Advanced Financial Accounting Chapter 6 - Cash Flow Statements

Advanced Financial Accounting
Chapter 6 Cash flow statements
Advanced Financial Accounting Chapter 6 Cash flow statements

What is a cash flow statement A cash flow statement provides details of the cash inflows and outflows of a firm for a given period. According to FRS 1 (revised), firms are required to prepare cash flow statements in a standard format. A cash flow statement throws more light on the cash generating activities of a firm. Format for cash flow statements The content and layout of a cash flow statement is presented below: $ Net cash inflow/outflow from operating activities Returns on investment and servicing of finance Preference dividends paid Interest paid Interest received Dividends received Net cash outflow from returns on investment and servicing of finance Capital expenditure and financial investments Payments to acquire tangible fixed assets Payments for financial investments Receipts from sale of financial investments Receipts from the sale of fixed assets Net cash outflow from capital expenditure Equity dividends paid Management of liquid resources Purchase of investments held as liquid resources Sale of investments held as liquid resources Net cash inflow/outflow before financing Financing Issue of ordinary shares Redemption of debentures New cash inflow from financing New increase/decrease in cash x x x x x x (x) (x) x x (x) (x) (x) (x) x x x $ x
x x
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Calculating the net cash inflow/outflow from operating activities There are two ways to calculate the net cash inflow from operating activities, the direct method and indirect method. Direct method - Net cash inflow/outflow from operating activities The Direct method reconstructs the income statement on a cash basis so that the main categories of operating cash inflows and outflows are presented. The sales revenue and expenses are converted from an accrual basis to a cash basis. Cash received from customers (Note 1) Cash paid to suppliers (Note 2) Cash paid to and on behalf of employees (Note 3) Net cash inflow from operating activities $ x x x x
Note 1 - cash received from customers: Cash received from customers can be calculated by either the opening balance of debtors, or using the debtors control account. If it is derived from debtor balances, the calculation is as follows: $ Opening balance of debtors x Add Sales for the period x Less Closing balance of debtors x Cash received from customers x Note 2 - cash paid to suppliers: Similar methods as calculating the cash received from customers, either the creditors control account or the following calculation can be used. $ Opening balance of creditors x Add Purchases of goods and services for the period x Less Closing balance of creditors x Cash paid to suppliers x Note 3 - Cash paid to and on behalf of employees: This amount includes the wages and salaries and the related costs, however, adjustment is required since all figures should be amounts paid but not necessary used.
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Indirect method - Net cash inflow/outflow from operating activities Under the indirect method, the net cash flow from operating activities is calculated by adjusting the operating profit calculated on an accrual basis to operating profit calculated on a cash basis. $ Net operating profit (Note 1) x Depreciation/amortisation (Note 2) x Increase/(decrease) in stock (Note 3) x (Increase)/decrease in debtors (Note 4) x Increase/(decrease) in creditors (Note 5) x (Profit)/loss on disposal of a fixed asset (Note 6) x Net cash inflow/outflow from operating activities x Notes 1: Net operating profit is the profit before charging interest. It can be derived from the retained profit by adjusting the dividends and interest charged. Retained profit/(loss) for the period Add dividends paid and proposed for the year Add interest charged for the year Operating profit for the year $ x x x x
Notes 2: There is no cash outflow for depreciation expenses, therefore, it has to be added back to the net profit. Notes 3: An increase in debtors means cash has not been received from all sales, therefore, it should be deducted from the operating profit. A decrease in debtors should be added to the operating profit. Notes 4: A decrease in creditors indicates that cash payments to suppliers over and above the amount of purchases, so it should be added to the net operating profit. An increase in creditors should be added to the operating profit. Notes 5: Loss and profits on disposal of fixed assets do not I involve the inflow or outflow of cash. So, these should be adjusted. Notes 6: Stock increases and decreases mean the stock that purchased is different from sold. Therefore, a decrease is added to operating profit, and an increase is deducted from the operating profit.
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Returns on investment and servicing of finance This relates to interest and dividends paid to providers of finance (lenders and preference shareholders) and interest and dividends received on investments held by the company. The following are the items under this topic, however, only the amount paid/received should be shown: Preference dividend paid Interest paid during the year Interest and dividends received Capital expenditure and financial investment The cash flow reported under this heading are cash paid for tangible and intangible fixed assets and financial investments and cash received from sale of these assets. The purchases of fixed assets on credit do not involve an outflow of cash, and so not reported under the heading. Equity dividends paid This is the amount paid by the company to the shareholders. Management of liquid resources This is the purchase or sale of liquid assets such as treasury bills. A purchase of treasury bills is an outflow and a sale of treasury bills is an inflows. Financing activities This heading deals with cash received from the issue of shares, loans acquired during the year, the repayment of loans and redemption of debentures. Usefulness of cash flow statements A cash flow statement is useful for the following reasons. It provides users with some information on the ability of a firm to generate cash from its trading operations. It provides users with information on the order courses and uses of cash. Limitations of cash flow statements It is a historical statement. It does not tell you what is going to happen in future. A company reporting an increase in cash balance during a period may not necessarily be a healthy company. The cash balances may be in currencies that may not be convertible.
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Exercises Exercise 6.1
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Exercise 6.2
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Exercise 6.3
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Exercise 6.4
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Exercise 6.5
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Exercise 6.6
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Exercise 6.7
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Exercise 6.8
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Exercise 6.9
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Exercise 6.10
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Advanced Financial Accounting Chapter 6 - Cash Flow Statements

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Advanced Financial Accounting

Chapter 6 Cash flow statements