Understanding Statements of Cash flows

IAS 7: STATEMENT OF CASH FLOWS

Objective of IAS 7

The objective of IAS 7 is to require the presentation of information about the historical changes in cash and cash equivalents of an entity by means of a statement of cash flows, which classifies cash flows during the period according to operating, investing, and financing activities.

Introduction

As much as it is important for a company to make profits, it must also generate cash in order to facilitate continuity of its operations. The statement of cash flow therefore helps to show the cash generated and issued.

Accounting concepts of accruals and matching are normally used to compute a figure which shows additional wealth created for the business owners during the accounting period (profits). Profits represent an increase in net assets in the statement of financial position during the accounting period.

Presentation of the statement of Cash Flow

Cash flows must be analyzed into operating, investing and financing activities.

Key principles specified by IAS 7 for the preparation of a statement of cash flows are as follows:

1. Operating activities are the main revenue-producing activities of the entity that are not investing or financing activities, so operating cash flows include cash received from customers and cash paid to suppliers and employees.
2. Investing activities are the acquisition and disposal of long-term assets and other investments that are not considered to be cash equivalents.
3. Financing activities are activities that alter the equity capital and borrowing structure of the entity.
4. Cash means the cash in hand and deposits available on demand e.g current a/c.
5. Cash Equivalent these are short term highly liquid investments that are readily convertible to known amounts and subject to insignificant risk of changes in value e.g treasury bills.

NOTE:

1.       Interest and dividends received and paid may be classified as operating, investing, or financing cash flows, provided that they are classified consistently from period to period

2.       Cash flows arising from taxes on income are normally classified as operating, unless they can be specifically identified with financing or investing activities.

3.       For operating cash flows, the direct method of presentation is encouraged, but the indirect method is acceptable.

Proforma of the Statement of Cash Flow:

                          ABC Ltd Statement of Cash Flow for the year ended XXXX

Cash Flow from Operating Activities:	$	$
Cash generated from Operations	xx
Less: Interest Paid	(xx)
Less: Dividends Paid	(xx)
Less: Income Tax Paid	(xx)
Net Cash from/used in Operating Activities		xx/(xx)
Cash Flow from Investing Activities:
Purchase of PPE	(xx)
Proceeds from sale of NCA	xx
Interest Received	xx
Dividends Received	xx
Net Cash from/ used in Investing Activities		xx/(xx)
Cash Flow from Financing Activities:
Proceeds on issue of shares	xx
Repayment of loans	(xx)
Net cash from/used in Financing Activities		xx/(xx)
Net Increase/ Decrease in Cash and Cash Equivalent		xx/(xx)
Add: Cash and Cash Equivalent at the Beginning of the Period		xx
Cash and Cash Equivalent at the end of the Period		xx

Cash Flow from Operating Activities

There are two methods of calculation of the cash generated from operations:

·         Direct Method

·         Indirect Method

1.       Direct Method

The direct method shows each major class of gross cash receipts and gross cash payments. The operating cash flows section of the statement of cash flows under the direct method would appear something like this:

Cash receipts from customers              xx

Less: Cash paid to suppliers                xx

Less: Cash paid to employees              xx

Example1: Direct Method

Statement of Financial Position

	20X1	20X2
Non Current Assets	153,364	149,364
Inventories	-	-
Receivables	265,840	346,000
Cash	-	165,166
Total Assets	410,204	660,530
Share Capital	200,000	200,000
Reserves	-	141,640
	219,204	318,890
Total Capital and Liabilities	410,204	660530

Extract of income Statement 20X2

	$	$
Sales		1,589,447
Cost of Sales
Purchases	1,105,830
Wages and Salaries	145,900	(1,251,730)
Administration
Purchases	96,077
Salaries	100,000	(196,077)
Operating and Retained profits		141,640

Additional information:

1)      Payables

	20X1	20X2
Non Current Assets	-	46,000
Other Payables	210,564	258,240
Wages Accrued	8,640	14,650

2)      Purchase invoice relating to acquisition of NCAs totaling $80,000 has been posted to the payables ledger during the year.

Required:

Using Direct Method, calculate the cash from operating activities.

2.       Indirect Method

The indirect method adjusts accrual basis net profit or loss for the effects of non-cash transactions. It reconciles the profit before tax (as reported in the income statement). The operating cash flows section of the statement of cash flows under the indirect method would appear something like this:

Profit Before Tax	xx
Add: Finance Costs/non operating	xx
Less: Investment Income/non operating	(xx)
Add: Depreciation charge/non cash impairments/ discounts unwound	Xx
Add: Amortization of Goodwill (if any)	xx
Loss/Profit on Disposal of NCA/ non operating	xx/(xx)
Increase/Decrease in Inventories	(xx)/xx
Increase/ Decrease in Receivables	(xx)/xx
Increase/ Decrease in Payables	xx/(xx)
Cash Generated from Operations	xx

NB: Interest expense/ finance cost is added back because it is not part of the cash generated from operations while Depreciation is a non cash expense.

Example 1: Indirect Method

XYZ Ltd has the following SOFP and IS.

Statement of Financial Position

	2006	2005
	$000	$000
Non Current Assets	1048	750
Accumulated Depreciation	(190)	(120)
Net Book Value	858	630
Current Assets
Inventories	98	105
Trade Receivables	102	86
Dividends Receivable	57	50
Cash	42	18
Total Current Assets	299	259
Total Assets	1157	889
Capital and reserves
Share Capital	200	120
Share Premium	106	80
Revaluation Reserve	212	12
Accumulated Profits	283	226
Total C and R	801	438
Non Current Liabilities
Loan	200	300
Current Liabilities
Trade Payables	47	52
Dividends Payable	30	27
Interest Accrued	3	5
Tax	76	67
Total C. L	156	151
Total Capital and Liabilities	1157	889

Income statement for the year ended 31^st December, 2006.

	$000	$000
Sales		1,100
Cost of sales		(678)
Gross Profit		422
Less: Operating Expenses		(309)
Operating Profit		113
Add: Investment Income
- Interest	15
- Dividends	57	72
Less: Finance Charges		(22)
Less: Income Tax		(71)
Net Profit for the year		92

Additional Information:

1.       Operating expenses include a loss on disposal of Non Current Assets of $5,000.

2.       During the year, plant which had originally cost $80,000 and depreciation of $15,000 was disposed off.

Required:

1.      Calculate the cash generated from operations using indirect method

2.      Prepare XYZ Statement of Cash Flow for the year ended 31^st December, 2006.