lOMoARcPSD|1910082

lOMoARcPSD|1910082

WEEK FIVE – STATEMENT OF CASH FLOWS

Statement of Cash Flows: Reports on an entity’s cash inflows and outflows for a specific period;
prepared on cash basis accounting. Concerned with the timing of cash receipts and payments, not
the timing of the underlying transaction.
Cash basis shows how much cash is actually at hand.

Net cash flows = inflows – outflows

Gives additional information to assess the entity’s ability to:

1. Generate cash flows
2. Meet financial commitments when they are due
3. Fund changes in scope/natures of activities
4. Obtain external finance
Three sections reflecting the major cash flow operations:
1. Operating activities – generate cash, meet short term obligations (current assets + liabilities)
2. Investing activities – how assets are purchased and financed (non-current assets)
3. Financing activities – where finance comes from; borrowing (non-current liabilities)
The AASB requires direct method be used in preparing statement of cash flows and reconciliation of
cash flows from operating activities to profit/loss (discloses major classes of gross cash receipts +
gross cash payments)
Profit is to be reconciled to net cash provided/used by operations – must be disclosed in notes to the
account – allows users to see changes in operating accounts brought about by use of accrual vs. cash
basis accounting

Cash Flows Statements contains:

Net cash flows from operating, investing and financing activities, total net cash flows, beginning and
ending cash balance and comparative figures (e.g. two to three years of data)
Information is usually recorded using accrual accounting; therefore, for statement of cash flows
(cash basis), conversion is required:
Direct method – discloses major classes of gross cash receipts + payments
Indirect method – adjusts profit/loss for effects of transactions of non-cash nature and
deferrals/accruals of operating revenue and expenses
IFRS + AAS give the choice of which to use but Australian entities are encouraged to use the direct
method.
To reconcile profit and loss and operating activities cash flows:
Increase in current assets means a reduction in cash
Decrease in current assets mean increase in cash
Increase in current liabilities means increase in cash
Decrease in current liabilities means a decrease in cash

Classifying transactions in activities:

1. Determine cash flows from operation:
a. Receipts from customers
b. Payments to suppliers and employees (inventory suppliers, phone, power, etc.)
c. Other cash payments and receipts for income (interest paid, tax, dividends, interest
received)
2. Determine cash flows from investing:
a. Proceeds from repayment of related party loans
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b. Payments for plant and equipment

c. Proceeds from sale of plant and equipment
d. Payments from businesses
3. Determine cash flows from financing:
a. Proceeds from issue of shares
b. Proceeds from borrowings
c. Repayment of borrowings
d. Dividends paid
4. Calculate net cash flows and ending cash balance for the year (direct method)
5. Reconcile cash from operating activities with operating profit (indirect method)
6. Complete notes to statement of cash flows

Statement of cash flows is useful for the investing and lending community
General analysis of the statement of cash flows can provide cash low warning signals:
Cash received vs. cash paid
Operating outflow
Cash from operations vs. profit after tax
Proceeds from share capital, investments and borrowings
Profit and loss trends

WEEK SEVEN AND EIGHT – ANALYSIS AND INTERPRETATION OF FINANCIAL STATEMENTS

Financial Reports:
Income statement – a statement that reports on income and expenses for a period and the resulting
profit or loss (uses accrual accounting)
Balance sheet – a statement that reports on assets, liabilities and equity of an entity at a particular
point in time. Documents assets, liabilities and equity. States the financial position and shows
financial solvency and stability of an entity.
Statement of Cash Flows - Reports on an entity’s cash inflows and outflows for a specific period;
prepared on cash basis accounting. Concerned with the timing of cash receipts and payments, not
the timing of the underlying transaction (uses cash basis accounting)
Independent auditors report – An audit conducted in accordance with AAS, expresses an opinion
based on the audit assessment that the financial statements are in accordance with The Corps. Act
(true and fair view of entity’s performance and position and comply with AAS and Corps. Act
regulations) and other mandatory reporting requirements.
Directors Declaration – declaration from the director of an entity that the financial reports are in
accordance with Corps. Act and comply with AASB and Corps. Act regulations and that there are
reasonable grounds to believe the entity can meet maturing debts as they fall due. Notes to
Statements – provide detail required by AASBs

Financial analysis – expressing reported numbers in relative terms rather than relying on absolute
numbers (this can highlight strengths and weaknesses of an entity, gives users a better position to
form opinions, enables comparison on an even footing).
Nature of the firm can effect – revenue, expenses, current assets, non-current assets, liabilities
Analytical methods – horizontal, vertical, trend, ratio analysis and benchmarks.

Horizontal Analysis – analysing a series of financial statement data over a period of time
Compares reported numbers in the current period with equivalent numbers for preceding periods.
Highlights the magnitude and significance of changes in values between reporting periods.
Dollar change = reported figure in current reporting period – reported figure in previous reporting
period
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Percentage change = Change in $ / reported figure in previous period x 100

Ideally revenue should increase at a greater % than % increase in expenses, including COGS so profit
is increasing
Can be applied to all financial statements.

Trend analysis – method of examining changes, movements and patterns in data over a number of
time periods. Use at least three years of information to establish a trend. Uses a base year, given a
value of 100 and future values are expressed as a % of the base year figure

Vertical analysis – analysing financial statement data by expressing each item in a financial
statement as a percentage of a base amount, such as total assets or sales revenue.
Revenue and expense items are expressed as a % of sales or revenue Assets, liabilities and
owner’s equity are expressed as a % of total assets

Ratio analysis – an examination of the relationship between two quantitative amounts with the
objective of expressing the relationship in ratio or percentage form.

PROFITABILITY RATIOS

Return on Equity: measures the rate of returned earned on equity provided by owner’s
Return on Assets: Measures the rate of return (before interest and tax) earned as a result of
investment of assets
Gross Profit Margin: Measures gross profitability per dollar sales revenue
Profit Margin: Measures net profitability (before interest and tax) per dollar sales revenue
Cash Flow to Sales Revenue Ratio: Measures the cash flow generated from operating activities for
each dollar of sales revenue

ASSET EFFICIENCY RATIOS

Asset Turnover Ratio: Measures the sales revenue dollar generated per dollar investment in assets
Inventory Turnover (Days): Measures the average length of time it takes to sell inventory
Debtors Turnover (Days): Measures the average length of time it takes to collect the monies due
from trade debtors

LIQUIDITY RATIOS

Current Ratio: Measures the dollars of current assets per dollar of current liabilities
Quick Asset Ratio: Measures the dollar of current assets (excluding inventory) per dollar of current
liabilities
Cash Flow Ratio: Measures the ability of the entity to meet its current obligations from operating
activities’ cash flows

CAPITAL STRUCTURE RATIOS

Debt to Equity: Measures the dollar of liabilities per dollar of equity

Debt Ratio: Measures the dollar of liabilities per dollar of assets
Equity Ratio: Measures the dollar of equities per dollar of assets
Interest Coverage Ratio: Measures the ability of the entity to meet its net finance costs out of
current year’s profits before interest and tax
Debt Coverage Ratio: Measures the payback period for the coverage of long-term debt
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MARKET PERFORMANCE RATIOS

Net Tangible Asset Backing: Measures the value of tangible assets per ordinary share on issue
Earning per share: Measures the profit generated for ordinary shareholders per ordinary share on
issue
Dividend per share: Measures the dividend declared or paid to ordinary shareholders per ordinary
share on issue
Dividend Payout Ratio: Measures the percentage of current period’s profits declared or paid as
dividends
Operating Cash Flow per Share: Measures the operating cash flows generated per ordinary share on
issue
Price Earnings Ratio: Measures the number of years of earnings that the market is capitalising into
share price

Ratio interrelationships – ratios should be linked to describe the financial health of the entity.
Limitations – nature of the financial statements and data disclosed in them, ratios are only one
analysis tool – comprehensive analysis considers information from beyond financial reported
numbers and non-financial considerations such as environmental performance are also taken into
consideration by users.