the
  statement are:
  ---Operating activities
  ---Investing activities
  ---Financing activities
• Specimen format for a cash flow statement
  from IAS 7
• CASH FLOW STATEMENT FOR THE
  PERIOD ENDED…
•                         $’000                      $’000
•   Cash flows from operating activities
•   Net profit before taxation                  X
•   Adjustments for:
•   Depreciation                               X
•   Interest expense                           X
•   Operating profit before working
•   capital changes                             X
•   (Increase)/decrease in trade receivables   (X)/X
•   (Increase)/decrease in inventories         (X)/X
•   (Increase)/decrease in trade payables       X / (X)
•   Cash generated form operations           X
•   Interest paid                           (X)
•   Dividends paid                          (X)
•   Income taxed paid                       (X)

• Net cash from operating activities              X/(X)

•   Cash flows from investing activities
•   Purchase of property, plant and equipment   (X)
•   Proceeds of sale of equipment               X
•   Interest received                            X
•   Net cash used in investing activities        X
•                                                  X/(X)
•   Cash flows form financing activities
•   Proceeds of issue of shares                X
•   Repayment of loans                        (X)
•   Net cash used in financing activities           X/(X)

•   Net increase/(decrease) in cash and cash        X/(X)
•   equivalents
•   Cash and cash equivalents at the beginning
•   of the period                                     X
•   Cash and cash equivalents at the end of the
•   period                                             X
• Cash flows from operating activities :begins
  with the profit before tax as shown in the income
  statement. The figures below are the adjustments
  necessary to convert the profit figure to the cash
  flow for the period.
   Depreciation    Added back to profit because it
                   is a non-cash expense
   Interest        Added back because it is not
   expense         part of cash generated from
                   operations (the interest actually
                   paid is deducted later)
   Increase in     Deducted because this is part of
   trade           the profit not yet realized into
   receivables     cash but tied up in receivables
Decrease in      Added on because the decrease in
inventories      inventories liberates extra cash
Decrease in      Deducted because the reduction in
trade payables   payables must reduce cash
Interest paid

Dividends paid      These are the amount actually
                    paid in the year
Income taxed
paid
• Cash flows from investing activities :cash spent
  on non-current assets, proceeds of sale of non-
  current assets and income from investments.
• Cash flows from financial activities: the
  proceeds of issue of shares and long-term
  borrowing made or repaid.
• Net increase in cash and cash equivalents :the
  overall increase9or decrease) in cash and cash
  equivalents during the year. Add the cash and cash
  equivalents at the beginning of the year to give the
  final balance of cash and cash equivalents at the
  end of the year.
  ---‘cash’:cash on hand and deposits available on
  demand.
  ---‘Cash equivalents': short-term highly liquid
  investments that are readily convertible to known
  amounts of cash and which are subject to an
  insignificant risk of changes in value usually
  excludes investments, unless they re readily
  convertible and with little or no risk of change in
  value).
• IAS 7 requires a note to the cash flow statement
  giving details of the make-up cash and cash
  equivalents:
       Cash and cash equivalents
•                          At end of     At
•                          year        beginning
•                                      of year
•                          $’000        $’000
• Cash on hand and
• balance at banks           X            X
• Short-term investments     X            X
•                            X            X
   3 PREPARATION OF A CASH FLOW
     STATEMENT
• Direct method :figure for the cash
  statement derived from the
  accounting records or form the other
  financial statements.
• Indirect method: figures derived
  from the other financial accounting
  statements:
   ---Balance sheets for the current year
  end and the previous period
   ---Income statement for the period.
  • The alternative reconciliations are as follows
Direct method          $’000       Indirect method        $’000
Cash received from                 Profit/(loss) before tax X/ (X)
customers            X
Cash payments to suppliers         Depreciation charges        X
(X)
Cash paid to and on                (Increase)/decrease (X)/X
behalf of employees (X)            in inventories
Other cash payments (X)            (Increase)/decrease (X)/X
                                   in receivables
                                   (Increase)/decrease (X)/X
                                   in payables
Net cash inflow/(outflow)          Net cash inflow/(outflow)
from operating activities X/ (X)   from operating activities X/ (X)
• Indirect method
  ---You are usually presented with two balance
  sheets: for the end of the prior period and for the
  end of the current period. All the differences
  between the opening and closing balances are
  various types of cash flow, or are otherwise
  needed to produce the cash flow statement.
  ---To calculate the operating cash flow:
     (1) Find the profit figure:
       ◇Take it from operating cash flow, or
       ◇Calculate the increase in retain profit and
          add back the period’s dividends and tax
          charge to arrive at profit before tax.
(2)Adjust the profit figure for:
   ◇ Non –cash expenses like depreciation, and
   ◇ Movements in working capital items such as inventory,
   receivables and payables.
(3)where there are sales of non- current assets you will need to
   find figures for additions or disposals, and depreciation on
   disposals.
  ◇ Set up three T accounts for non-current asset
     cost, aggregate depreciation and disposal
  ◇ Enter the opening and closing balances from
     the balance sheets.
  ◇ Do the double entry in the ledger accounts and the cash
      flow statements for all additional information given to you
      in the question
  ◇ The balancing figures will give you the figures you need
• (4) set up a format as follows, leaving
  plenty of space between the headings,
  then go through the given balance
  sheets from the top entering the
  differences in the correct positions in
  the format.
Cash flows from operating    to give   Net cash from operating   X
activities                             activities
Cash flows from investing   to give    Net cash used in investing X
activities                             activities
Cash flows from financing   to give    Net cash used in financing X
activities                             activities
Net increase in cash and cash equivalents                        X

Cash and cash equivalents balance at beginning of year           X
(from prior period balance sheet)

Cash and cash equivalents balance at end of year                 X
(agree to closing balance sheet)
• Direct method
  ---Gross cash flows can be derived:
    (1) from the accounting record: total the cash
        receipts and payments directly, or
    (2) for net cash flow from operating
        activities, from the opening and closing
        balance sheets and income statements for
        the year by constructing summary control
        accounts for:
       ◇ Sales (to derive cash received from
           customers)
       ◇ Purchases (to derive cash payments to
           suppliers)
       ◇ Wages( to derive cash paid to and on
           behalf of employees)
           (W1) Receivables ledger control
•                        $                         $
•   Balance b/d         X Cash receipts (balancing X
•                          figure)
•   Sales revenue       X Balance c/d              X
•                       X                           X
        (W2)Payables ledger control (excluding
             non-current asset purchases)
•                       $                           $
•   Cash paid (bal fig) X Balance b/d                X
•   Balance c/d         X Purchases
•                           -Cost of sales           X
•                           -Administration          X
•                        X                           X
                        (W3)Wages control
•                       $                              $
•   Net wages paid X          Balance b/d              X
•   (bal fig)           X     Cost of sales            X
•   Balance c/d                Administration          X
•                       X                              X
•   Alternatively, the figure for net cash flows from operating
    activities could be derived from the reconciliation shown
    above.
•   A further working for non- current assets may be required.
                 (W4) Non-current assets (NBV)
•                         $                                $
•   Balance b/d           X        Depreciation charge     X
•   Addition (bal fig)    X         Balance c/d            X
•                         X                                X
  Whether you use the direct or the indirect method,
  here are the steps you should take in the exam.
Step 1
  Allocate one or two pages to the cash flow
  statements so that easily identifiable cash flows
  can be inserted. Allocated a father page to
  workings.
Step 2
  Go through the balance sheets and take the
  balance sheet movements to the cash flow
  statement or to workings as appropriate, Tick off
  the information in the balance sheets once it has
  been used.
Step 3
  Go through the additional information provided
  and deal with as per Step2
Step 4
  The amounts transferred to working can now be
  reconciled so that the remaining cash flows can be
  inserted on the statements.
Step 5
  Complete the cash flow statement.
4 INTERPRETATION USING THE CASH
  FLOW STATEMENT
• The cash flow statement reveals:
  ---Whether the overall activities reveal a positive
  cash flow
  ---Whether the operating activities yield a positive
  cash flow
  ---The manner in which capital expenditure has
  been financed (for example, whether it has come
  from internally-generated resources, borrowings,
  issue of shares or from cash balance)
• Cash flow statements allow users to evaluate:
  ---How the enterprise generates and uses cash and
  cash equivalents.
  ---Changes in net assets, financial structure
  (including liquidity and solvency) and the ability of
  the enterprise to adapt to changing circumstances.
  ---The ability of the enterprise to generate cash
  ---Between different enterprises, because the
  effects of using different accounting treatments
  are eliminated
  ---Forecasts of future cash flows
  ---The accuracy of past assessments of future cash
  flows.

				
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posted:2/23/2010
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