Cash Flow Statement

Cash flow statements
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

© 2005 Peter Walton and Walter Aerts
Contents
 Introduction – The cash flow statement
 Usefulness of cash flow information
 Cash flow cycles
 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
 Disposal of fixed assets
 Presentational differences
Cash flow statement
 A cash flow statement presents information
about the cash flows associated with the
company’s 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)
 IAS 7 Cash Flow Statements

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

Cash flow versus profit
 Cash flow and profit are different economic
phenomena
 But linked through the mechanisms of accrual
accounting!
 Cash flows are factual details of incoming and
outgoing flows of cash, while the balance sheet
and income statement emanate from
professional judgement and are not a direct
projection of objective economic data

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
 Solvency
- 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
 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. From which sources did the company raise cash last
year? How was this cash used?
2. Were the normal operating activities capable of
satisfying its need for cash during the year?
3. If not, is the shortage of cash compensated by new
borrowings, issuing new share capital or by selling
fixed assets?
4. Is a surplus of cash used for repayment of debt, for
investments or for distribution of dividends?
5. Why has the balance of cash available decreased,
knowing that the company’s operations have been
profitable?

Cash conversion cycles
 Cash flows through the company
continuously in a series of short-term and
long-term conversion cycles
 The ST - cash conversion cycle (operating
cycle) relates to the main business
operations
= OPERATING ACTIVITIES

Cash conversion cycles (cont.)
 The LT- cash conversion cycles relate to the
acquisition, renewal and disposal of
intangible and tangible infrastructure and the
long-term sourcing of funds
 Productive capacity acquired for cash and
subsequently consumed during several ST-
operating cycles
 Acquisition and disposal of infrastructure =
INVESTING ACTIVITIES
 External sourcing of funds = FINANCING
ACTIVITIES
Fig. 10.1 Long-term and short-term cash
flow cycles
Main operations
Inventory
Procurement Work in Progress Sales
Current payables Inventory Current receivables
Cash and cash

Payments Receipts
equivalents
Investing/ Productive
External financing
infrastructure
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

Cash flows from operating
activities
 Operating activities are primarily the revenue-generating
activities of a company
 “Operating cash flow” is conceptually most near to “net
profit”
 Main differences:
1. Non-cash expenses and non-cash revenues (f.i.
depreciation expense)
2. Non-operating items (f.i. gain on disposal of tangible
fixed assets)
3. Timing differences between net profit and underlying
cash flow (f.i. changes in the level of inventories,
receivables, creditors, etc.)

Operating cash flows: Examples
 Receipts from sale of goods and rendering of
services (cashing in of receivables included)
 Receipts from taxes on sales and VAT
 Receipts from royalties, fees, commissions,…
 Payments to suppliers (payment of creditors
included)
 Payments to employees
 Payments of taxes, VAT, fines, …

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

Direct method - Example
Cash receipts from customers 30,150
Cash paid to suppliers and employees (27,600)
Cash generated from main operations 2,550
Income taxes paid (1170)
Net cash flow from operating activities 1,380

Indirect method - Example
Net profit before tax 3,350
Adjustments for:
Depreciation 490
Investment income (100)
3,740
Working capital changes:

Increase in trade and other receivables (500)
Decrease in inventories 1,050
Decrease in trade payables (1,740)
Cash generated from main operations 2,550
Net cash flow from operating activities 1,380

Cash flow proxy
Net profit or loss after tax xxxxxxxxxxxxxx

Add back:
Depreciation charge for the year xxxxxxxxxxxxxxx
Provisions created in year xxxxxxxxxxxxxxx
Deduct:
Provisions released in year (xxxxxxxxxxxxxx)
‘Cash flow proxy’ xxxxxxxxxxxxxx

Cash flow proxy (bis)
Net profit or loss after tax xxxxxxxxxxxx
Add back:
Depreciation for the year xxxxxx
Provisions created in year xxx
Deduct:
Provisions released (xxxx)
Gain on asset disposal (xxxxx)
Net change in non-cash working capital (xxxxx)
‘Cash flow proxy’ xxxxxxxxxxxx

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

Constructing a cash flow statement
1. Determine the net change in cash
 Compare beginning and ending balance
2. Identify all transactions of the period leading to a change
in cash
 Direct: analyze movements in the accounts of cash
(equivalents) transaction by transaction
 Indirect: explain net change of cash by analyzing all
other accounts, knowing that each transaction with
an impact on cash also affects a non-cash account
3. Use the information (of step 1 and 2) to construct a cash
flow statement according to the formal rules

Applying step 2
 Information for operating cash flow is primarily
derived from balances in the IS, while information for
the two other principal categories comes from the
Balance Sheet (and details in the Notes)
 Movements in the accounts indicate a change in
financial position and further examination is needed
to determine if they had a cash impact
 Check if balances have been impacted by “accrual-
based adjustments” or other “non-cash activities”

Fig. 10.2 Classifying balance sheet
movements as inflows or outflows of cash
Assets Equity/liabilities
Increase Outflow Inflow
Decrease Inflow Outflow

Illustration - Constructing a CFS (1)
X2 X1 ∆ Outflow Inflow
Assets
Fixed assets (at cost) 980 740 240 240
Acc. depreciation -350 -265 85 85
Inventories 180 171 9 9
Trade receivables 115 98 17 17
Cash 92 110 18 18
1017 854
Financing
Equity
__
Share capital 600 600
__
Reserves 90 90
__
X2 profit 50 50 50
Liabilities
Trade payables 62 59 3 3
LT debt 215 105 110 110
1017 854 266 266

Illustration - Constructing a CFS (2)
Operating activities
Net profit after tax 50
Add back depreciation 85
135
Changes in non-cash working capital –23
Net cash flow from operations (A) 112
Investing activities
Purchase of fixed assets (B) –240
Financing activities
New LT debt (C) 110
Net change in cash (A+B+C) –18
Cash balances
At beginning of year 110
At balance sheet date 92
Difference –18

Disposal of fixed assets - Example
Disposal of equipment:
Acquisition cost 275
- Accum. depreciation - 200
Net carrying value = 115  Sale at 135
 Result (gain) on disposal = 135 - 115= 20
 Incoming cash flow = 135, composed of a decrease in

net carrying value of equipment in the BS (115) and
gain on disposal in the IS (20)

Disposal of fixed assets
Net profit after tax xxxxxxxxxxxx
Add back:
Depreciation xxxxxx
Provisions created xxxxxx
Loss on disposal of assets xxxxxx
Deduct:
Provisions released xxxxxx
Gain on asset disposal xxxxxx
+/- Change in non-cash working capital xxxxxx
Net cash flow from operating activities xxxxxxxxxxxx
Incoming cash flows
Cash + Other assets = Liabilities + Owners’equity
(1) + -
(2) + +
(3) + +

Outgoing cash flows
Cash + Other assets = Liabilities + Owners’equity
(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)

IAS 7 - Direct Method (Extract)
20X2
Cash generated from operations 2,550
Interest paid (270)
Net cash from operating activities 1,380
Cash flows from investing activities

Acquisition of subsidiary X, net of cash acquired (550)
Purchase of property, plant and equipment (350)
Proceeds from sale of equipment 20
Interest received 200
Dividends received 200
Net cash used in investing activities (480)
Cash flows from financing activities

Proceeds from issue of share capital 250
Proceeds from long-term borrowings 250
Payment of finance lease liabilities (90)
Dividends paid* (1,200)
Net cash used in financing activities (790)
Net increase in cash and cash equivalents 110

Cash and cash equivalents at beginning of period 120
Cash and cash equivalents at end of period 230
Source: IAS 7 – Cash Flow Statements, Appendices
* This could also be shown as an operating cash flow.
IAS 7 - Direct Method (Extract)
20X2
Interest paid (270)

Acquisition of subsidiary X, net of cash acquired (550)

IAS 7 - Direct Method (Extract- cont.)



IAS 7 - Indirect Method (Extract)
20X2
Profit before taxation 3,350
Adjustments for:
Depreciation 450
Foreign exchange loss 40
Interest expense 400
3,740
Interest paid (270)

Acquisition of subsidiary X net of cash acquired (550)




IAS 7 - Indirect Method (Extract)
20X2
Profit before taxation 3,350
Adjustments for:
Depreciation 450
Foreign exchange loss 40
Interest expense 400
3,740
Interest paid (270)

IAS 7 - Indirect Method (Extract – cont.)
20X2
Acquisition of subsidiary X net of cash acquired (550)




Cash Flow Statement

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Cash flow statements

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

 Ability to generate adequate cash flows

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

BS at start Cash flow BS at end

A cash flow statement reflects both “profit related” and

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

Procurement Work in Progress Sales

Current payables Inventory Current receivables

Cash and cash

Cash flows from operating activities

+ Cash flows from financing activities

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

 Direct method: engenders the presentation of the

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

Cash receipts from customers 30,150

Cash paid to suppliers and employees (27,600)

Cash generated from main operations 2,550

Income taxes paid (1170)

Net cash flow from operating activities 1,380

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

Working capital changes:

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

Net profit or loss after tax xxxxxxxxxxxxxx

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

Increase Outflow Inflow

Decrease Inflow Outflow

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

 Result (gain) on disposal = 135 - 115= 20

 Incoming cash flow = 135, composed of a decrease in

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

Net cash from operating activities 1,380

Cash flows from investing activities

Net cash used in investing activities (480)

Cash flows from financing activities

Net cash used in financing activities (790)

Net increase in cash and cash equivalents 110

Net cash from operating activities 1,380

Cash flows from investing activities

Net cash used in investing activities (480)

Source: IAS 7 – Cash Flow Statements, Appendices

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

Cash flows from financing activities

Net cash used in financing activities (790)

Net increase in cash and cash equivalents 110

* This could also be shown as an operating cash flow.

Source: IAS 7 – Cash Flow Statements, Appendices