Chapter 21

Statement of cash flows

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Contents
1. IAS 7 statement of cash flows

2. Preparing a statement of cash flows

3. Interpretation of statements of cash flows

Accounting standards

Accounting standards: IAS 7

IAS 7 Cash flow statements Objective of IAS7 The objective of IAS7 is to ensure that all enterprises provide information about the historical changes in cash and cash equivalents by means of a cash flow statement which classifies cash flows i.e. inflows and outflows of cash and cash equivalents during the period between those arising from operating, investing and financing activities.

IAS 7 Cash flow statements

A cash flow statement demonstrates the points that: (a) Provides information on business activities (b) Helps to assess the current liquidity of the business (c) Highlights the major cash inflows and outflows of the business (d) Helps the user to estimate future cash flows (e) Distinguishes between trading cash flows and other types of cash flow (f) Removes accrual accounting from financial information

Key Definition
Cash comprises cash on hand and demand deposits

Cash equivalents are short-term ,high liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value.
Cash flows are inflows and outflows of cash and cash equivalents.

Key Definition
Operating activities are principal revenue-producing activities of the entity and other activities that are not investing or financing activities. Investing activities are the acquisition and disposal of non-current assets and other investments not included in cash equivalents. Financing activities are activities that result in changes in the size and composition of the equity capital and borrowings of the entity.

IAS 7 Cash flow statements Operation activities

Cash flow from the operation activities will be those items which determine the net profit or loss of the activities. (a) cash receipts from the sale of goods and the rendering of services (b) cash payments to suppliers for goods and services

Investment activities
Investment activities show the investments in assets which will generate future profit and cash flows. (a) cash payments to acquire shares or debentures of other entities. (b) cash receipts from the repayment of advantages and loans made to other parties. (c) cash receipts from the repayment of advances and loans made to other parties.

IAS 7 Cash flow statements Financing activities

Financing activities is an indicator of likely future interest and invest and dividend payments. (a) cash proceeds from issuing shares . (b) cash payments to owners to acquire or redeem the entitys shares. (c) principal repayments of amounts borrowed under finance lease.

IAS 7 Cash flow statements

Example :finance lease rental
The notes to the financial statements of Hayley Co. show the following in respect of obligations under finance leases. Year ended 30 June 20*5 20*4 000 000 Amounts payable within one year 12 8 Within two to five years 110 66 122 74 Less finance charges allocated to future periods (14) (8) 108 66 Interest paid on finance leases in the year to 30 June 20*5 amounted to 6m.addions to tangible non-current assets acquired under finance lease were shown in the non-current asset note at 56,000 Required Calculate the capital repayment to be shown in the statement of cash flows of Hayley Co. for the year to 30 June 20*5.

IAS 7 Cash flow statements Solution

obligations under finance leases
000 14 108 122 000 66 56 122

Capital repayment (bal fig) Bal 30.6.*5

Bal 1.7.*4 Additions

IAS 7 Cash flow statements Reporting cash flow methods

The standard offers a choice of method for this part of the statement of cash flows. Direct method: disclose major classes of gross cash receipts and gross cash payments Indirect method: net profit or loss is adjusted for the effects of transactions of a non-cash payments, and items of income or expense associated with investing or financing cash flows. The direct method is the preferred method because it discloses information , not available elsewhere in the financial statements, which could be of use in estimating future cash flows.

IAS 7 Cash flow statements The indirect method

The net profit or loss for the period is adjusted for the following: (a) Changes during the period in inventories, operating receivables and payables. (b) Non-cash items, eg depreciation , provisions, profits/loss on the sales of assets. (c) The cash flows from which should be classified under investing or financing activities. The direct method is encouraged where the necessary information is not too costly to obtain ,but IAS7 does not require it, in practice the indirect method is more commonly used, since it is quicker and easier.

IAS 7 Cash flow statements

Cash flow from operating activities (indirect method) Cash flow from operating activities Profit before taxation Adjustment for : Depreciation Foreign exchange loss Investment income () Interest expense Increase in trade and other receivables ( ) Decrease in inventories Decrease in trade payables ( ) Cash generated from operations Interest paid () Income taxes paid () Net cash from operating activities

IAS 7 Cash flow statements

Why certain items are added and others subtracted . (a) depreciation is not a cash expense, but is deducted in arriving at profit, it makes sense, therefore, to eliminate it by adding it back (b) by the same logic , a loss on a disposal of a non-current asset (arising through under provision of depreciation) needs to be added back and a profit deducted. (c) an increase in inventories means less cash-you have spent cash on buying inventory. (d) an increase in receivables means the companys debtors have not paid as much, and therefore there is less cash. (e) if we pay off payables, causing the figure to decrease, again we have less cash.

IAS 7 Cash flow statements

Interest and dividends

Cash flows from interest and dividends received and paid should each be disclosed separately. Dividends paid by the entity can be classified in one or two ways: (a) as a financing cash flow, showing the cost of obtaining financial resources. (b) as a component of cash flows from operating activities so that users can assess the entitys ability to pay dividends out of operating cash flows.

IAS 7 Cash flow statements Taxes on income

Cash flows arising from taxes on income should be separately disclosed and should be classified as cash flows from operating activities unless they can be specifically identified with financing and investing activities.

IAS 7 Cash flow statements Components of cash and cash equivalents The components of cash and cash equivalents should be closed and a reconciliation should be present, showing the amounts in the statement of cash flows reconciled with the equivalent items reported in the statement of financial position

IAS 7 Cash flow statements Other disclosures

All entities should disclose, together with a commentary by management ,any other information likely to be of importance, for example: (a) restrictions on the use of or access to any part of cash equivalents (b) the amount of undrawn borrowing facilities which are available (c) cash flows which increased operating capacity compared to cash flows which merely maintained operating capacity (d) cash flows arising from each reported industry and geographical segment.

IAS 7 Cash flow statements

Cash flow statements (direct method)
STATEMENT OF CASH FLOWS (DIRECT METHOD) YEAR ENDED 31 DECEMBER 20*7 m Cash flows from operating activities Cash receipts from customers 30,330 Cash paid to suppliers and employees (27,600) Cash generated from operations 2,730 Interest paid (270) Income taxes paid (900) Net cash from operating activities Cash flows from investing activities Purchase of property, plant and equipment (900) Proceeds from sales of equipment 20 Interest received 200 Dividends received 200 Net cash used in investing activities m

1,560

(480)

IAS 7 Cash flow statements

m Cash flows from financing activities Proceeds from issue of share capital 250 Proceeds from long-term borrows 250 Dividend paid (1290) Net cash used in financing activities Net increased in cash and cash equivalents Cash and cash equivalents at beginning of period (Note) Cash and cash equivalents at end of period (Note) m

(790) 290 120 410

IAS 7 Cash flow statements

Cash flow statements (indirect method)
STATEMENT OF CASH FLOWS (INDIRECT METHOD) YEAR ENDED 31 DECEMBER 20*7 Cash flows from operating activities m Profit before taxation 3,570 Adjustments for: Depreciation 450 Investments income (500) Interest expense 400 3920 Increase in trade and other receivables (500) Decrease in inventories 1050 Decrease in trade payables (1740) Cash generated from operations 2730 Interest paid (270) Income taxes paid (900) Net cash from operating activities m

1560

IAS 7 Cash flow statements

m Cash flows from investing activities Purchase of property, plant and equipment (900) Proceeds from sale of equipment 20 Interest received 200 Dividends received 200 Net cash used in investing activities Cash flows from financing activities Proceeds from issue of share capital 250 Proceeds from long-term borrowings 250 Dividends paid (1290) Net cash used in financing activities Net increase in cash and cash equivalents Cash and cash equivalents at beginning of period Cash and cash equivalents at beginning of period m

(480)

(790) 290 120 410

Preparing a statement of cash flows

We should learn the format and apply the steps noted in the example .note that the following items are treated in a way that might seem confusing, but the treatment is logical if you think in terms of cash. (a) increase in inventory is treated as negative (in brackets). This is because it represents a cash outflow; cash is being spent on inventory. (b) an increase in receivable would be tread as negative for the same reasons; more receivables means less cash. (c) by contrast an increase in payable is positive because cash is being retained and not used to settle accounts payable. There is therefore more of it.

Preparation of a statement of cash flows

Example: Kane Cos income statement for the year ended
31December 20*2 and statements of financial position at 31 December 20*1 and 31December 20*2 were as follows. KANE CO INCOME STATEMENT FOR THE YEAR ENDED 31 DECEMBER 20*2 000 000 Sales 720 Raw materials consumed 70 Staff costs 94 Depreciation 118 Loss on disposal of non-current asset 18 300 Operating profit 420 Interest payable 28 Profit before tax 392 Taxation 124 Profit for the year 268

Preparation of a statement of cash flows

STATEMENTS OF FINANCIAL POSITION AS AT 31 DECEMBER 20*2 20*1 000 000 Non-current assets 1,596 1,560 Cost (318) (224) Depreciation 1,278 1,336 Current assets 24 20 Inventory 76 58 Trade receivables 48 56 Bank 148 134 Total assets 1,426 1,470 Equity and liabilities Equity 360 340 Share capital 36 24 Share premium 716 514 Retained earnings 1,112 878

Example: KANE CO

Preparation of a statement of cash flows

Example :
Non-current liabilities Long-term loans Current liabilities Trade payables Taxation 200 12 102 114 1,426 500 6 86 92 1,470

Total equity and liabilities Dividends paid were 66,000 During the year, the company paid 90,000 for a new piece of machinery Required Prepare a statement of cash flows for Kane Co for the year ended 31 December 20*2 in accordance with the requirements of IAS 7,using the indirect method.

Preparation of a statement of cash flows Step to solve the problem

STEP 1 set out the Performa statement of cash flows with the headings required by IAS7. STEP2 begin with the cash flows from operating activities as far as possible. STEP3 calculate the cash flow figures for purchase or sale of non-current assets, issue of shares and repayment of loans if these are not already given to you . STEP4 if you are not given the profit figure, open up a working for profit or loss. STEP5 you will be now be able to complete the statement by slotting in the figures given or calculated.

Preparation of a statement of cash flows

Solution: KANE CO
STATEMENT OF CASH FLOWS FOR THE YEAR ENDED 31 DECEMBER 20*2 000 000 Cash flows from operating activities Profit before tax 392 Depreciation charges 118 Loss on sale of tangible non-current assets 18 Interest expense 28 Increase in inventories (4) Increase in receivables (18) Increase in payables 6 Cash generated from operations 540 Interest paid (28) Dividends paid (66) Tax paid (86+124-102) (108) Net cash from operating activities 338 Cash flows from investing activities

Preparation of a statement of cash flows

Payments to acquire tangible non-current assets (90) Receipts from sales of tangible non-current assets (w) 12 Net cash used in investing activities Cash flows from financing activities Issues of share capital(360+36-340-24) 32 Long-term loans repaid(500-200) 300 Net cash used in financing activities Decrease in cash and cash equivalents Cash and cash equivalents at 1.1*2 Cash and cash equivalents at 21.12*2

(78)

(268) (8) 56 48

Preparation of a statement of cash flows

Working: non-current asset disposals

cost
At 1.1.*2 Purchases 000 1,560 90 1,650 318 24 342 000 At 31.12.*2 1,596 Disposals (balance) 54 1.650 At 1.1*2 224 Charge for year 118 342 30 (18) 12

At 31.12*2 Depreciation on disposals (balance)

NBV of disposals Net loss reported Proceeds of disposals

Interpretation of statements of cash flows What kind of information does the statement of cash flows ,along with its notes, provide? (a) the relationships between profit and cash can be seen clearly and analyzed accordingly (b) cash equivalents are highlighted, give a better picture of the liquidity of the company (c) financing inflows and outflows must be shown, rather than simply passed through reserves.

Interpretation of statements of cash flows The advantages of cash flow accounting

Survival in business depends on the ability to generate cash Cash flow is more comprehensive than profit which is dependent on accounting conventions and concept Creditors are more interested in an entitys ability to repay them than in its profitability Cash flow reporting provides a better means of comparing the results of different companies than traditional profit reporting Cash flow reporting satisfies the needs of all users better Cash flow forecasts are easier to prepare, as well as more useful the profit forecasts

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