Accounting for Managers 550

Online Class Module 5

Introduction to Limited Companies and Measuring and Reporting Cash
Flows (Ch 4 & 6)

Learning Objectives

1. Explain why cash is important to the

reporting entity
2. Define cash and cash equivalents
3. Discuss the three components of the
statement of cash flows (operating activities,
investing activities, financing activities)
4. Identify non-cash transactions
5. Recognise the alternative approaches for
preparing a statement of cash flows
6. Prepare and analyse a statement of cash
flows

The importance of cash and cash flow

Cash is important because organisations and

people will not normally accept any other form of
settlement of claim against the business

Businesses fail as a result of their inability to find

sufficient cash to settle their responsibilities

The accrual nature of the statements of financial

position, statement of comprehensive income are
thought to obscure the question of how and
where a company is generating the cash it needs
to continue operating.
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Differences between the four external

financial reports

Statement of financial position

Static report made at a given point in time and
based on balances in assets, liabilities and
owners equity
Normally based on accrual transactions

Statement of comprehensive income (profit &

loss)
Measures the financial performance over a
period of time
Normally one year, related to revenues earned
less expenses incurred
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Differences between the four external

financial reports

Statement of changes in equity

Identifies all changes in equity for the period
related both to comprehensive income, owners
contributions and withdrawals, and all other
changes in equity

Statement of cash flows (SCF)

Identifies all cash receipts and cash payments
for the period
All account types are included and is based on
cash not accrual transactions
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Statement of cash flows

Is an analysis of the business cash

movements over the period concerned

All payments/receipts of a particular type are

added together to give just one figure, which
appears in the statement

The net total of the statement is the net

increase or decrease in cash of the business
over the period

Reference: AASB 107 Statement of Cash Flows

Structure and Format of statement of cash

flows
Statement of Cash Flows
Cash flows from operating activities
Cash flows from investing activities
Cash flows from financing activities
Net increase (decrease) in cash & cash
equivalents xxx
Opening cash and cash equivalents
Closing cash and cash equivalents
xxx

xxx
xxx
xxx

xxx

Cash and cash equivalents

Cash represents cash on hand and demand deposits

Cash equivalents represent short-term, highly liquid

investments that can be readily converted to a fixed
amount of cash and are subject to an insignificant risk
of changes in value
Examples include:
Short-term (e.g. less than 3 months) deposits
Bank bills

Question: Can we classify short-term investment in

No. (Risk of changes in
stock market as cash equivalents?
value)

Three Components

1. Operating activities:
the principal revenue-producing activities
other activities that are not investing or financing
activities.

Examples of cash flows from operating activities

Cash receipts from the sale of goods and the
rendering of services
Cash receipts from fees, commissions and other
revenue
Cash payments to suppliers and employees
Cash payments for income taxes

Three Components

2. Investing activities
the acquisition and disposal of long-term assets and
other investments

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Examples of cash flows from investing activities

Cash payments to buy property, plant and
equipment, and other long-term assets
Cash receipts from the sale of property, plant and
equipment, and other long-term assets
Cash payments to buy shares or bonds of other
companies (for investment purposes)
Cash receipts from sales of shares or bonds of
other companies

Three Components

3. Financing activities
activities that result in changes in the size and
composition of the contributed equity and
borrowings

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Examples of cash flows from financing activities

Cash proceeds from issuing shares
Cash payments to acquire or redeem the
business's shares
Cash proceeds from issuing bonds
Cash proceeds from bank borrowings
Cash repayments of amounts borrowed

Interest and Dividend

Operating
Activities

Investing
Activities

Interest
received

Yes

Yes

Interest
payment

Yes

Dividend
received

Yes

Dividend
cashpaid
flows

Financing
Activities

Yes
Yes

Yes
interest and dividends
cash flows fromYes
received and paid shall each be:
(i) disclosed separately; and
(ii) classified in a consistent manner from
period to period as either operating,
investing, or financing activities.

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Non-cash transactions

= Transactions that do not directly involve cash

Most relate to the operating activity section and are

linked to the difference between cash-based and
accrual-based transactions
Examples depreciation, revaluations, doubtful
debts, etc.

Some relate to the investing and financing activity

section
Examples direct exchanges such as shares for
assets, non-current assets for reduction in debt, etc.
Not included in SCF but should be disclosed
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Recap

1. Explain why cash is important to the

reporting entity
2. Define cash and cash equivalents
3. Discuss the three components of the
statement of cash flows (operating activities,
investing activities, financing activities)
4. Identify non-cash transactions

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Before moving on to the

next VDO clip, please
attempt Quiz 5.1

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Welcome back!
Now we will continue with
Clip 5.2: Cash flow
from operating
activities.

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Cash flows from operating activities Two

approaches

1. Direct method
report major classes of gross cash receipts and
gross cash payments

2. Indirect method
reconcile from profit or loss to net cash provided
by operating activities
more often used

The two methods have no effect on investing or

financing activities.
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Derivation of cash flows

Note that we use the accrual basis to account

for transactions during the period.

We need to make some adjustments to derive

the amounts of cash receipts or cash
payments.

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Cash received from customers

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Salesxxx
Add Opn. Accounts Receivable (AR) xxx
Cash collectable from customers xxx
Less Clo. AR
(xxx)
Cash receipts from customers xxx
Sales + Opn. AR Clo. AR = Cash receipts
from sales
Sales AR = Cash receipts from sales
AR = Change in AR = Clo. AR Opn. AR
AR = Accounts Receivable

Cash received from customers

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Cash receipts from sales = Sales AR

Cash receipts from sales = Sales if AR = 0

Cash receipts from sales = Sales Increase in AR

Increase in AR => cash inflows from sales is
less than the sales itself

Cash receipts from sales = Sales + Decrease in

AR
Decrease in AR => cash inflows from sales is
greater than the sales itself

Cash paid to suppliers

Purchase of inventory xxx

Add Opn. Accounts Payable (AP) xxx
Cash payable to suppliers xxx
Less Clo. AP
(xxx)
Cash paid to suppliers xxx

Purchase (Clo. AP Opn. AP) = Cash paid to suppliers

Purchase AP = Cash paid to suppliers

COGS = Opn. Inventory + Purchase Clo. Inventory
Purchase = COGS + Inventory

Cash paid to suppliers = COGS + Inven - AP

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Cash paid to suppliers

Cash paid to suppliers = COGS + Inven -

AP

An increase in inventory will increase the cash

payment to suppliers => decrease cash flows
from operating activities

An increase in accounts payable will decrease the

cash payment to suppliers => increase cash flows
from operating activities

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Cash paid to employees

Salary Expense
xxx
Add Opn. SP (Salary Payable)xxx
Cash payable to employees
xxx
Less Clo. SP
(xxx)
Cash paid to employees
xxx
Cash paid to employees = Salary Exp SP
If SP > 0 (an increase in SP), cash payment is
less than the salary expense.
If SP < 0 (a decrease in SP), cash payment is
greater than the salary expense.
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Cash payment related to prepaid expense

Clo. Prepaid Insurance (PI) xxx

Add Insurance Expense xxx
Amount payable related to prepaid insurance
Less Opn. PI
(xxx)
Cash payment xxx

xxx

Cash Paid for Insurance = Insurance Expense + PI

If PI > 0 (an increase in PI), cash payment is
greater than the insurance expense.
If PI < 0 (a decrease in PI), cash payment is less
than the insurance expense.

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Summary
Net Income

+/- Adjustment

= Cash flows from

operating activities

Sales revenue

- Accounts
Receivable

Cash receipts from

sales

Costs of Goods Sold

+ Inventory
- Accounts Payable

Cash paid to suppliers

Salary Expense

- Salary Payable

Cash paid to
employees

Insurance Expense

+ Prepaid Insurance Cash paid for

insurance

Depreciation Expense Add back

Non-cash item
Profit +/- adjustments for changes in
Ex: Gains or
working capital
losses on sales
+/- adjustments for noncash items
of non-current
+/- adjustments for non-operating items
assets.
= Cash flows from operating activities
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When to add/deduct the

increase/decrease?

See the previous slides for details.

Intuitive way to remember:

Increase in current assets means you need to pay
cash to buy them

=> we have less cash

=> deduct increase/ add decrease

Decrease in current liabilities means you pay

more cash to retire the debts

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=> we have less cash

=> deduct decrease/ add increase

Recap

5. Recognise the alternative approaches to

preparing a statement of cash flows

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Just one more clip to go.

Before moving on to the
next VDO clip, please
attempt Quiz 5.2.

33

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Welcome back!
Now we will continue with
Clip 5.3: Preparation
and use of statement of
cash flows.

35

Three Components

1. Operating activities
the principal revenue-producing activities
other activities that are not investing or financing
activities.

2. Investing activities
the acquisition and disposal of long-term assets and
other investments

3. Financing activities
activities that result in changes in the size and
composition of the contributed equity and borrowings
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Cash flows from investing activities

Opn. Asset
Add Purchase
Less Disposal
Clo. Asset

xxx
xxx
(xxx)
xxx

Asset purchase = Clo. Asset + Disposal

Opn. Asset

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Cash flows from investing activities

Opening balance of equipment = $300,000

Closing balance of equipment = $550,000
If machinery that originally cost $100,000 was
sold during the year, what was the value of new
equipment purchased?
Asset purchase = Clo. Asset + Disposal Opn.
Asset
= 550,000 + 100,000 300,000 =
$350,000

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Cash flows from financing activities Long-Term Loan

Opening balance = $100,000.

New debt amounting to $50,000 during the
year.
Closing balance = $120,000.

How much is the repayment?

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$100,000 + 50,000 120,000 = $30,000

Cash flows from financing activities - Issues

and Buy-backs of Shares

Opening balance of ordinary share capital =

$200,000.
New shares issued during the year =
$100,000.
Closing Balance = $280,000.
How much is the cash payment for buy-backs
(share repurchase)?

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$200,000 +$100,000 $280,000 = $20,000

Cash flows from financing activities

Dividend Payment

Opening balance of equity = $45,000

Closing balance of equity = $35,000
Profit = $10,000
Calculate the amount of dividends paid.

In simple situation:
Opn. Equity + Owners Investment + Profit
Dividend = Clo.
Equity
$45,000 +$0 + 10,000 Dividend = $35,000
Dividend = $20,000

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Example of Statement of Cash Flows

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What does the statement of cash flows tell

us?

The statement of cash flows tells us how the business has

generated cash during the period and where that cash has
gone

Tracks the sources and uses of cash over time, which is

indicative of trends and useful for predicting future
opportunities and patterns of cash flow

Equity investors are interested in cash flows because

Value of a firm = PV(Expected future cash flow)

Future cash flows can be forecasted from history.

Creditors monitor cash flows because they wants to make sure

they will receive interest and the repayment of the principal.
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SCF helps you evaluate

Liquidity: ability to meet financial obligations

Financial Flexibility: the ability to generate

sufficient cash to meet unanticipated needs
and opportunities.

Risk: Stability in cash flows.

Subjectivity involved in the determination of

net income: earnings management generally
does not affect cash.

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Analysis of SCF

Cash flows from operating activities (CFO)

High CFO is a good sign

CFO should be the main source of cash since this
is what the business is founded for
Risk averse investors may prefer a business with
steady CFO
CFO should tell the same story as the net income

Cash flows from investing activities (CFI)

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High positive CFI can be a bad sign, especially

when the firm has negative CFO and has lots of
debt.

Analysis of SCF

Cash flows from financing activities (CFF)

High CFF can be good or bad, depending on the

situation and the capital structure of the firm

Note that positive CFF with negative CFO may not

be a good sign, since the business cannot get
cash from investors or creditors to pay for day to
day operation forever.

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Manipulation of CF from Operation

Classification

Capitalize operating costs

Classify interest and dividend revenues as CFO rather than CFI

Classify dividend paid as CFF rather than CFO.

Ex: Classify as a long-term asset the R&D expenditure which

should be classified as expense => The R&D expenditure
becomes investing cash outflow rather than operating cash
outflow. (This will also boost the net income.)

Real transactions

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Delay the payment of short-term debt or accelerate the

collection of AR (Accounts Receivable) (may not be good in a
long run).

Recap

6. Prepare and analyse a statement of cash

flows

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Before you go, please

work on DQ 4.5, 4.6, 6.3,
6.6, 6.7 and Application
Exercise 6.1, 6.3, 6.6 and
6.8

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