Measuring cash flowsMeasuring cash flows

Prepared by: Prepared by: Muhammad zubairMuhammad zubair

Roll# 7170Roll# 7170GOVERNMENT COLLEGE UNIVERSITY GOVERNMENT COLLEGE UNIVERSITY

FAISALABAD FAISALABAD BANKING & FINANCE BANKING & FINANCE

History & variationHistory & variation Prior to 1988, the financial statement showing the sources and uses liquid Prior to 1988, the financial statement showing the sources and uses liquid

resources was called a “resources was called a “Statement of Changes in Financial PositionStatement of Changes in Financial Position”. ”. Informally, this statement was often termed as Informally, this statement was often termed as “Funds Statement“Funds Statement”. Some ”. Some companies prepared funds statement showing the sources and uses of cash. companies prepared funds statement showing the sources and uses of cash. Other companies however, prepared funds statements showing the sources Other companies however, prepared funds statements showing the sources and uses of working capital or some other type of “Liquid Resources”. As a and uses of working capital or some other type of “Liquid Resources”. As a result, “Funds Statement” or “Statement of changes in financial position” result, “Funds Statement” or “Statement of changes in financial position” prepared by different companies varied greatly in content. This created prepared by different companies varied greatly in content. This created difficulties for investors in comparing the Funds Statements of different difficulties for investors in comparing the Funds Statements of different companies.companies.

To solve this problem the Financial Accounting Standards Board (To solve this problem the Financial Accounting Standards Board (FASB)FASB) stated that beginning in 1988 al companies should discontinue the statement stated that beginning in 1988 al companies should discontinue the statement of changes in financial position and instead prepare a “of changes in financial position and instead prepare a “Statement ofStatement of Cash Cash FlowsFlows””..[1][1] The FASB provided considerably more guidance as to the form The FASB provided considerably more guidance as to the form and content of the new statement of cash flows than it did for the old funds and content of the new statement of cash flows than it did for the old funds statement. To avoid confusion between the old “Funds Statement” and the statement. To avoid confusion between the old “Funds Statement” and the new statement of cash flows, the FASB has asked companies to new statement of cash flows, the FASB has asked companies to avoidavoid the the use of the word use of the word “Funds“Funds” in the new financial statement. In 1992 the ” in the new financial statement. In 1992 the “International Accounting Standards Board” “International Accounting Standards Board” (IASB) (IASB) issued international issued international accounting standard 7 (IAS 7) cash flows statements which became effective accounting standard 7 (IAS 7) cash flows statements which became effective in 1994.in 1994.

[1][1] FASB. Statement No. 95, “Statement of Cash Flows” (Norwalk, Conn.: FASB. Statement No. 95, “Statement of Cash Flows” (Norwalk, Conn.: 1987), Para. 34.1987), Para. 34.

Differences between FASB & ISA Differences between FASB & ISA 7 rules7 rules

The The Financial Accounting Standards BoardFinancial Accounting Standards Board  (FASB)(FASB) defined rules that made defined rules that made it mandatory under it mandatory under Generally Accepted Accounting PrinciplesGenerally Accepted Accounting Principles  (US GAAP)(US GAAP) and and (IAS 7)(IAS 7) rules for cash flow statements are similar, but some of the rules for cash flow statements are similar, but some of the differences are:differences are:

IAS 7 requires that the cash flow statement include changes in both cash IAS 7 requires that the cash flow statement include changes in both cash and cash equivalents. US GAAP permits using cash alone or cash and cash and cash equivalents. US GAAP permits using cash alone or cash and cash equivalents. equivalents.

IAS 7 permits bank borrowings (overdraft) in certain countries to be IAS 7 permits bank borrowings (overdraft) in certain countries to be included in cash equivalents rather than being considered a part of included in cash equivalents rather than being considered a part of financing activities. financing activities.

IAS 7 allows interest paid to be included in operating activities or financing IAS 7 allows interest paid to be included in operating activities or financing activities. US GAAP requires that interest paid be included in operating activities. US GAAP requires that interest paid be included in operating activitiesactivities

US GAAP (FAS 95) requires that when the direct method is used to present US GAAP (FAS 95) requires that when the direct method is used to present the operating activities of the cash flow statement, a supplemental the operating activities of the cash flow statement, a supplemental schedule must also present a cash flow statement using the indirect schedule must also present a cash flow statement using the indirect method. The IASC strongly recommends the direct method but allows method. The IASC strongly recommends the direct method but allows either method. The IASC considers the indirect method less clear to users either method. The IASC considers the indirect method less clear to users of financial statements. Cash flows statements are most commonly of financial statements. Cash flows statements are most commonly prepared using the indirect method, which is not especially useful in prepared using the indirect method, which is not especially useful in projecting future cash flows.projecting future cash flows.

Importance:Importance:

The official name of cash flows The official name of cash flows statement is “Statement of Cash statement is “Statement of Cash Flows”. It’s the third major financial Flows”. It’s the third major financial statement in accounting. It can be statement in accounting. It can be prepare monthly, quarterly, half prepare monthly, quarterly, half yearly and yearly.yearly and yearly.

Cash flows?Cash flows?

A term describing both the cash A term describing both the cash receipt and cash payments receipt and cash payments

Statement of Cash Flows?Statement of Cash Flows?

A statement in which cash receipts A statement in which cash receipts and cash payments of operating, and cash payments of operating, investing and financing activities are investing and financing activities are mentioned.mentioned.

PURPOSE OF THE PURPOSE OF THE STATEMENTSTATEMENT::

The basic purpose of a statement of cash flows is to provide The basic purpose of a statement of cash flows is to provide information about the Cash Receipts and Cash Payments of information about the Cash Receipts and Cash Payments of a business entity during the accounting period. A statement a business entity during the accounting period. A statement of cash flows assists investors, creditors and others in of cash flows assists investors, creditors and others in assessing such factors as:assessing such factors as:

The company’s ability to generate positive cash flows in The company’s ability to generate positive cash flows in future periods.future periods.

The company’s ability to meet its obligations and to pay The company’s ability to meet its obligations and to pay dividends.dividends.

The company’s need for external financing.The company’s need for external financing. Both the cash and noncash aspects of the company’s Both the cash and noncash aspects of the company’s

investment and financing transactions for the period.investment and financing transactions for the period. Causes of the change in the amount of cash and cash Causes of the change in the amount of cash and cash

equivalents between the beginning and at the end of the equivalents between the beginning and at the end of the accounting period accounting period

Classification of Cash flows:Classification of Cash flows:

Operating activities Operating activities Investing Activities Investing Activities Financing Activities Financing Activities Effects of changes in exchange rates Effects of changes in exchange rates

on cashon cash

Operating activities Operating activities

Collection from customers for sales of Collection from customers for sales of goods and services goods and services

Interest and dividends received Interest and dividends received Other receipts from operations Other receipts from operations Payments to suppliers of merchandise and Payments to suppliers of merchandise and

services, including payments to employees services, including payments to employees Payments of interestPayments of interest Payments of income taxes Payments of income taxes Other expenditures relating to operations Other expenditures relating to operations

Investing Activities Investing Activities

Cash proceeds from selling Cash proceeds from selling investments or plant assets or fixed investments or plant assets or fixed assets assets

Cash proceeds from collecting Cash proceeds from collecting principal amounts on loans principal amounts on loans

Payments to acquire investments or Payments to acquire investments or plant assets or fixed assets plant assets or fixed assets

Amounts advanced to borrowersAmounts advanced to borrowers

Financing Activities Financing Activities

Proceeds from both short term and Proceeds from both short term and long term borrowing long term borrowing

Cash received from owners e.g. Cash received from owners e.g. issuing stocks and debentures issuing stocks and debentures

Payments of amounts borrows Payments of amounts borrows excluding interest payments excluding interest payments

Payments to owners such as cash Payments to owners such as cash dividendsdividends

Supplementary scheduleSupplementary schedule

Companies using the direct method are Companies using the direct method are required to provide a “required to provide a “supplementary supplementary scheduleschedule” illustrating the computation ” illustrating the computation of net cash flow from operating of net cash flow from operating activities by the indirect method. activities by the indirect method. Therefore, supplementary schedule is Therefore, supplementary schedule is also a compulsory part of statement of also a compulsory part of statement of cash flows if the company is following cash flows if the company is following Direct Method.Direct Method.

Cash and Cash Cash and Cash EquivalentsEquivalents

The “FASB” has defined “Cash” as The “FASB” has defined “Cash” as including both “cash and cash including both “cash and cash equivalents”. “Cash Equivalents” are equivalents”. “Cash Equivalents” are short term highly liquid Investments, short term highly liquid Investments, such as money market funds, such as money market funds, commercial paper and treasury bills commercial paper and treasury bills

Adjustments (operating Adjustments (operating activities)activities)

1.1. Cash received from customersCash received from customers

2.2. Interest and Dividend receivedInterest and Dividend received

3.3. Payments for PurchasesPayments for Purchases

4.4. Cash payments for expensesCash payments for expenses

Cash received from Cash received from customerscustomers

Net sales Net sales

Add Decrease in accounts Add Decrease in accounts receivablereceivable

Less Increase in accounts receivableLess Increase in accounts receivable

Net cash received from customers Net cash received from customers

Interest and Dividend Interest and Dividend receivedreceived

Interest revenue Interest revenue

Add Decrease in interest Add Decrease in interest receivablereceivable

Less Increase in interest receivableLess Increase in interest receivable

Net interest received Net interest received

Payments for PurchasesPayments for Purchases

Cost of goods sold Cost of goods sold

Add increase in inventoryAdd increase in inventory

Less decrease in inventoryLess decrease in inventory

Add decrease in accounts payableAdd decrease in accounts payable

Less increase in accounts payableLess increase in accounts payable

Net cash payments for purchases Net cash payments for purchases

Cash payments for Cash payments for expensesexpenses

ExpensesExpenses

Less Less Depreciation Depreciation

Add Add Increase in related expenseIncrease in related expense

Less Less Decrease in related expenseDecrease in related expense

Less Less Increase in related liabilityIncrease in related liability

Add decrease in related liability Add decrease in related liability

Net cash payments for expenses Net cash payments for expenses

Reporting MethodsReporting Methods

Direct MethodDirect Method Indirect MethodIndirect Method

Direct MethodDirect Method

A method of reporting net cash flows A method of reporting net cash flows from operating activities by listing from operating activities by listing specific types of cash inflows and specific types of cash inflows and outflows. This is the method outflows. This is the method recommended by the FASB recommended by the FASB

Indirect MethodIndirect Method

A format of reporting net cash flows A format of reporting net cash flows from operating activities that from operating activities that reconciles this figure with the reconciles this figure with the amount of net income shown in the amount of net income shown in the income statement. Both the methods income statement. Both the methods almost same, the difference is only in almost same, the difference is only in calculating cash flows from operating calculating cash flows from operating activities activities

Format (indirect method) for Format (indirect method) for operating activitiesoperating activities

NET INCOMENET INCOMEAdd Add depreciation, amortization of intangible and depletiondepreciation, amortization of intangible and depletion Decrease in accounts receivableDecrease in accounts receivable Decrease in inventoriesDecrease in inventories Decrease in prepaid expensesDecrease in prepaid expenses

Increase in accounts payableIncrease in accounts payable Increase in accrued exp. PayableIncrease in accrued exp. Payable Increase in deferred income taxes payableIncrease in deferred income taxes payable Non operating loss deducted in computing net incomeNon operating loss deducted in computing net incomeDeduct Deduct Increase in accounts receivable, inventoriesIncrease in accounts receivable, inventories Increase in prepaid expensesIncrease in prepaid expenses Decrease in accounts P/A, accrued expenses P/ADecrease in accounts P/A, accrued expenses P/A Non cash gains included in net incomeNon cash gains included in net income Net cash flows from operating activities Net cash flows from operating activities

NOTE:NOTE:Remaining format same like Direct Method, therefore that is not explained.Remaining format same like Direct Method, therefore that is not explained.