CHAPTER 2 Cash flow statements

Contents
Introduction The cash flow statement Usefulness of cash flow information

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

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)

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

Liquidity/solvency and cash flows

Liquidity
-

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

Solvency
-

Liquidity and solvency ratios are determined on

static financial position data, while cash flows reflect changes in financial position

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

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?

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

Operating cash flows: Examples

Operating activities are primarily the revenuegenerating activities of a company Operating cash flow is conceptually most near to net profit Cash received as interest income * Cash received as dividend income Receipts from sale of goods and rendering of services (cashing in of receivables included) Receipts from royalties, fees, commissions, Payments to suppliers (payment of creditors included) Payments to employees Payments of taxes, VAT, fines Cash paid for interest

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

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

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

Fig. 10.2 Classifying balance sheet movements as inflows or outflows of cash

Assets Equity/liabilities

Increase Decrease

Outflow Inflow

Inflow Outflow

Illustration - Constructing a CFS (1)

X2 Assets Fixed assets (at cost) Acc. depreciation Inventories Trade receivables Cash X1

980 -350 180 115 92 1017

740 -265 171 98 110 854

Financing Equity Share capital Reserves X2 profit Liabilities Trade payables LT debt

600 90 50 62 215 1017

600 90
__

59 105 854 PAT-50 Depreciation85

Illustration - Constructing a CFS (1)

X2 Assets Fixed assets (at cost) Acc. depreciation Inventories Trade receivables Cash X1 Outflow Inflow

980 -350 180 115 92 1017

740 -265 171 98 110 854

240 85 9 17 18

240 85 9 17 18

Financing Equity Share capital Reserves X2 profit Liabilities Trade payables LT debt

600 90 50 62 215 1017

600 90
__

__ __

50 3 110 266

50 3 110 266

59 105 854

Illustration - Constructing a CFS (2)

Operating activities Net profit after tax Add back depreciation Changes in non-cash working capital Net cash flow from operations (A) Investing activities Purchase of fixed assets (B) Financing activities New LT debt (C) Net change in cash (A+B+C) Cash balances At beginning of year At balance sheet date Difference 50 85 135 23 112 240 110 18 110 92 18

Outgoing cash flows

Cash + Other assets = Liabilities + Ownersequity (1) (2) (3)

+ -

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)

 Any Question..