CHAPTER 10 cash flow statements

CHAPTER 10
Cash flow statements

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts


Contents
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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

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts


Cash flow statement
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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

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts


Usefulness of cash flow information
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Ability to generate adequate cash flows is a significant
performance dimension

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Cash flow information clarifies the dynamics of shortterm liquidity and long-term solvency

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Cash flow information is an essential input for economic
decision models

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts


Cash flow versus profit
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Cash flow and profit are different economic
phenomena
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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
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts


Liquidity/solvency and cash flows
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Liquidity
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Solvency
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Relates to “nearness to cash” of the structure of assets
Determined by capacity to convert current assets into cash
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
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts


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

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts


Related questions
1.
2.
3.

4.

5.

From which sources did the company raise
cash last year? How was this cash used?
Were the normal operating activities capable
of satisfying its need for cash during the year?
If not, is the shortage of cash compensated by
new borrowings, issuing new share capital or
by selling fixed assets?
Is a surplus of cash used for repayment of
debt, for investments or for distribution of
dividends?
Why has the balance of cash available
decreased, knowing that the company’s
operations have been profitable?
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts


Cash conversion cycles
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Cash flows through the company continuously in a series of
short-term and long-term conversion cycles

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The ST - cash conversion cycle (operating cycle) relates to the
main business operations
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= OPERATING ACTIVITIES

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts


Cash conversion cycles (cont.)
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The LT- cash conversion cycles relate to the acquisition,
renewal and disposal of intangible and tangible infrastructure
and the long-term sourcing of funds
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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

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts


Fig. 10.1 Long-term and short-term cash
flow cycles
Main operations
Inventory

Procurement

Work in Progress

Sales

Current payables

Inventory

Current receivables

Payments

Cash and cash
equivalents

Receipts

Investing/ Productive
infrastructure

External financing

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts


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
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts


Cash flows from operating
activities
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Operating activities are primarily the revenuegenerating 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.)
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts


Operating cash flows: Examples
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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, …

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts


Operating cash flows –
Direct versus indirect method
2 methods for identifying and presenting the
operating cash flow:
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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

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts


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

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts


Indirect method - Example
Net profit before tax
Adjustments for:
Depreciation
Investment income

3,350
490
(100)

3,740
Working capital changes:
Increase in trade and other receivables

(500)

Decrease in inventories

1,050

Decrease in trade payables

Cash generated from main operations
Income taxes paid
Net cash flow from operating activities
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts

(1,740)

2,550
(1170)
1,380


Cash flow proxy
Net profit or loss after tax
Add back:
Depreciation charge for the
year

Provisions created in year
Deduct:
Provisions released in year
‘Cash flow proxy’

xxxxxxxxxxxxxx

xxxxxxxxxxxxxxx
xxxxxxxxxxxxxxx

(xxxxxxxxxxxx
xx)
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Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts


Cash flow proxy (bis)
Net profit or loss after tax

xxxxxxxxxxxx

Add back:
Depreciation for the year
Provisions created in year
Deduct:
Provisions released

xxxxxx

xxx
(xxxx)

Gain on asset disposal
(xxxxx)
Net change in non-cash working capital
(xxxxx)
‘Cash flow proxy’
xxxxxxxxxxxx
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts


Cash flows from investing
activities
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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:
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Payments for newly acquired equipment
Receipts from the disposal of a building
Payments for new investments

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts


Cash flows from financing
activities
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Financing activities relate to changes in the
size and composition of contributed capital
and financial debt of the company
Examples:
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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

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts


Constructing a cash flow statement
1.

2.

3.

Determine the net change in cash
 Compare beginning and ending balance
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
Use the information (of step 1 and 2) to construct
a cash flow statement according to the formal rules
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts


Applying step 2

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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 “accrualbased adjustments” or other “non-cash activities”

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts


Fig. 10.2 Classifying balance sheet
movements as inflows or outflows of cash
Assets

Equity/liabilities

Increase

Outflow

Inflow

Decrease

Inflow

Outflow

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts


Illustration - Constructing a CFS (1)

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts