ACC5502: Module 5 Statement of Cash Flows. shows an entity: what money came in (cash inflows e.g....

ACC5502: Module 5

Statement of Cash Flows

Statement of Cash Flows

shows an entity: what money came in (cash inflows

e.g. sales receipts; loans) and what money went out (cash outflows

e.g. wages; electricity). The difference between the two is

called net cash flow.

What is cash?

Cash on hand Cash Equivalents

Highly liquid assets Short periods to maturity

Cash on Hand

Cash Equivalents

Examples:

•Notes and coins held

•Deposits held at call with a financial institution

Highly liquid investments

•With short periods to maturity

•Readily convertible to cash on hand at the investor’s option; and

•Subject to an insignificant risk of change in value

Short term borrowings

•That are integral to the cash management functions; and

•Not subject to a term facility

Examples:

•Banks and non-bank bills

•Money market deposits with 3 months or less maturity

Example:

Money market funds or bank overdraft repayable on demand

Cash

Purpose

To give information about the cash receipts and payments and net changes in cash

Cash is the most liquid asset Therefore integral to assessing an entity’s

financial position

Importance of cash

Entities can be quite profitable yet still fail due to poor cash mananagement techniques

An entity needs to ensure it has enough cash on hand to meet its financial commitments in a timely fashion (workers don’t like waiting to be paid their wages)

So how much cash should an entity have on hand?

Disadvantages of having too much cash on hand

There are costs involved in this: May have to pay unnecessary interest

to bank for loans Missed investment opportunities

So the trick is to have an equilibrium of cash to commitments

Cash Flow Management

Cash from sales Credit policy and debt collection Paying bills Alternative credit Progress payments Buyer’s terms Inventory control Surplus cash Cash planning Supplier relationships

Some methods to improve cash flow

Credit and debt collection policies Use trade/alternative credit (e.g. Visa) Progress payments/buyer terms Inventory control Develop good supplier relationships Cash planning Invest surplus cash wisely

Reminder -The Accrual Accounting System

Measuring income as earned and matching to expenses incurred in same period = Accrual Accounting

Under accrual accounting: Net profit or loss for the period

MAY NOT BE THE SAME AS Net cash inflows or outflows for the period

Accrual accounting used for Income StatementAccounts for credit transactions

Accrual V Cash

P&L is based on an accrual system focused on when a transaction takes place (not

when the payment for the transaction occurs) SCF is based on cash

Focused on the actual receipts and payments (not the underlying transaction)

It gives users of GPFRs additional information to the Balance Sheet and Profit & Loss Statement

Balance Sheet What the entity owns and owes at a set point in time

Income Statement A flow report that shows revenues, expenses and

profit/loss for a particular period Statement of Cash Flows

Shows a flow of actual receipts and payments for a particular period

Relationship to other financial reports

Relationship to other financial reports

CFS gives users of GPFRs information on cash receipts, cash payments and the

net changes in cash during a period. Cash is an entity’s most liquid asset and it

is an integral component in assessing an entity’s financial position.

Relationship to other financial reports (cont.) Sometimes a company can be quite

profitable and yet still fail because of poor cash management

Accounting is based on an accrual system. The statement of cash flow is concerned with the actual receipts and payments and not the timing of the underlying transaction

Relationship to other financial reports (cont.)

CFS gives additional information to assist decision makers in assessing

an entity’s ability to generate cash flows meet its financial commitments as they fall

due fund changes in the scope and/or nature of

its activities obtain external finance.

Relationship to Other Financial Reports

It gives additional information to the Balance Sheet and Profit & Loss Statement

Balance Sheet What the entity owns and owes at a set point in time

Profit & Loss Statement A flow report that shows revenues, expenses and

profit/loss for a particular period Statement of Cash Flows

Shows a flow of actual receipts and payments for a particular period

How do these financial statements connect?

Make-a-BuckIncome Statement

For the year ended 30 June 2007

RevenueService Fees 20,000ExpensesWages 17,000Electricity 500 17,500

Profit/Loss 2,500

Make-a-BuckCash Flow Statement

for the year ended 30 June 2007

Cash Inflows 11,500

Cash Outflows 8,500

Net flows for the period 3,000

Beginning Balance 2,000

Ending Balance 5,000

Make-a-BuckStatement of Changes in EquityFor the year ended 30 June 2007

Opening Balance of Capital 5,500Add: additional funds contributed by owner 1,500

7,000Minus: drawings (500)

Add: Profit (or deduct loss) 2,500

Equals: Closing balance of capital (owner’s equity) 9,000

Make-a-BuckBalance Sheet

As at 30 June 2007

ASSETS 2007 2006

Cash 5,000 2,000 Trade Debtors 6,000

11,000Machinery 9,000

20,000LIABILITIESTrade Creditors 6,000Bank Loan 5,000

11,000

EQUITYCapital 9,000

TOTAL LIABILITIES & EQUITY 20,000

NOTE: Remember the accounting equation

ASSETS = LIABILITIES + EQUITY

Format (direct method)

Example: Ansell Ltd

Operating Activities Investing Activities Financing Activities

Cash at Beginning Cash at EndLtd

http://www.ansell.com/en/About/Investor-Center/Annual-Review-2014.aspx

Ansell Ltd (direct method)

operating

investing

financing

CashBalances

Comparative figures

Cash flows:

Balance Sheet 2014

Consolidated Income St 2014

Classification The Statement of Cash Flows is divided into 3 main sections –

1. operating activities – day-to-day activities including receipts and payments (NB: dividend receiptsare considered inflows)

Cash Inflows Receipt of cash from sale of goods or services Receipt of interest or dividends

Cash Outflows Payments to suppliers Payment of salaries and wages Payment of tax and interest

21

Operating Activities Activities relating to provision of goods and services

and other activities that are neither investing or financing activities

Activities reported in the income statement are adjusted from accrual to cash basis

Cash from operating activities shows ability to: generate cash meet short term obligations continue as a going concern expand

Classification cont.

2. investing activities – relate to the acquisition and/or disposal of non-current assets, and investments, (e.g. securities). Relates to the asset section of the balance sheet

Cash Inflows Sale of property, plant and equipment Receipt of loan payments Sale of equity in other entities

Cash Outflows Purchase of property, plant and equipment Making loans Purchase of equity in other entities

These items allow users to analyse future directions of the entity by studying major asset acquisitions and disposals

Classification cont.3. financing activities – activities that relate to

changing the size and/or composition of the financial structure of the entity (e.g. equity and borrowings). Relates to the non-current liability and equity section in the balance sheet

Cash Inflows: Borrowing cash Proceeds from share issues

Cash Outflows: Repayment of borrowed cash Payments to acquire or redeem the entity’s shares

Simple Example Revisited – Teresa’s carpets

Teresa’s Carpets and Rugs

Balance Sheet as at 30 April

Assets Liabilities

Current Current

Cash $78 750 Accounts Payable $35 000

Inventory $15 000 Non-current

Non-current Loan $50 000

Lease Prepaid $10000Less amortisation $ 167 $ 9 833

Equity

Shop Fixtures $20000Less accum deprec$ 334 $19 666

Capital Contrib $20 000+Retain Profit $18 249 $38 249

$123 249 $123 249

26

Assets Liabilities

Current Current


Inventory $15 000

Non-current



Equity



$123 249 $123 249

Income Statement for May

Sales $100 000

Less COGS

Beginning Inventory $15,000

+Purchases $50 000

$65 000

-End Inventory $10 000 $ 55 000

Gross Profit $ 45 000

Other Expenses

Depreciation $ 334

Interest $ 250

Marketing $ 5 000

Lease Prepaid $ 167

Lease Rent Payment $ 1 000 $ 6 751

Net Profit $ 38 249

Income Statement for April and May

Sales $140 000

Less COGS

Beginning Inventory $0

+Purchases $85 000

$85 000

-End Inventory $10 000 $ 75 000

Gross Profit $ 65 000

Other Expenses

Depreciation $ 668

Interest $ 500

Marketing $ 5 000

Lease Prepaid $ 334

Lease Rent Payment $ 2 000 $ 8 502

Net Profit $ 56 498


Balance Sheet as at 31 May

Assets Liabilities

Current Current


Inventory $15 000 Non-current



Equity



$123 249 $123 249

29

Assets Liabilities

Current Current


Accounts receivable $20 000 Non-current

Inventory $10 000 Loan $50 000

$147,500 Total liabilities $100 000

Non-current


Equity


Capital Contrib $20 000+April Profit $18 249 +May Profit $38 249

$76 498

$28 998

TOTAL ASSETS $176 498 TOTAL L + OE $176 498

30

Relationship to other financial statements Classified into three main sections

reflecting the major cash flow activities Operating activities Investing activities Financing activities

Non-current liabilities and equity in the balance sheet

Income statement revenue and

expenses; Current assets and

liabilities in the balance sheet

Non-current assets in the balance sheet


Cash Flow Statement For the period of April and May Cash flows from operating activitiesReceipts from customers ($40 000 + $80 000) $Payments to suppliers and employees ($35 000 + $2 000 + $5000) ($ )Dividends receivedInterest receivedInterest paid ($ )Income taxes paidNet Cash from operating activities $ Cash from Investing ActivitiesPayments for property, plant and equipment ($10 000 + $20 000) ($ )Proceeds from sale of property, plant and equipmentNet Cash from Investing Activities ($ )Cash from financing activitiesProceeds from issue shares/capital introduced $Proceeds from borrowings $Repayment of borrowingsDistributions PaidNet Cash flow from financing activities $

Net increase/decrease in cash for the year $Cash at the beginning of the financial year $Cash at the end of the financial year $

Teresa’s Carpets and Rugs - CFS SolutionCash Flow Statement For the period of April and May

Cash flows from operating activities

Receipts from customers ($40 000 + $80 000) 120,000

Payments to suppliers and employees ($35 000 + $2 000 + $5000) (42,000)

Dividends received 0

Interest received 0

Interest paid (500)

Income taxes paid 0

Net Cash from operating activities 77,500

Cash from Investing Activities

Payments for property, plant and equipment ($10 000 + $20 000) (30,000)

Proceeds from sale of property, plant and equipment 0

Net Cash from Investing Activities (30,000)

Cash from financing activities

Proceeds from issue shares/capital introduced 20,000

Proceeds from borrowings 50,000

Repayment of borrowings 0

Distributions Paid 0

Net Cash flow from financing activities 70,000

Net increase/decrease in cash for the year 117,500

Cash at the beginning of the financial year 0

Cash at the end of the financial year 117,500

Net cash flow..

Net Cash Flow versus Gross Cash Flow If positive, ‘net cash provided by ***

activities If negative, ‘net cash used in *** activities

Reconciliation

Standards require a reconciliation of cash flow from operating activities to the operating profit

Presented as a note to the accounts Called the ‘indirect method’ In Australia required to present ‘direct’ and

‘indirect’ (in notes) International standards give a choice

35

Reconciliation

Profit must be reconciled to net cash provided/used by operations

Allows users to see the changes in operating accounts brought about by use of accrual versus cash basis of accounting

Reconciliation must be disclosed in financial statements as a note to the accounts

JB Hi-Fi direct method 2014

Example of Indirect Method

Ansell Ltd (indirect method)

Summary of Indirect Method

This method not emphasised in course

Analysis & Evaluation

The evaluation of the Statement of Cash Flows includes an ‘eyeball’ analysis as well as the use of trend and ratio analysis.

“Eyeball”: You would expect operating activities to be positive (that is

their core activity) Normally you would expect investing activities to be

negative (shows investment in assets that will hopefully bring in cash from operations)

Normally you would expect financing activities to be positive (loans, etc. to help finance asset purchases)

Reconciliation can show inefficient management of working capital (current assets and current liabilities)

Evaluation (cont.)

Trend and ratio analysis Eg. Cash flow ratio (liquidity), debt coverage ratio

(solvency), cash flow to sales ratio (profitabiltity)

Capital adequacy ratio (Cash from operations/capital expenditure + dividends paid)

Liquidity ratio – cash flow ratio (Cash from operating activities/current liabilities)

Solvency ratio – the debt coverage ratio (NC liabilities/cash from operating activities) and

Profitability ratio – the cash flow to sales ratio (cash from operating activities/net sales).

Free cash flow Represents the free cash an entity has

available to repay debt, pay dividends and expand operations

Capital investments for PPE to maintain existing operations

Free cash flowCash from operating activities

–=

The Working Capital Cycle

Raw Materials

Work in Process

Finished Goods

Trade Debtors

Cash

Trade Creditors

What is Working Capital?

Current Assets less Current Liabilities

Current AssetsCurrent Assets Current LiabilitiesCurrent Liabilities

CashCash Trade CreditorsTrade Creditors

Trade DebtorsTrade Debtors

InventoriesInventories

Analysis

The statement of cash flow can provide warning signals Cash received compared to cash paid Operating outflow Cash from operations compared to after tax

profit Proceeds from share capital, investments and

borrowings Loss of cash on a continual basis

What does this table illustrate?

Source: Montgomery, R. 2011, Eureka Report, p.25.

p.303

Basic finance is relevant at all levels

If the US Government was a family, they would be making $58,000 a year, spending $75,000 a year, and have $327,000 in credit card debt. They are currently proposing BIG spending cuts to reduce their spending to $72,000 a year. These are the actual proportions of the federal budget and debt, reduced to a level that we can understand.” Wesley LeGrand, Grand Private Equities, July 2011.

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