Cash Flow StatementCash Flow Statement

Cash Cash

• Cash is king. It is relatively easy to Cash is king. It is relatively easy to “manufacture” profits but creating “manufacture” profits but creating cash is virtually impossiblecash is virtually impossible

(UBS Philips and Drew Jan 1991.Accounting for (UBS Philips and Drew Jan 1991.Accounting for Growth)Growth)

Cash flow statementCash flow statement

• It is defined as a statement prepared It is defined as a statement prepared periodically that summarises the cash flows periodically that summarises the cash flows into and out of a businessinto and out of a business

• A cash flow statement records the inflow and A cash flow statement records the inflow and outflow of cash over a period of timeoutflow of cash over a period of time

• The statement is required under FRS1The statement is required under FRS1• It differs from a cash flow forecast in that it It differs from a cash flow forecast in that it

concerns what has happened rather than what concerns what has happened rather than what is expected to happenis expected to happen

• It is different from a profit and loss account in It is different from a profit and loss account in that it concerns cash flow not accounting profitthat it concerns cash flow not accounting profit

How does it differ from a P&L How does it differ from a P&L Account?Account?• A cash statement is concerned with movements of cash A cash statement is concerned with movements of cash

into and out of the businessesinto and out of the businesses• A cash statements does not feature “promised” moneys A cash statements does not feature “promised” moneys

or paymentsor payments• It ignores non cash expenses. For instance, depreciation It ignores non cash expenses. For instance, depreciation

is a negative item on a P&L account but as it does not is a negative item on a P&L account but as it does not involve a flow of cash into or out of a business and involve a flow of cash into or out of a business and therefore it is not part of a cash flow statementtherefore it is not part of a cash flow statement

• A P&L account does not include spending on capital – but A P&L account does not include spending on capital – but cash spending on capital items is recorded in a cash flow cash spending on capital items is recorded in a cash flow statementstatement

• The cash flow statement includes all movements of cash The cash flow statement includes all movements of cash whether for operating or non-operating reasonswhether for operating or non-operating reasons

How does it differ from a P&L How does it differ from a P&L Account?Account?• The P&L account summaries sales during the accounting The P&L account summaries sales during the accounting

period and the expenses linked to those sales.period and the expenses linked to those sales.• Sales are included in a P&L when the sale occurs – not Sales are included in a P&L when the sale occurs – not

when the cash flows in. Credit sales in 2005 will raise the when the cash flows in. Credit sales in 2005 will raise the level of sales revenue in 2005 even if cash does not flow level of sales revenue in 2005 even if cash does not flow until 2006until 2006

• A P&L account records income and expenses at the time A P&L account records income and expenses at the time of sales - not when cash flows of sales - not when cash flows

• Stock purchases linked to those sales are included at the Stock purchases linked to those sales are included at the time of the purchase whether or not the stock has been time of the purchase whether or not the stock has been paid forpaid for

• In a cash flow statement we are only concerned with In a cash flow statement we are only concerned with flows of cash at the time of the actual flowflows of cash at the time of the actual flow

What is in the P&L but not in a What is in the P&L but not in a cash flow statement?cash flow statement?

• Sales on creditSales on credit

• Purchase of stock on creditPurchase of stock on credit

• Tax charge not yet paidTax charge not yet paid

• Write off of bad debt and stockWrite off of bad debt and stock

• Depreciation of fixed assetsDepreciation of fixed assets

What is in a cash flow What is in a cash flow statement but not in the P&L?statement but not in the P&L?

• Cash purchase of stock not used during the yearCash purchase of stock not used during the year

• Payments to creditorsPayments to creditors

• Cash purchase of fixed assetCash purchase of fixed asset

• Payment of dividendPayment of dividend

• Cash payment for redemption of sharesCash payment for redemption of shares

• Payment by credit customersPayment by credit customers

• Cash from sale of fixed assetsCash from sale of fixed assets

• Cash from loans receivedCash from loans received

• Cash received from share issueCash received from share issue

Cash flow statement v P&LCash flow statement v P&LCash flow Cash flow statementstatement

Profit and Loss Profit and Loss AccountAccount

SalesSales Only when cash Only when cash receivedreceived

Include all salesInclude all sales

Purchases of Purchases of stock stock

Only when paid forOnly when paid for Include all purchases Include all purchases associated with the associated with the year’s salesyear’s sales

Opening/closing Opening/closing stockstock

Not includedNot included Part of calculation of Part of calculation of gross profitgross profit

Expenses without Expenses without any period of any period of creditcredit

Included Included Included Included

Depreciation Depreciation Not includedNot included Included as an Included as an expenseexpense

Cash v profitsCash v profits

Cash flowCash flow

==

Cash inflow (cash Cash inflow (cash paid)paid)

minusminus

Cash outflow (cash Cash outflow (cash received) received)

Profit Profit

==

Income earnedIncome earned

minusminus

Expenses incurredExpenses incurred

What the cash flow What the cash flow statement showsstatement shows• How cash flows (either positive or How cash flows (either positive or

negative) have been generated over the negative) have been generated over the yearyear

• Major financing activities for the yearMajor financing activities for the year

• How the company met its obligations to How the company met its obligations to service loans and pay dividendsservice loans and pay dividends

• How and in what way reported profits How and in what way reported profits differ from related cash flows during the differ from related cash flows during the yearyear

Advantages of cash Advantages of cash accountingaccounting• Focuses attention on the critical issue of cash Focuses attention on the critical issue of cash

generationgeneration• Cash is more objective than profitCash is more objective than profit• Creditors are more interested in a firm’s ability Creditors are more interested in a firm’s ability

to repay debts than its profitabilityto repay debts than its profitability• Cash is an easy concept for users to understandCash is an easy concept for users to understand• The P&L Account can be more easily window-The P&L Account can be more easily window-

dresseddressed• Declared profits may give a false impression if Declared profits may give a false impression if

sales are mainly credit salessales are mainly credit sales• Cash and liquidity are essential for business Cash and liquidity are essential for business

survivalsurvival

Sources and uses of cashSources and uses of cash

SourcesSources• Cash from salesCash from sales• Cash injections of capitalCash injections of capital• Long term borrowingLong term borrowing• Cash proceeds from the Cash proceeds from the

disposal of fixed assetsdisposal of fixed assets• Interest received from Interest received from

bank deposit accountsbank deposit accounts

UsesUses • CashCash toto meetmeet tradingtrading

expensesexpenses• CashCash paymentspayments toto supplierssuppliers• CashCash paymentspayments forfor servicesservices• CashCash purchasepurchase ofof newnew fixedfixed

assetsassets• RepaymentRepayment ofof longlong termterm

loansloans• InterestInterest paidpaid onon loansloans• TaxTax paymentspayments• WithdrawalWithdrawal ofof capitalcapital byby

ownersowners

Headings in a cash flow Headings in a cash flow statementstatement• Net cash flow from operating activitiesNet cash flow from operating activities• Returns on investment and servicing of financeReturns on investment and servicing of finance• TaxationTaxation• Capital and financial investmentCapital and financial investment• Acquisitions and disposalsAcquisitions and disposals• Equity dividends paidEquity dividends paid• Management of liquid assetsManagement of liquid assets• Net cash flow before financingNet cash flow before financing• FinancingFinancing• Increase/decrease in cashIncrease/decrease in cash

A simple cash flow statement - A simple cash flow statement - exampleexample

Net cash flow from operating activitiesNet cash flow from operating activities 11001100

Return on investment and servicing of Return on investment and servicing of financefinance

(100(100))

Taxation Taxation (200(200))

Capital expenditure and financial Capital expenditure and financial investmentsinvestments

(900(900))

Net cash flow before financingNet cash flow before financing (100(100))

Financing Financing 500500

Increase/decrease in cashIncrease/decrease in cash 400400

Commentary on the example Commentary on the example cash flow statementcash flow statement• There was a net cash inflow of £1,100,000 from There was a net cash inflow of £1,100,000 from

normal trading operationsnormal trading operations• Interest paid net of interest received meant an Interest paid net of interest received meant an

outflow of £100,000outflow of £100,000• A tax bill of £200,000 was paidA tax bill of £200,000 was paid• There was expenditure of £900,000 on new There was expenditure of £900,000 on new

fixed assetsfixed assets• So far there was a net outflow of £100,000So far there was a net outflow of £100,000• £500,000 was raised by a share issue£500,000 was raised by a share issue• At the end of the accounting period there was a At the end of the accounting period there was a

£400,000 increase in cash shown in the balance £400,000 increase in cash shown in the balance sheetsheet

Tesco’s cash flow for 2005 Tesco’s cash flow for 2005 (£m)(£m)Net cash inflow from operating activitiesNet cash inflow from operating activities 3,0043,004

Dividends from joint venture and associatesDividends from joint venture and associates 135135

Net cash outflow from returns on investment and Net cash outflow from returns on investment and servicing of financeservicing of finance

(263) (263)

Taxation Taxation (483)(483)

Net cash outflow from capital expenditure and financial Net cash outflow from capital expenditure and financial investmentsinvestments

(1,458)(1,458)

Net cash outflow from acquisitions and disposalsNet cash outflow from acquisitions and disposals (228)(228)

Equity dividend paid Equity dividend paid (448)(448)

Management of liquid reserves- decrease in short term Management of liquid reserves- decrease in short term depositsdeposits

9797

Net cash outflow from financingNet cash outflow from financing (235)(235)

Increase in cashIncrease in cash (121) (121)

Net cash flow from Net cash flow from operating activitiesoperating activities• This refers to cash flows from the normal This refers to cash flows from the normal

trading activities of the businesstrading activities of the business– Cash received from customersCash received from customers– Cash paid to suppliersCash paid to suppliers– Cash paid to employeesCash paid to employees

• Broadly it is equal to the operating profit Broadly it is equal to the operating profit (net profit, before deduction of interest) of (net profit, before deduction of interest) of the business before adjustments relating tothe business before adjustments relating to– depreciation charge for the yeardepreciation charge for the year– changes in debtors, creditors and stockchanges in debtors, creditors and stock

Cash flow from operating Cash flow from operating activitiesactivities

• This involves reconciliation between This involves reconciliation between operating profits and net cash flow from operating profits and net cash flow from operating activitiesoperating activities

• Convert operating profits into net cash Convert operating profits into net cash flow by:flow by:

• Adding back depreciation (a non-cash Adding back depreciation (a non-cash item)item)

• Adjusting for changes in working capitalAdjusting for changes in working capital

Net cash inflow from operatingNet cash inflow from operating activities equals….activities equals….

• Net profit (before interest and tax)Net profit (before interest and tax)

• Plus depreciation for the yearPlus depreciation for the year

• Plus decrease in debtors ( deduct Plus decrease in debtors ( deduct increase in debtors)increase in debtors)

• Plus increase in creditors (deduct Plus increase in creditors (deduct decrease in creditors)decrease in creditors)

• Plus decrease in stock (deduct Plus decrease in stock (deduct increase in stock)increase in stock)

Why the adjustments?Why the adjustments?

• Depreciation is excluded because it does Depreciation is excluded because it does not represent a cash costnot represent a cash cost

• Changes in creditor and debtor balances Changes in creditor and debtor balances are included because they represent an are included because they represent an inflow or outflow of cash to the businessinflow or outflow of cash to the business

• Reduction in debtors = cash inflowReduction in debtors = cash inflow• Increase in debtors = cash outflowIncrease in debtors = cash outflow• Increase in creditors = cash inflowIncrease in creditors = cash inflow• Decrease in debtors = cash outflowDecrease in debtors = cash outflow

Returns on investment and Returns on investment and servicing of financeservicing of finance• Cash received from investments minus cash paid Cash received from investments minus cash paid

on loans and dividends. This shows dividend on loans and dividends. This shows dividend received together with interest paid and receivedreceived together with interest paid and received

• It is the net result of inflow from investments and It is the net result of inflow from investments and outflow in the form of cost of financeoutflow in the form of cost of finance

• InflowsInflows– Investment incomeInvestment income– Interest receivedInterest received– Dividends receivedDividends received

• OutflowsOutflows– Interest paidInterest paid– Dividends paidDividends paid

Taxation Taxation

• Payments of taxes on profits, sales Payments of taxes on profits, sales revenue and capital gainsrevenue and capital gains

• Usually an Usually an outflowoutflow - corporation tax paid - corporation tax paid by limited companies during the yearby limited companies during the year

• On occasions it can be an inflow if the On occasions it can be an inflow if the company has obtained a repayment of company has obtained a repayment of corporation taxcorporation tax

• Not VAT - which comes under operating Not VAT - which comes under operating activitiesactivities

Capital expenditureCapital expenditure

• Cash flows relating to the purchase and sale Cash flows relating to the purchase and sale of fixed assets and investmentof fixed assets and investment

• Cash Inflow from: Cash Inflow from: – sale proceeds from fixed assets and investmentsale proceeds from fixed assets and investment– sale of plant and machinery sale of plant and machinery – the sale of businessesthe sale of businesses

• Cash Outflow from:Cash Outflow from:– purchase cost of fixed assets and investmentspurchase cost of fixed assets and investments– cash outflow from the purchase of fixed assets cash outflow from the purchase of fixed assets

and subsidiariesand subsidiaries

Net cash outflow from capital Net cash outflow from capital expenditureexpenditure

• Expenditure on new fixed assets less Expenditure on new fixed assets less receipts from sale or disposal of such receipts from sale or disposal of such itemsitems

• Usually a negative (net outflow) Usually a negative (net outflow)

• But can be positive if proceeds from But can be positive if proceeds from sale exceed cash outflowsale exceed cash outflow

Acquisitions and disposalsAcquisitions and disposals

• Payments for the purchase or sale of other Payments for the purchase or sale of other companiescompanies

• Inflows: sale proceeds from investment and Inflows: sale proceeds from investment and interests ininterests in– subsidiary companiessubsidiary companies– associated companiesassociated companies– joint venturesjoint ventures

• Outflows-purchase costs of investments in Outflows-purchase costs of investments in – subsidiary companiessubsidiary companies– associated companiesassociated companies– interests in joint venturesinterests in joint ventures

Equity dividends paidEquity dividends paid

• An outflow An outflow

• The amount of dividend paid to The amount of dividend paid to equity (ordinary) shareholders during equity (ordinary) shareholders during the year the year

• In the case of a sole trade or In the case of a sole trade or partnership the drawings will be partnership the drawings will be shownshown

Management of liquid Management of liquid assetsassets

• InflowsInflows– sale proceeds from short term sale proceeds from short term

investment that are almost as good as investment that are almost as good as cash e.g. treasury bills and term cash e.g. treasury bills and term deposits of up to a year with a bankdeposits of up to a year with a bank

• OutflowsOutflows– purchase of short term liquid purchase of short term liquid

investmentsinvestments

Net cash flow before Net cash flow before financingfinancing• This is the sum of all previous sectionsThis is the sum of all previous sections• Net cash flow from operating activitiesNet cash flow from operating activities• PlusPlus net cash flow from investments and net cash flow from investments and

servicing of financeservicing of finance• Plus Plus net cash from capital expenditurenet cash from capital expenditure• Minus Minus taxation taxation • Minus Minus equity dividends paidequity dividends paid• It is the net cash result of running the It is the net cash result of running the

business in the period concerned after business in the period concerned after paying taxes and dividendpaying taxes and dividend

• But if does not include any financingBut if does not include any financing

Financing Financing

• Cash flows relating to the issue or buying Cash flows relating to the issue or buying back of shares or loan capitalback of shares or loan capital

• Cash inflow from :Cash inflow from :– the issue of sharesthe issue of shares– the issue of debentures the issue of debentures – new loansnew loans

• Cash outflow: Cash outflow: – repayment of loansrepayment of loans– redemption of sharesredemption of shares

Change in cashChange in cash

• The final total shows the absolute change in The final total shows the absolute change in cash levels between the tow balance sheet cash levels between the tow balance sheet datesdates

• The subtotals from the previous areas of The subtotals from the previous areas of the statement activity are totalled to give the statement activity are totalled to give the increase/ decrease in cash for the yearthe increase/ decrease in cash for the year

• If this item is positive it will mean that the If this item is positive it will mean that the firm’s holdings of cash have risenfirm’s holdings of cash have risen

• If negative, then cash holdings have fallenIf negative, then cash holdings have fallen

A final thoughtA final thought

• Writing about the collapse of Enron in Writing about the collapse of Enron in the USA Jack Welch, a successful the USA Jack Welch, a successful American businessman:American businessman:

• ““There’s one thing you can’t cheat on There’s one thing you can’t cheat on and that’s cash and Enron didn’t have and that’s cash and Enron didn’t have any cash for the last three years. any cash for the last three years. Accounting is odd, but cash is real stuff. Accounting is odd, but cash is real stuff. Follow the cash”Follow the cash”

(Guardian 27.2/02)(Guardian 27.2/02)