FAC1601
Financial Accounting
Reporting
STUDY UNIT 9
STATEMENT OF CASH FLOWS
STATEMENT OF CASH FLOWS
A statement of cash flows is a financial statement that shows a business
entity’s flow of cash and cash equivalents.
The presentation of a statement of cash flows is dealt with in IAS 7.
The main objective is to disclose how cash and cash equivalents of a
business entity were generated and managed.
ACCRUAL vs CASH BASIS OF ACCOUNTING
The statement of comprehensive income and statement of financial position is
prepared on the accrual basis of accounting.
In terms of the accrual accounting:
“income, the sale of non-current assets etc., is reported when earned, and expenses,
the purchase of non-current assets etc., when incurred”
In terms of the cash basis of accounting:
“income, the sale of non-current assets etc., is reported when received, and
expenses, the purchase of non-current assets etc., when paid”
The period when earned or incurred is irrelevant
BUSINESS IS BASED ON THREE GROUPS OF ACTIVITIES
Operating activities
Principal revenue-producing activities,
primarily disclosed in the statement of comprehensive income.
Investing activities - Mainly the acquisition and disposal of noncurrent assets, primarily disclosed in the non-current asset sections
of the statements of financial position.
Financing activities - Activities that result in changes of the equity
and borrowings, primarily disclosed in the equity and liabilities
sections of the statements of financial position.
CASH FLOWS FROM OPERATING ACTIVITIES
Two methods for reporting cash flows from operating activities:
– Direct Method - The direct method for creating a statement of cash
flows reports major classes of gross cash receipts and payments.
– Indirect Method - involves reconciling comprehensive income to a
cash basis. It shows how non-cash flows affect comprehensive
income. The indirect method uses net-income as a starting point,
makes adjustments for all transactions for non-cash items, then adjusts
for all cash-based transactions.
Remember that outflows of cash are always
indicated in brackets, whereas cash inflows are
indicated without brackets.
DIRECT METHOD
CASH FLOWS FROM OPERATING ACTIVITIES
(DIRECT METHOD)
R
CASH FLOW FROM OPERATING ACTIVITIES
Cash receipts from customers
0000
Cash paid to suppliers and employees
(0000)
Cash generated from operations
0000
Interest received
000
Interest paid
(000)
Income tax paid
(000)
Distribution to members paid
(000)
Net cash from operating activities
0000
CASH FLOWS FROM OPERATING ACTIVITIES
(DIRECT METHOD
METHOD))
1. Determination of cash receipts from customers:
•
Where goods are sold for CASH use the REVENUE figure.
•
Where goods are sold on CREDIT, the following calculation is necessary:
•
•
•
•
Opening receivable balance
Plus revenue
Less closing balance receivable
Example 8.5
CASH FLOWS FROM OPERATING ACTIVITIES
(DIRECT METHOD
METHOD))
2. Determination of cash paid to suppliers and employees:
Where goods are purchased for CASH, use the PURCHASES amount.
PLUS
All expenses incurred by the entity paid for in CASH
•
•
•
•
Opening payable balance
Add purchases
Less closing balance payable
Example 8.5
ITEMS REQUIRING SEPARATE
DISCLOSURE
DIRECT METHOD
ITEMS REQUIRING SEPARATE DISCLOSURE
(DIRECT & INDIRECT METHOD)
•
•
•
•
•
•
•
•
Dividends received
Interest received
Interest paid
Income tax paid
Drawings (sole proprietor / partnership)
Distribution to members paid (cc)
Proceeds from sale of listed investments
Acquisition of listed investments
INDIRECT METHOD
INDIRECT METHOD
CASH FLOWS FROM OPERATING ACTIVITIES
Indirect Method - involves reconciling comprehensive income to a cash
basis. It shows how non-cash flows affect comprehensive income. The
indirect method uses net-income as a starting point, makes adjustments
for all transactions for non-cash items, then adjusts for all cash-based
transactions.
Profit (or loss) before tax
Adjusted for
• any non-cash entries; and
• any items that must be disclosed on the face of the statement of cash flows.
Adjust for working capital
INDIRECT METHOD
CASH FLOWS FROM OPERATING ACTIVITIES
R
Profit before tax
Non-cash items
Items disclosed after cash generated from/(used) in operations
000
+/+/=
Changes in current assets and liabilities:
Decrease in current assets
+
Increase in current assets
-
Decrease in current liabilities
-
Increase in current liabilities
+
Cash generated from operations
Items disclosed after cash generated from/(used) in operations
Net cash flow from operating activities
=
+/-
=
INDIRECT METHOD
CASH FLOWS FROM OPERATING ACTIVITIES
• Profit (or loss)
before tax
• Adjust for :
• Non-cash
items
• Items
separately
disclosed
• Working capital
movement
INDIRECT METHOD
CASH FLOWS FROM OPERATING ACTIVITIES
• Profit (or loss)
before tax
• Adjust for :
• Non-cash
items
• Items
separately
disclosed
• Working capital
movement
INVESTING ACTIVITIES
Cash Flows from Investing Activities
This section of the cash flow is based on cash received or paid based on changes in the Non-current assets of an entity
•
Discloses money used to purchase assets (resources that will generate future economic benefits)
•
Discloses money received from the selling of assets
•
Also, the cash used for purchasing of non-current financial assets like investments or fixed deposits
•
Cash received for sale/ maturity of non-current financial assets or investment
OF CASH INFLOW OR OUTFLOW
Calculation of Cash inflows and Outflows
NFLOW O
Ascertain the following:
- was there a change?
- if yes, was it for cash or credit?
Cost is given
- deduct current year and prior years from each other
- difference is due to cash or not, refer to additional information
Carrying amount is given
- deduct the prior year and current year from each other, take into account the depreciation for the current year
- difference cash or not, refer to additional information
Property, plant and equipment (PPE) note is given
- refer to additions and disposal line
- cash or not, refer to additional information
Selling price or Proceeds on sale = Carrying amount + profit (– loss)
Workings
Workings to determine proceeds on the CASH sale of
equipment
Proceeds from the maturity of fixed deposit
Cost of Equipment 2014
220 500,00
Cost of Equipment 2015
177 000,00
43 500,00
Accumulated depreciation relating to the asset that was sold
Balance at 2014
49 000,00
Current year depreciaton
19 000,00
Less 2015
- 43 000,00
25 000,00
Carrying value of Equiment
Cost
less accumulted deprecaition
43 500,00
- 25 000,00
18 500,00
Proceeds on sale
Carrying value
less Loss on sale
18 500,00
-
500,00
18 000,00
Balance at 2015
50 000,00
Less balance at 2014
-35 000,00
15 000,00
INVESTIGATING ACTIVITIES
CASH FLOWS FROM FINANCING ACTIVITIES
Determination of cash spent or received from changes in Equity
and Long-term borrowings
• Shows the sources of money used to finance the entity’s activities
• Indicates future claims on the entity
• Equity – retained earnings is non-cash
• Shows money repaid on borrowings or capital/membership
contributions
EXAMPLE 23:
CASH FLOWS FROM FINANCING ACTIVITIES
The following information is extracted from the accounting records of UnicornCC, at
31 December, the end of the financial year:
2009
2008
R
R
Member contributions
300 900
275 900
Mortgage
500 000
Long term-borrowings
207 500
Current portion of long-term borrowings
207 500
Bank (Dr)
265 530
36 500
Additional information:
1. A member of the CC contributed specialised equipment, valued at R25 000, to the
CC. This contribution was regarded as capital contribution and was recorded as
such. All the other additions was were paid for in cash.
Required: Prepare the cash flow from financing activities section.
EXAMPLE 23:
CASH FLOWS FROM FINANCING ACTIVITIES
The following information is extracted from the accounting records of UnicornCC, at
31 December, the end of the financial year:
2009
2008
R
R
Member contributions
300 900
275 900
Mortgage
500 000
Long term-borrowings
207 500
Current portion of long-term borrowings
207 500
Bank (Dr)
265 530
36 500
Additional information:
1. A member of the CC contributed specialised equipment, valued at R25 000, to the
CC. This contribution was regarded as capital contribution and was recorded as
such. All the other additions was were paid for in cash.
Required: Prepare the cash flow from financing activities section.
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from mortgage R(500 000 – 0)
Net cash from financing activities
R
500 000
500 000
UNICORN CC
STATEMENT OF CASH FLOWS FOR THE YEAR ENDED 31 DEC 2009
CASH FLOWS FROM OPERATING ACTIVITIES
.........................................................................................
.........................................................................................
Net cash from operating activities
CASH FLOWS FROM INVESTING ACTIVITIES
.........................................................................................
.........................................................................................
Net cash from investing activities
CASH FLOWS FROM FINANCING ACTIVITIES
.........................................................................................
.........................................................................................
Net cash from financing activities
Net increase in cash and cash equivalents
Cash and cash equivalents at beginning of the year
Cash and cash equivalents at end of the year
R
......
......
R
58 530
......
......
(329 500)
......
......
500 000
229 030
36 500
265 530
FAC1601
Financial Accounting
Reporting
FAC1601
eTUTORS
Dr S Moolman
Mr. L Nkoana
E-mail:
fac1601@unisa.ac.za
STUDY UNIT 9
ANALYSIS AND INTERPRETATION OF
FINANCIAL STATEMENTS
PRESENTATION CONTENTS
1.
THEORY
2.
THE ANALYSIS AND
INTERPRETATION
OF FINANCIAL
STATEMENTS
THE PURPOSE OF FINANCIAL STATEMENTS ANALYSIS
• Serves as a tool used to assess the entity’s performance
and financial position in relation to its risk exposure.
- The results of the financial statements analysis can be used to
highlight areas that require attention for further investigation in an
entity
- Ratios are used for the purpose of financial statements analysis
- The following are categories of key ratios used.
a) Profitability ratios
b) Liquidity ratios
c) Solvency ratios
PROFITABILITY RATIOS
• Measure the success of an entity in generating comprehensive
income.
• The following ratios are used in this regard.
-
-
-
-
-
-
The return on equity (ROE): measures how profitable the owners’ investment
to the entity is = Profit before tax x100
Total Equity
The return on assets (ROA): measures how effectively the entity’s assets are
being used in generating comprehensive income
=Profit before interest and tax X100
Total assets.
The gross profit %: measures gross profit on sales, (before deducting selling
costs) = Gross profit x100
Sales .
The profit margin: measures the comprehensive income the entity made for
every R and amount generated in revenue = Profit before tax x100
Sales.
The financial leverage ratio and financial leverage effect: measure the
extent to which the entity benefits from using debt instead of equity in
expanding the business.
Financial leverage= Return on equity
Return on assets
PROFITABILITY RATIOS
• Note: financial leverage effect is about the effect of debt on the return on
equity.
• An example: If the entity pays 3% interest on debt and its members receive
5% return, this yields a positive. Therefore, it is worth increasing the level of
debt as long the return on equity remains higher.
• Therefore, the leverage effect is the difference between Return on Equity and
Return on Assets.
- Leverage effect = Return on equity less Return on Assets
LIQUIDITY RATIOS
Used to measure the ability of an entity to meet its short-term financial
obligations (current liabilities)as they become due with its current
assets. Ratios are.
- Current ratio: measures the extent to which current liabilities are covered by
current assets = Current asset
Current liabilities.
- Asset test ratio: Same as in the current ratio but deduct the inventory from
current assets. = Current assets-inventory
Current liabilities
– Trade receivables collection period: measures time (in days) it takes to
collect accounts receivables = Average trade debtors x 365 days
Credit debtors
– Trade payables settlement period: measures time it takes for an entity to pay
its trade creditors/accounts receivables = Average trade payables x 365 days
credit purchases.
LIQUIDITY RATIOS
– Inventory turnover rate: measures the number of times the entity has sold
and replenished its inventory over a specific time
= Cost of sales.
Average inventory
– Inventory holding period: measures period it takes the entity to have its
inventory on hand = Average inventory x 365 days
Cost of sales
SOLVENCY RATIOS
• Measures the entity’s ability to meet its long-term debts and obligations
– Debt-Equity ratio: compares the level of total liabilities in relation to total equity
= Total debt
Total Equity
– Times interest earned ratio: measures the number of times interest payment
is covered by profits = Profit before interest
Interest expense
SOLVENCY RATIOS
• Measures the entity’s ability to meet its long-term debts and obligations
– Debt-Equity ratio: compares the level of total liabilities in relation to total equity
= Total debt
Total Equity
– Times interest earned ratio: measures the number of times interest payment
is covered by profits = Profit before interest
Interest expense
SOLVENCY RATIOS
• Measures the entity’s ability to meet its long-term debts and obligations
– Debt-Equity ratio: compares the level of total liabilities in relation to total equity
= Total debt
Total Equity
– Times interest earned ratio: measures the number of times interest payment
is covered by profits = Profit before interest
Interest expense
SOLVENCY RATIOS
• Measures the entity’s ability to meet its long-term debts and obligations
– Debt-Equity ratio: compares the level of total liabilities in relation to total equity
= Total debt
Total Equity
– Times interest earned ratio: measures the number of times interest payment
is covered by profits = Profit before interest
Interest expense
THE ANALYSIS OF FINANCIAL STATEMENTS
(PROFITABILITY RATIOS)
USUTHU CC
STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR THE
YEAR ENDED 28 FEBRUARY 20.15
Revenue
Cost of sales
Inventory (1 March 20.14)
Purchases
Inventory (28 February 20.15)
Gross profit
Other income
Interest income
Distribution, administrative and other expenses
Administration expenses
Depreciation
Remuneration: Accounting officer
Finance costs
Interest on long-term loan
Profit before tax
Income tax expense
Profit for the year
Other comprehensive income for the year
Total comprehensive income for the year
ROE = Profit before tax X 100
Total equity
ROA = profit before interest & tax X100 = (R7000+R15000) = R22 000
Total Assets
Profit margin = Profit before tax X 100
Sales
20.15
R
360,000
(270,000)
66,000
273,000
339,000
(69,000)
90,000
1,000
1,000
91,000
(69,000)
45,000
9,000
15,000
(15,000)
(15,000)
7,000
(2,000)
5,000
5,000
Gross profit %
= Gross Profit x 100
Sales
20.14
R
307,500
(225,000)
58,000
233,000
291,000
(66,000)
82,500
1,000
1,000
83,500
(61,000)
43,000
8,000
10,000
(10,000)
(10,000)
12,500
(3,600)
8,900
8,900
THE ANALYSIS OF FINANCIAL STATEMENTS
(PROFITABILITY) Cont…
USUTHU CC
STATEMENT OF CHANGES IN NET INVESTMENT OF MEMBERS FOR THE YEAR
ENDED 28 FEBRUARY 20.15
Balances at 1 March 20.14
Members' contributions
Total comprehensive income for the year
Members' Contributions
R
100,000
23,000
5,000
123,000
Retained
Earnings
R
19,000
24,000
Total
R
119,000
23,000
5,000
147,000
USUTHU CC
STATEMENT OF FINANCIAL POSITION AS AT 28 FEBRUARY 20.15
20.15
R
20.14
R
ASSETS
Non-current assets
Property, plant and equipment
Fixed deposit
115,000
107,000
8,000
100,000
92,000
8,000
Current assets
Inventories
Trade receivables
Total assets
137,000
69,000
68,000
252,000
123,000
66,000
57,000
223,000
EQUITY AND LIABILITIES
Total equity
Members' contributions
Retained earnings
147,000
123,000
24,000
119,000
100,000
19,000
Total liabilities
Non-current liabilities
Long-term borrowings
105,000
50,000
50,000
104,000
50,000
50,000
Current liabilities
Trade payables
Bank overdraft
Total equity and liabilities
55,000
41,000
14,000
252,000
54,000
36,000
18,000
223,000
THE ANALYSIS OF FINANCIAL STATEMENTS
(PROFITABILITY) Cont…
USUTHU CC
STATEMENT OF CHANGES IN NET INVESTMENT OF MEMBERS FOR THE YEAR
ENDED 28 FEBRUARY 20.15
Balances at 1 March 20.14
Members' contributions
Total comprehensive income for the year
Members' Contributions
R
100,000
23,000
5,000
123,000
Retained
Earnings
R
19,000
24,000
Total
R
119,000
23,000
5,000
147,000
USUTHU CC
STATEMENT OF FINANCIAL POSITION AS AT 28 FEBRUARY 20.15
20.15
R
20.14
R
ASSETS
Non-current assets
Property, plant and equipment
Fixed deposit
115,000
107,000
8,000
100,000
92,000
8,000
Current assets
Inventories
Trade receivables
Total assets
137,000
69,000
68,000
252,000
123,000
66,000
57,000
223,000
EQUITY AND LIABILITIES
Total equity
Members' contributions
Retained earnings
147,000
123,000
24,000
119,000
100,000
19,000
Total liabilities
Non-current liabilities
Long-term borrowings
105,000
50,000
50,000
104,000
50,000
50,000
Current liabilities
Trade payables
Bank overdraft
Total equity and liabilities
55,000
41,000
14,000
252,000
54,000
36,000
18,000
223,000
INTERPRETATION OF PROFITALITY RATIOS
20.15
2014
ROE
R7 000 X100
R147 000
4.76%
Huge decrease in ROE from 20.14 to 20.15
R12 500 x100
R119 000
10.50%
ROA
R22 500 x100
R223 000
10.09%
R22 000 x100
R252 000
8.75%
Slight decrease in ROA from 20.14 to 20.15
Gross profit %
R90 000 x100
R82 500 x100
R360 000
R307 500
25%
26.83%
Decrease in Gross profit %. Which affected the overall profitability of the entity
INTERPRETATION OF PROFITABILITY RATIOS Cont…
Net Profit margin
20.15
2014
R7 000 x100
R360 000
1.94%
R12 500 x100
R307 500
4.07%
Decrease in net profit margin
Financial leverage = ROE
ROA
4.76%
8.73%
0.55
There is a decline in financial leverage
10.50%
10.09%
1.04
Leverage effect = ROE
Less ROA
10.50%
(10.09%)
0.41%
4.76%
(8.73%)
(3.97)
FINANCIAL ANALYSIS
LIQUIDITY RATIOS
• Current Ratio
• Acid Test Ratio
• Trade Receivables Collection Period
• Trade Payables Settlement Period
• Inventory Turnover Rate
• Inventory Holding Period
FINANCIAL ANALYSIS
FINANCIAL INFORMATIONAND INTERPRETATION OF FINANCIAL STATEMENTS
FINANCIAL ANALYSIS
CURRENT RATIO
• ANALYSIS AND INTERPRETATION OF FINANCIAL STATEMENTS
2021
2020
Current Assets
R221 000
R171 000
=
:
R111 000
R101 000
Current liabilities
=
1,99 : 1
:
1,69 : 1
COMMENT:
The company’s current ratio increased by 17,75% over the year, which is an
ideal result for the company. This means that each R1 of the current liabilities
is covered by R1,99 of current assets or a margin of 99%.
FINANCIAL ANALYSIS
ACID TEST RATIO
• ANALYSIS AND INTERPRETATION OF FINANCIAL STATEMENTS
2021
2020
Current Assets less Inventory
R(221 000 – R100 000)
R(171 000 – R80 000)
=
:
R111 000
R101 000
Current liabilities
=
1,09 : 1
:
0,9 : 1
COMMENT:
The company’s acid test ratio improved by more than 100% which is a good coverage
of current liabilities. It means that each R1 of current liabilities is covered by R1,09 of
“quick” assets. This also indicates that the cash flow position of the company is
favourable.
FINANCIAL ANALYSIS
TRADE RECEIVABLES COLLECTION PERIODANALYSIS AND INTERPRETATION
OF FINANCIAL STATEMENTS
2021
2020
Average trade receivables
X 365
Credit Sales
R77 200
X 365
69 days
X 365
R360 000
R400 000
=
R66 000
=
66 days
(R88 000 + R66 400)/2 = R77 000
COMMENT:
The company’s credit control weakened as debtors’ amounts were outstanding for a
longer period in 2021 that in 2020. The company decreased its collection period by
4,92% which was accompanied by a 11,11% increase in sales. This means that the
company extended credit terms to boost sales.
FINANCIAL ANALYSIS
TRADE PAYABLE SETTLEMENT PERIODANALYSIS AND INTERPRETATION OF
FINANCIAL STATEMENTS
2021
2020
Average trade payables
X 365
Credit purchases
=
R104 500 X 365
R99 000
R320 000
R290 000
117 days
=
X 365
124 days
(R110 000 + R99 000)/2 = R104 500
COMMENT:
The company paid its creditors sooner in 2021 than in 2020. When compared with
trade receivables collection period, the trade payables settlement period is still
favourable to the company’s cash flow. The company will receive payments from its
debtors sooner that it would be required to settle it creditors accounts.
FINANCIAL ANALYSIS
INVENTORY TURNOVER RATEANALYSIS AND INTERPRETATION OF
FINANCIAL STATEMENTS
FINANCIAL ANALYSIS
INVENTORY TURNOVER RATEANALYSIS AND INTERPRETATION OF
FINANCIAL STATEMENTS
FINANCIAL ANALYSIS
SOLVENCY RATIOS
• Debt-to-Equity Ratio
• Times Interest Earned Ratio
FINANCIAL ANALYSIS
DEBT-TO-EQUITY RATIOAND INTERPRETATION OF FINANCIAL STATEMENTS
FINANCIAL ANALYSIS
DEBT-EQUITY RATIOANALYSIS AND INTERPRETATION OF FINANCIAL
STATEMENTS
the company
FINANCIAL ANALYSIS
TIME INTEREST EARNED RATIOANALYSIS AND INTERPRETATION OF
FINANCIAL STATEMENTS