chapter 16 statementsof cash flowblackhallpublishing.com/webresources/html/slides/slidesch16.pdf ·...

Chapter 16

Statements of Cash Flow

Copyright D O'Donoghue 1

Statements of Cash FlowContents:

1. Introduction – ‘Cash is King’ - The importance of cash.

2. IAS 7 – Overview of the statement of cash flows

3. IAS 7 Categories of Cash flow1. Cash generated from operating activities2. Cash flow from investing activities3. Cash flow from financing

4. A Comprehensive Example

5. Interpreting statements of cash flow


1. Cash is king

q Cash is the life blood of a businessq A business running out of cash will die the

same as heart-failure stops the flow of blood in a person.

q Many profitable businesses fail due to poor cash management

“profits can be manufactured by creative accounting but creating cash is impossible”.

Terry Smith, Accounting for Growth


Typical cash flows

1. Customer payments Þ Þ 1. Suppliers payments

2. Capital grants Þ Þ 2. Staff payments

3. Owners buy shares Þ Þ 3. Dividends

4. Sale of fixed assets Þ Þ 4. Purchase of fixed assets

5. Bank Loans6. Tax refunds

Þ

Þ

Þ

Þ

5. Repayment of loans6. Tax

7. Interest received Þ Þ 7. Interest paid

8. Sale of Business Þ Þ 8. Business acquisitions

9. Dividends received Þ Þ 9. Overheads/expenses

CASH FLOWS

IN OUT

X X

X X

X X

X X

X XX XX X

X X

X X


2. International Accounting Standard 7 (IAS 7)

q IAS 7 is the accounting standard that applies to the preparation and presentation of statements of cash flow.

q This standard supersedes all previous accounting standards and applied to medium and large companies as defined by the companies acts 1963- today.

q The objective of the statement of cash flows is to provide the users of financial statements with information on how a company has generated and spent cash during the reporting period.


International Accounting Standard 7 (IAS 7)

IAS 7 requires:

the presentation of information about the historical changes in cash and cash equivalents of an entity

by means of a statement of cash flows, which classifies cash flows during the period according to operating, investing, and financing activities’

Hence all cash flows are to be categorised under 3 headings

qOperating cash flowsqInvesting cash flowsqFinancing cash flow


International Accounting Standard 7 (IAS 7)

IAS 7 defined cash and cash equivalents as

‘cash on hand and demand deposits, together with short-term, highly liquid investments that are readily convertible to a known amount of cash, and that are subject to an insignificant risk of changes in value’.

IAS 7


Cash flow statement – 2 stepsTotal cash movement €(000)

Total movement in cash in the reporting period Cash at 1 Jan 300Cash at 31 Dec 470Cash Movement +170Cash increased by €170,000 over the year.

Step One Calculate overall cash flow

Step Two Prepare Cash Flow StatementCategories of cash € (‘000) €(000)

1. Net cash generated from Operating activitiesCash generated from operations 500Loan interest paid (10)Corporation Tax paid (20) 470

2. Cash flow from investing activitiesPayments to acquire non-current assets (300)sales of non current assets 100 (200)

3. Cash flow from Financing activitiesRepayment of loans (150)Increase in equity financing 100 Equity Dividends paid (50) (100)

Movement in cash + 170Copyright D O'Donoghue 8

3. Categories of Cash flow

IAS 7 requires all cash flows, positive or negative must be categorised under the following activity headings

q Cash generated from operating activities

q Cash flow from investing activities

q Cash flow from financing activities


Category 1: Cash generated from operating activities

Cash flows from operating activities relate to the casheffects of transactions relating to the operating or tradingactivities of the business (the normal trading activities ofthe business, not capital activities).

Operating cash flows will be concerned with:q cash collected from customersq cash paid to creditors for purchasesq cash paid to staff /PAYE/PRSIq cash paid for services (overheads)

In calculating the net cash flow from operating activitiestwo formats are permitted by FRS 1 called

q The Direct Methodq The Indirect Meth


Calculation of loan interest and corporation taxation paid figures

In calculating the net cash flow from operating activities one must deduct from cash generated from operations any loan interest paid and corporation tax paid. These figures are calculated in exactly the same way.

1. Assess if there is any tax owed at the beginning of the year by checking current liabilities in the opening balance sheet. Let say this figure is €1,800

2. Add to this figure the corporation tax charged on profits in the income statement. Let say this figure is €20,000. Thus if the company paid zero tax during the year they would owe €21,800 in tax at the year -end.

3. Assess the tax owed figure in the closing balance sheet under current liabilities. Lets say this figure is €5,000.

4. That implies tax paid amounted to €21,800 – €5,000 = €16,800 Copyright D O'Donoghue 14

Category 2 Cash flow from Investing Activities

This category of activity includes cash flows from the following categories1. Sales of non-current assets (tangible and intangible) 2. Purchase of non-current assets (tangible and intangible)3. Acquisitions/disposals of subsidiaries, associated or joint

venture companies4. Investment income received

Most exam question deal with categories 1 and 2.

Most exam questions will require you to calculate the purchase or sales of non-current assets (see example 16.4)


Category 3Cash flows from financing

activitiesThis category of activity covers the cash flows which arise from the following1. Issue of shares, and increases in loans debentures/bonds2. Repayment of the capital element of loans bonds

debentures3. Dividend payments.4. Any expenses relating to the above (legal fees, stamp duty

etc)

The calculation of these cash flows usually involves comparing figures for share capital, debentures and loan at the beginning and end of the year.


Interpreting cash flow statementsq Is the overall cash movement positive or negative, and is the cashmovement significant?

q Is the company heavily in overdraft?q Compare the operating net profit (PBIT) to operating cash flow. Is thecompany generating sufficient cash from its operating activities?Operating cash flow should be significantly greater than operating profitdue in the main to depreciation changes which are a non cash expense

q If the company is not generating sufficient cash from its operatingactivities is this due to large increases in stocks and debtors which cansignal poor control over working capital.

q Identify the main cash inflows to the business. The biggest cash inflowfor a business should be its operating activities but other major oneswould be issues of shares/debentures.

q Identify the major cash outflows of a business. These in general wouldbe in the whole area of capital expenditure (investing in new fixed assetsor investments). Try and assess how this capital expenditure wasfinanced. Was it through a new issue of shares, debentures or from thecash flows generated from operating activities.

q Come to an overall conclusion about the cash position of the business interms of the business’s ability to generate cash and how it spends it.Also link this to the profitability performance of the business.


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