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THE CASH FLOW STATEMENT & C S O S & OTHER REPORTS
LECTURE 5
LEARNING OBJECTIVESLEARNING OBJECTIVES` Understand the difference between cash flow and profit` Revisit the accruals concept` Understand and interpret the cash flow statementp` Get familiar with the structure of and items in cash flow
statements
` Understand how to compare balance sheets to explain changes in cash` Link changes in cash to cash flow statement
` Produce cash flow statements in a form suitable for publication
` Discuss other financial statements and reports
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IN TODAYS LECTUREIN TODAY S LECTURE...` Topics` Cash flow and profit` The accruals concept revisited` The cash flow statement` Understanding and interpretation
R l i hi i h b l h` Relationship with balance sheet` Preparation of
` Other financial statements` Other financial statements` Directors report` Auditors reportp` Notes to the financial statements
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CASH FLOW VS PROFITCASH FLOW VS. PROFIT` Profit not determined by cash` Cash inflows cash outflows not profit
` Increasing cash balance` Does not imply success` Sale of assets` Massive borrowing
` Decreasing cash balance` Does not imply failure` Investment in assets
I d d diff b fi d ` Important to understand difference between profit and cash flow
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ACCRUALS CONCEPT: REVISITEDACCRUALS CONCEPT: REVISITED` Profit` Revenues earned less costs incurred in earning those revenues` Cash receipts and payments are irrelevant to profit
measurement` Accruals and matching principle
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ACCRUALS CONCEPT: REVISITEDACCRUALS CONCEPT: REVISITED` Not all expenses have cash effects` Depreciation` Accruals
` N t ll h h ff t` Not all revenues have cash effects` Credit sales
` Not all cash payments are expenses` Not all cash payments are expenses` Purchase of non-current assets` Investments in other firms` Investments in other firms` Prepayments
` Not all cash receipts are revenuesp` Sale of non-current assets` Borrowing money
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EXAMPLE 1EXAMPLE 1` Omega ltd sells a piece of machinery to another company
for 100,000 in March 2010 and receives full amount of cash upon the sale. The cost of purchasing this asset back i 2009 94 000in 2009 was 94,000.` What is the effect of this sale on the income statement for the
year ending 2010 and what is the respective effect on the cash year ending 2010, and what is the respective effect on the cash flow statement for the same period?
` Only the profit from the sale (6,000) is going to be addedon the income statement. The full amount of cashreceived would not count towards profit, but will be shown onthe cash flow statement as a cash inflow.
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EXAMPLE 2EXAMPLE 2
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CASH FLOW STATEMENTCASH FLOW STATEMENT` Cash Flow` Movement of money into and out of the business` Cash receipts and cash payments during the period
` Cash Flow Statement` Aggregate data on all cash inflows and cash outflows` Cash inflows (outflows) are decreases (increases) in assets and/or
increases (decreases) in liabilities` Shows origin (target) and amount of cash received (paid)` Shows origin (target) and amount of cash received (paid)
` Facilitates reconciliation between` Amount of profit generated during periodou o p o ge e a ed du g pe od` Amount by which cash balances have increased (decreased)
during period
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CASH FLOW STATEMENTCASH FLOW STATEMENT` Cash and cash equivalents at the start of year` Add cash inflows` Deduct cash outflows
` = Cash and cash equivalents at the end of year` Cash equivalents are short term investments that can be
turned into cash quickly` Activities that generate cash` Operating` Investing` Financing
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ACTIVITIES AFFECTING CASHACTIVITIES AFFECTING CASH
OPERATING
FINANCINGINVESTING
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OPERATING ACTIVITIESOPERATING ACTIVITIES` Any transaction that determines net income` Cash inflows` EBIT` Depreciation` Added back as it is not a cash outflow
` Add Interest received` Changes in working capital` Add decrease in inventories and receivables` Add increase in payables
` Add tax rebate` Add tax rebate
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OPERATING ACTIVITIESOPERATING ACTIVITIES` Any transaction that determines net income` Cash outflows` EBIT (only if negative)` Deduct interest paid` Changes in working capital` Deduct increase in inventories and receivables` Deduct decrease in payablesD d id` Deduct tax paid
` Deduct dividends paid` Typically under financing activities` Typically under financing activities
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OPERATING ACTIVITIES: CHANGES IN WORKINGCAPITAL & CASH FLOWCAPITAL & CASH FLOW` What are the cash effects of changes in working capital
items?
` WC = Current Assets Current Liabilities
` Inventory increase means cash spent` Receivables decrease means cash received` Receivables decrease means cash received` Payables decrease means cash spent
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INVESTING ACTIVITIESINVESTING ACTIVITIES` Any transaction related to acquisition or sale of non-
current assets` Cash inflows` Sale of property plant or equipment` Collection of loans to other entities` Sale of non-cash equivalent securities` Long-term investments (stocks, bonds)
` Cash outflows` Purchase of property plant or equipment` Lending of money to subsidiary` Purchase of non-cash equivalent securities
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FINANCING ACTIVITIESFINANCING ACTIVITIES` Any transaction related to borrowing from creditors or
involving owners` Excludes interest payments
` Cash inflows` Share issues` Additional capital
` Short term borrowingN b d ` Notes, bonds, mortgages etc.
` Cash outflowsP f h di id d` Payment of cash dividends
` Share repurchases
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CASH FLOW STATEMENT: AN EXAMPLECASH FLOW STATEMENT: AN EXAMPLE
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CASH FLOW STATEMENT: PREPARATIONCASH FLOW STATEMENT: PREPARATION` Important to use balance sheet and income statement` Collect items from income statement` EBIT` Depreciation (if does not appear on IS, find on notes)` Amortisation` Provisions` Profit from sale of assets (deduct from EBIT)` Interest` Tax
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CASH FLOW STATEMENT: PREPARATIONCASH FLOW STATEMENT: PREPARATION` Important to use balance sheet and income statement` Collect items from balance sheet` Change in inventory (stock)` Change in receivables (debtors)` Change in payables (creditors)` Change in long-term borrowings
` Problem items` Share issues` Purchase or disposal of non-current assets` Detailed info on notes to the balance sheet
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CASH FLOW STATEMENT: PREPARATIONCASH FLOW STATEMENT: PREPARATION
EBIT
AddDepreciation
Deduct(Increase)/Add(decrease)ininventories
Deduct(increase)/Add(decrease)intradereceivables
Add(increase)/Deduct(decrease)intradepayables
DeductInterestpaid
Deducttaxpaid
D d t di id d idDeductdividendspaid
Netcashflowfromoperatingactivities
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CASH FLOW STATEMENT: INTERPRETATIONCASH FLOW STATEMENT: INTERPRETATION` Free Cash Flow` Net cash arising from operating activities` Can be used to pay dividends, investments, pay loans` What about essential upgrades investments?
` Cash Flow Ratios` Interest and dividend cover
InterestforFlowCashFlowCashFree
C h l l d
Interestf
Dividend,
` Cash return on capital employed` Cash flow per share
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CASH FLOW STATEMENT: INTERPRETATIONCASH FLOW STATEMENT: INTERPRETATION` Important areas` Cash flow from operating activities` Changes in working capital and how they are financed` Investing activities and finance` Financing activities` Dividends coverage by net operating cash flows` Cash balance at beginning of year vs. cash balance at end of
year` Investigate reasons for changes
` Limitations` Limitations` Not to be used in isolation necessary to use balance sheet
and income statement
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and income statement
OTHER FINANCIAL STATEMENTS:DIRECTORS REPORTDIRECTORS REPORT` States among other things` Information about directors` Directors remuneration` Principal activities (and any changes)` Business review` Future developments` Research and development` Post balance sheet events` Market value of land and buildings
R d d di id d` Recommended dividend` Creditor payment
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OTHER FINANCIAL STATEMENTS:AUDITORS REPORTAUDITOR S REPORT` Scope` Verifies that a corporation's financial statements comply with
accounting standards and that represent the companys fi i l i t d f i financials in a true and fair manner
` OutcomesU lifi d i l ` Unqualified report is a clean report
` Qualified report shows reservationAl i l d` Also includes` Statement of Directors responsibilities to make clear that
financial statements are the responsibilities of the directorsfinancial statements are the responsibilities of the directors
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OTHER FINANCIAL STATEMENTS:NOTES TO THE FINANCIAL STATEMENTSNOTES TO THE FINANCIAL STATEMENTS` Also known as footnotes` Additional notes and information` Important information that cannot be presented on balance
sheet and income statementsheet and income statement` Added to the end of the financial statements` Supplement users with more information` Supplement users with more information
` Present` Computation of specific items` Computation of specific items` Accounting methodologies used` Pension plan details` Stock option compensation information` List of subsidiaries controlling interest
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READING LISTREADING LIST` Core reading` Perks and Leiwy` Chapter 6` Chapter 7 section 7.6
` Further readingG` Gowthorpe` Chapter 10
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NEXT WEEK IS ISLNEXT WEEK IS ISL
Not Independent Student Partying (ISP) week...p y g ( )
Use responsibly!!
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