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
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
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
The ST - cash conversion cycle (operating
cycle) relates to the main business
operations
=
OPERATING ACTIVITIES
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© 2005 Peter Walton and Walter Aerts
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 SToperating 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 revenue-generating
activities of a company
“Operating cash flow” is conceptually most near to “net
profit”
Main differences:
1.
2.
3.
Non-cash expenses and non-cash revenues (f.i.
depreciation expense)
Non-operating items (f.i. gain on disposal of tangible
fixed assets)
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:


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
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© 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
(xxxxxxxxxxxxxx)
xxxxxxxxxxxxxx
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:



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)
Assets
Fixed assets (at cost)
Acc. depreciation
Inventories
Trade receivables
Cash
Financing
Equity
Share capital
Reserves
X2 profit
Liabilities
Trade payables
LT debt
X2
X1
∆
980
-350
180
115
92
1017
740
-265
171
98
110
854
240
85
9
17
18
600
90
50
600
90
__
__
50
50
62
215
1017
59
105
854
3
110
3
110
266
Outflow
Inflow
240
85
9
17
18
__
266
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts
Illustration - Constructing a CFS (2)
Operating activities
Net profit after tax
Add back depreciation
Changes in non-cash working capital
Net cash flow from operations (A)
Investing activities
Purchase of fixed assets (B)
Financing activities
New LT debt (C)
Net change in cash (A+B+C)
Cash balances
At beginning of year
At balance sheet date
Difference
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© 2005 Peter Walton and Walter Aerts
50
85
135
–23
112
–240
110
–18
110
92
–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)
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts
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
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts
Incoming cash flows
Cash + Other assets = Liabilities + Owners’equity
(1)
+
(2)
+
(3)
+
+
+
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts
Outgoing cash flows
Cash + Other assets = Liabilities + Owners’equity
(1)
-
(2)
-
(3)
-
+
-
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts
Presentational choices
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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)
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts
IAS 7 - Direct Method (Extract)
20X2
Cash flows from operating activities
Cash receipts from customers
Cash paid to suppliers and employees
Cash generated from operations
Interest paid
Income taxes paid
30,150
(27,600)
2,550
(270)
(900)
Net cash from operating activities
Cash flows from investing activities
Acquisition of subsidiary X, net of cash acquired
Purchase of property, plant and equipment
Proceeds from sale of equipment
Interest received
Dividends received
1,380
(550)
(350)
20
200
200
(480)
Net cash used in investing activities
Cash flows from financing activities
Proceeds from issue of share capital
Proceeds from long-term borrowings
Payment of finance lease liabilities
Dividends paid*
Net cash used in financing activities
Net increase in cash and cash equivalents
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period
* This could also be shown as an operating cash flow.
250
250
(90)
(1,200)
(790)
110
120
230
Source: IAS 7 – Cash Flow Statements, Appendices
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts
IAS 7 - Direct Method (Extract)
20X2
Cash flows from operating activities
Cash receipts from customers
Cash paid to suppliers and employees
Cash generated from operations
Interest paid
Income taxes paid
30,150
(27,600)
2,550
(270)
(900)
Net cash from operating activities
Cash flows from investing activities
Acquisition of subsidiary X, net of cash acquired
Purchase of property, plant and equipment
Proceeds from sale of equipment
Interest received
Dividends received
1,380
(550)
(350)
20
200
200
(480)
Net cash used in investing activities
Source: IAS 7 – Cash Flow Statements, Appendices
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts
IAS 7 - Direct Method (Extract- cont.)
Cash flows from financing activities
Proceeds from issue of share capital
Proceeds from long-term borrowings
Payment of finance lease liabilities
Dividends paid*
250
250
(90)
(1,200)
(790)
Net cash used in financing activities
Net increase in cash and cash equivalents
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period
110
120
230
* This could also be shown as an operating cash flow.
Source: IAS 7 – Cash Flow Statements, Appendices
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts
IAS 7 - Indirect Method (Extract)
20X2
Cash flows from operating activities
Profit before taxation
Adjustments for:
Depreciation
Foreign exchange loss
Investment income
Interest expense
Increase in trade and other receivables
Decrease in inventories
Decrease in trade payables
Cash generated from operations
Interest paid
Income taxes paid
3,350
450
40
(500)
400
3,740
(500)
1,050
(1,740)
2,550
(270)
(900)
Net cash from operating activities
Cash flows from investing activities
Acquisition of subsidiary X net of cash acquired
Purchase of property, plant and equipment
Proceeds from sale of equipment
Interest received
Dividends received
1,380
(550)
(350)
20
200
200
Net cash used in investing activities
Cash flows from financing activities
Proceeds from issue of share capital
Proceeds from long-term borrowings
Payment of finance lease liabilities
Dividends paid*
Net cash used in financing activities
Net increase in cash and cash equivalents
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period
* This could also be shown as an operating cash flow.
(480)
250
250
(90)
(1,200)
(790)
110
120
230
Source: IAS 7 – Cash Flow Statements, Appendices
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts
IAS 7 - Indirect Method (Extract)
20X2
Cash flows from operating activities
Profit before taxation
Adjustments for:
Depreciation
Foreign exchange loss
Investment income
Interest expense
Increase in trade and other receivables
Decrease in inventories
Decrease in trade payables
Cash generated from operations
Interest paid
Income taxes paid
Net cash from operating activities
3,350
450
40
(500)
400
3,740
(500)
1,050
(1,740)
2,550
(270)
(900)
1,380
Source: IAS 7 – Cash Flow Statements, Appendices
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts
IAS 7 - Indirect Method (Extract – cont.)
20X2
Cash flows from investing activities
Acquisition of subsidiary X net of cash acquired
Purchase of property, plant and equipment
Proceeds from sale of equipment
Interest received
Dividends received
(550)
(350)
20
200
200
(480)
Net cash used in investing activities
Cash flows from financing activities
Proceeds from issue of share capital
Proceeds from long-term borrowings
Payment of finance lease liabilities
Dividends paid*
250
250
(90)
(1,200)
(790)
Net cash used in financing activities
Net increase in cash and cash equivalents
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period
110
120
230
* This could also be shown as an operating cash flow.
Source: IAS 7 – Cash Flow Statements, Appendices
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
© 2005 Peter Walton and Walter Aerts