Topic 3: Measuring and reporting

cash flows

Chapter 6
What we will look at in this lecture?

Discuss the crucial importance of

cash to a business

Explain the nature of the statement of cash

flows and discuss how it can be helpful in
identifying cash flow problems

Interpret a statement of cash flows

 The Nature of Cash and Cash Equivalents

Cash flows - ‘inflows and outflows of cash and cash equivalent’

Cash - ‘cash on hand or in bank deposits’

Cash equivalents - ‘short-term, highly liquid investments that are

readily convertible to known amounts of cash and which are
subject to an insignificant risk of changes in value’ (IASB, IAS 7,
2018)
 What is a Cash Flow statement?
The cash flow statement shows:
• Movements in the cash balance of the company during the
accounting period.
• the manner in which cash has been generated and used during
the year.
• the effects on cash flows of an entity’s operating, investing and
financing activities for a given period.
• provides information that assists in the assessment of liquidity,
solvency and financial adaptability.

Cash inflows
Less Cash outflow
= Increase (or decrease) in cash over the period
 Why is cash flow statement an important
element of the annual financial statement?
The adequate liquidity and cash availability are vital to the
successful operation of a business.

The income statement and Statement of Financial Position do

not provide adequate information about these factors.
Businesses may be profitable but at the same time have severe
cash shortages. Cash flows statements focus on cash
movements over the reporting period and therefore facilitate
prediction of possible or likely cash movements in the future.

Electric scooter rental pioneer Bird files for bankruptcy (ft.com

)
 The Relationship between Statement of Cash
Flows and:
INCOME STATEMENT – the Income Statement shows the
profit, whereas the Cash Flow Statement shows the reasons for the
change in cash. Profit is not the same as an increase in cash, it is
only one source of cash;

STATEMENT OF FINANCIAL POSITION – the SFP is a list

of assets, liabilities and Equity at the end of the year, whereas the
Cash Flows Statement identifies the effect on cash of the changes
in assets, liabilities and capital during the accounting year.
 Profit v Cash
Effect

on profit on cash

1 Repayment of a loan

2 Buying a non-current asset on credit

3 Receiving cash from trade receivable

4 Depreciating a non-current asset

5 Buying some inventories for cash

6 Issuing shares for cash

7 Making a profitable sale for cash

Standard presentation for the statement of cash
flows

Cash flows
from operating activities
plus or
minus

Cash flows
from investing activities
plus or
minus

Cash flows
from financing activities
equals

Net increase (or decrease) in

cash and cash equivalents over
the period
 Cash Flows from Operating Activities
• Operating activities are the principal revenue-producing
activities of the entity and other activities that are not investing
or financial activities.

• Cash flows from operating activities are primarily made up of

the net increase (or decrease) in cash that results from a
company’s normal trading activities.

There are two approaches that can be taken:

• The direct method
• The indirect method (more popular and we will
concentrate on this)
 Cash Flows from Investing Activities
Cash flows related to acquiring or disposing of long-term assets are
reported in the investing activities section of the statement of cash
flows.

1. Cash receipts (inflows) from selling property, plant,

equipment or marketable securities,

2. Cash payments (outflows) for purchasing property, plant,

equipment or marketable securities.
 Cash Flow from Financing Activities
Cash flows related to borrowing (short - or long-term) and
stockholders’ equity are reported in the financing activities section
of the statement of cash flows.

1. Cash received (inflows) from borrowing money and issuing

stock.

2. Cash payments (outflows) to repay debt and/or to buy back

stock.
 Direct Method
• Involves analysing the cash records of the business for
the accounting period identifying all cash payments and
receipts related to operating activities.
• It shows the cash received from customers, cash paid to
suppliers, and cash paid in wages and for operating
expenses.
 Indirect method of Cash Flows from Operating Activities

The indirect method involves adjusting the profit or loss before tax
for:

• The effects of transactions of a non-cash nature, such as

depreciation.

• Cash receipts or payments related to the changes in working capital;

• Items of income or expense associated with investing or financial

cash flows.

Basic principle:

• If Assets go up – cash flows go down and vice-versa

• If Liabilities (including Equity) go up – cash flows go up and vice-
versa.
 Cash Flows from Investing Activities
•Investing activities

•Cash outflows to acquire non-current assets and cash inflows from their
disposals. It includes not only cash in(out)flows related to property, plant
and equipment, intangible assets but also financial investments made in
loans or shares in another business.

•In terms of investments in financial assets cash flows comprise both the
purchase/sale of financial assets and the interest and dividends received on
these assets.

•The separate disclosure of cash flows from investing activities is

important because it shows clearly investment or dis-investment on non-
current assets which are an important resource for generation of future
income and cash flows.
 Cash Flows from Financing Activities
• Financial activities

• This encapsulates cash received and paid to external providers of

finance in respect of the principal amounts of finance and the
payments required to service these principal amounts (interest and
dividends).

• The most common external providers of finance are equity

shareholders, preference shareholders, bank loans and
bondholders (borrowing direct from the public via issue of bonds).

• The separate disclosure of cash flows from financial activities is

important because it helps in predicting claims on future cash
flows by providers of capital to the entity.
 Uses of Statements of Cash Flows
1. To enable users to see how the various activities have been
financed.
2. To assist users in making judgements on the amount, timing
and degree of certainty of future cash flows, and thus the
ability of the entity to:
(a) pay its debts (loans, payables, etc);
(b) pay interest and dividends;
(c) continue without the need for extra external finance .
3. To explain how there can be a profit but a decrease in cash (or
vice versa).
4. To show the reasons for the difference between profit and its
associated cash inflows and outflows.
 Summary – Some Key Points
• The purpose of the statement of cash flows is to show the
reasons for the change in cash and cash equivalents over a
period

• It shows how cash has been generated and used

• IAS 7 – splits the analysis into three categories (operating

activities, investing activities and financing activities)

• Cash flows from operating activities can be obtained using the

direct or indirect method (the latter is the more commonly used)
 Tesco plc
Summary group statement of cash flows for the year
ended 27 February 2021

Source: Adapted from Tesco plc, Annual Report and Financial Statements 2021, p. 117, www.tescoplc.com
[accessed 23 May 2022].
 Field Limited
P& L account for the year ended 31 May 2022
2021 2022
£000 £000

Sales 2,400 3,000

Less: Cost of sales 1,600 2,000
Gross profit 800 1,000

Less: Expenses
Administrative expenses 310 320
Depreciation
vehicles 55 60
furniture 35 40

Operating profit 400 580

less: Interest 20 5

Profit before tax 380 575

less: Tax 120 150

Net profit 260 425

less: Dividend 200 250

Retained profit 60 175

 Balance Sheet for the year ended 31 May 2022
2021 2022
£000 £000

Non-Current Assets
Vehicle at cost 600 800
Less: Depreciation 200 400 260 540
Furniture 200 250
Less: Depreciation 100 100 140 110

Current assets
Inventory 400 540
Trade Receivables 180 200
Cash 300 880 115 855

Less: Current liabilities

Trade Payables 270 300
Corporation tax due 170 220
Dividends due 150 590 100 620

Less: Non-Current Liabilities

Loan 190 40

Shareholders’ funds
Ordinary share capital 500 570
Retained profit 100 275
 Cash Flow Statement for the year ended 31 May 2022
2022 (£000)

Cash Flow from Operating Activities

Profit Before Tax (comes from the Income Statement) 575
Adjustments for:
Add Depreciation (comes from the IS) 100
Add Interest payable (Comes from the IS) 5
(Increase)/Decrease in Inventory (the change of inventories from SFP) -140
(Increase)/Decrease in Trade Receivables (the change on receivables from SFP) -20
Increase/(Decrease) in Trade Payables (the change on payables from SFP) 30

Take away Interest paid -5

Take away Taxation paid -100
Take away Dividend paid -300
Net cash inflow from operating activities 145

Cash Flow from investing Activities

Investment in non-current Assets (change in non-current asset from SFP) -250

Cash Flow from Financing Activities

Loan (Change on loans from SFP) -150
Equity (Change in Equity from SFP) 70

Increase / (Decrease) in cash -185

Cash at bank at beginning of period (From previous SFP) 115

Cash at bank at end of period (From Current year SFP) 300

Movement in cash balance -185