OVERVIEW
Objective
¾
To provide information about historical changes in cash and cash equivalents by means of a statement of cash flows which classifies cash flows during the period fromoperating, investing and financing activities.
PRESENTATION OF A STATEMENT
OF CASH FLOW
INVESTING AND FINANCING
ACTIVITIES OPERATING
ACTIVITIES
PROFORMA
¾ Classification
¾ Direct method ¾ Indirect method ¾ Techniques ¾ Which method?
¾ Separate reporting ¾ Investing activities ¾ Financing activities
¾ Direct method ¾ Indirect method
¾ Notes to the cash flow statement
INTRODUCTION ¾¾ Applies to all entities Importance of cash flow
¾ Benefits of cash flow information ¾ Definitions
DISCLOSURES
¾ Analysis of cash and cash
equivalents
¾ Major non cash transactions
1
INTRODUCTION
1.1
Applies to all entities
¾
Users of financial statement are interested in cash generation regardless of the nature of the entity’s activities.¾
Entities need cash for essentially the same reasons: to conduct operations; to pay obligations;
to provide returns to investors.
¾
Profit is not the same as cash . . . . and profitability does not mean liquidity (even profitable companies “crash”).1.2
Importance of cash flow
¾
To show that profits are being realised(e.g. that trade receivables are being recovered).
¾
To pay dividends.¾
To finance further investment (which will generate more cash).1.3
Benefits of cash flow information
¾
Provides information that enables users to evaluate changes in: net assets;
financial structure (including its liquidity and solvency);
ability to affect amounts and timing of cash flows
(
to adapt to changingcircumstances and opportunities).
¾
Useful in assessing ability to generate cash and cash equivalents.¾
Users can develop models to assess and compare the present value of future cash flows of different entities.¾
Enhances comparability of reporting operating performance by different entities (by eliminating effects of alternative accounting treatments).¾
Historical cash flow information may provide an indicator of the amount, timing and certainty of future cash flows.1.4
Definitions
¾
Cash – cash on hand and demand deposits.¾
Cash equivalents – short-term, highly liquid investments: readily convertible to known amounts of cash; subject to an insignificant risk of changes in value;
excluding equity investments unless they are, in substance, cash
equivalents (e.g. preferred shares acquired within a short period of their maturity and a specified redemption date).
Cash equivalents are treated as cash because if they were not, the liquidity of entities which manage their cash effectively (e.g. employing overnight deposit facilities, buying bonds etc) would not look as good as it actually was.
Illustration 1
Notes to the consolidated financial statements (extract)
Cash and cash equivalents
Bank and cash consist of cash at bank and in hand. Cash equivalents consist of highly liquid available-for-sale investments purchased with remaining maturities at the date of acquisition of three months or less.
Nokia in 2006
¾
Cash flows – inflows and outflows of cash and cash equivalents.¾
Operating activities – principal revenue-producing activities and other activities that are not investing or financing activities.¾
Investing activities – acquisition and disposal of long-term assets and other investments not included in cash equivalents.¾
Financing activities – result in changes in the size and composition of equity capital and borrowings. Bank borrowings generally included.2
PRESENTATION OF A STATEMENT OF CASH FLOWS
¾
A statement of cash flows is essentially a list of cash in and cash out reconciling opening and closing cash balances.2.1
Classification
¾
IAS 7 requires cash inflows and outflows to be analysed across three headings:Operating
Investing
Financing
¾
Key indicator of sufficiency of cash flows to: repay loans;
maintain operating
capability;
pay dividends;
make new investments.
without recourse to external sources of finance
¾
Separate disclosure is important – cash flows
represent extent to which expenditures have been made for resources intended to generate future income and cash flows
Examples
¾
Separate disclosure is useful in predicting claims on future cash flows by providers of capitalExamples
¾
Useful in forecasting futureoperating cash flows.
¾
Payments to acquire/ receipts from sales of:¾
Cash proceeds from issuing:¾
Primarily derived fromprincipal revenue-producing activities.
¾
Generally result from transactions and events so included in profit or loss.Examples
¾
Cash receipts from: sale of goods/rendering
services;
royalties, fees,
commissions.
¾
Cash payments to: suppliers for
goods/services;
and on behalf of
employees.
property, plant and
equipment, intangibles;
equity or debt
instruments of other entities.
¾
Cash advances andloans made to other parties and repayments thereof. shares/equity instruments; Debentures, loans, notes, bonds, mortgages, other short or long-term
borrowings.
¾
Cash payments toowners to acquire or redeem own shares.
¾
Cash repayments ofIllustration 2
Bayer Group Consolidated Statements of Cash Flows
€ million Note 2005 2006
Income after taxes from continuing operations 1,374 1,526
Income taxes 538 454
Non-operating result 602 782
Income taxes paid (463) (763)
Depreciation and amortization 1,608 1,913
Change in pension provisions (501) (295)
(Gains) losses on retirements of noncurrent assets (44) (133)
Non-cash effects of the remeasurement
of acquired assets (inventory work-down) – 429
Gross cash flow 3,114 3,913
Decrease (increase) in inventories (130) (155)
Decrease (increase) in trade accounts receivable 211 (201)
(Decrease) increase in trade accounts payable (117) 130
Changes in other working capital, other non-cash items 149 241
Net cash provided by (used in) operating activities
(net cash flow), continuing operations [33] 3,227 3,928
Net cash provided by (used in) operating activities
(net cash flow), discontinuing operations [7.2] 275 275
Net cash provided by (used in) operating activities
(net cash flow), total 3,502 4,203
Cash outflows for additions to property, plant,
equipment and intangible assets (1,389) (1,876)
Cash inflows from sales of property, plant and equipment and other assets 105 185
Cash inflows from divestitures 293 489
Cash inflows from noncurrent financial assets 1,189 850
Cash outflows for acquisitions less acquired cash (2,188) (15,351)
Interest and dividends received 451 686
Cash inflows (outflows) from current financial assets (202) 287
Net cash provided by (used in) investing activities (total) [34] (1,741) (14,730)
Capital contributions 0 1,174
Bayer AG dividend and dividend payments to minority stockholders,
reimbursements of advance capital gains tax payments (440) (535)
Issuances of debt 2,005 13,931
Retirements of debt (2,659) (3,216)
Interest paid (787) (1,155)
Net cash provided by (used in) financing activities (total) [35] (1,881) 10,199
Change in cash and cash equivalents due to business activities (total) (120) (328)
Cash and cash equivalents at beginning of year 3,570 3,290
Change in cash and cash equivalents due to changes in scope of consolidation (196) (2)
Change in cash and cash equivalents due to exchange rate movements 36 (45)
Cash and cash equivalents at end of year [36] 3,290 2,915
3
OPERATING ACTIVITIES
¾
There are two ways permitted to present cash flows from ordinary activities:Either
3.1 Direct method
Or
3.2 Indirect method
¾
Discloses major classes of gross cash receipts and gross cash payments.¾
Information obtained either fromaccounting records; or
¾
Adjusts profit or loss for effects of: non-cash transactions (e.g.
depreciation);
¾
By adjusting sales, cost of sales for: changes during period in
inventories and operating receivables and payables;
other non-cash items;
other items for which cash effects
are investing/financing cash flows.
any deferrals or accruals of
past or future operating cash receipts or payments;
items of income or expense
associated with investing or financing cash flows.
3.3
Techniques
¾
Direct methodSteps 1 Cash receipts from customers
Less cash paid to suppliers and employees ⇒ Cash generated from operations
Step 2 Payments for interest and income taxes
⇒ Net cash from operating activities
¾
Indirect methodStep 1(a) Start with profit before tax, or profit before interest and tax.
Step 1(b) Adjust for non-cash items and investing and financing items accounted for on the accruals basis.
⇒ Operating profit before working capital changes
Step 1(c) Making working capital changes.
3.4
Which method?
¾
IASB encourages, but does not require, the use of the direct method.3.4.1
Advantages of the direct method
9
Reporting the major classes of operating cash receipts and payments better reveals an entity’s ability to generate sufficient cash from operations to pay debts, reinvest in operations, and make distributions to owners. Thus it better fulfils information needs for decision-making purposes.Commentary
In particular, being able to see cash paid is particularly important to many users.
9
The format is simpler to understand.3.4.2
Disadvantages of the direct method
8
Many entities do not collect information that would allow them to determine the information necessary to prepare the direct method.8
It effectively presents profit or loss information on a cash rather than an accrual basis. This may suggest, incorrectly, that net cash flow from operations is a better measure of performance than profit per the statement of comprehensive income.8
It requires supplemental disclosure of a reconciliation of net income and net cash. (However, the incremental cost of providing the additional information disclosed in the direct method is not significant.)3.4.3
Advantages of the indirect method
9
It focuses on the difference between profit per the statement of comprehensive income and net cash flow from operations.Commentary
The indirect method is also sometimes called the reconciliation method.
9
It provides a useful link between cash flows, the statement of comprehensive income, and the statement of financial position.Commentary
4
INVESTING AND FINANCING ACTIVITIES
4.1
Separate reporting
¾
Major classes of gross cash receipts and gross cash payments arising from investing and financing activities should be reported separately.4.2
Investing activities
¾
Purchase of property plant and equipment – this must represent actual amounts paid.¾
Proceeds from sales of tangible assets.Example 1
2007 2006
$m $m
Statement of financial position extracts
Non-current assets 10,000 9,000
Further information
Depreciation during the year 1,000
Net book value of assets disposed of 100
Required:
Calculate additions in the period.
4.3
Financing activities
¾
Again the approach is to reconcile statement of financial position movements to identify the cash element.Example 2
Statement of financial position extracts $m $m
Share capital 150 100
Share premium 48 40
During the period the following transactions affected share capital
1) The entity issued shares with a nominal value $10m (Share premium $2m) to acquire an interest in a subsidiary
2) The entity issued shares for cash. The expense of the issue was $1m. This has been debited to the share premium account.
Required:
Proforma solution
Share
capital premium Share
Balances at the year end
Add back expenses of the share issue _______
_______
Less non cash transaction
_______ _______
Less balances at the start of the year
_______ _______
_______ _______
5
PROFORMA
5.1
Direct method
$ $
Cash flows from operating activities
Cash receipts from customers x
Cash paid to suppliers and employees (x) ____
Cash generated from operations(see next for alternative) x
Interest paid (x)
Income taxes paid (x)
____
Net cash from operating activities x
Cash flows from investing activities
Purchase of property, plant and equipment (x)
Proceeds from sale of equipment x
Interest received x
Dividends received x
____
Net cash used in investing activities x
Cash flows from financing activities
Proceeds from issuance of share capital x
Proceeds from long-term borrowings x
Dividends paid * (x)
____
Net cash used in financing activities x
____
Net increase in cash and cash equivalents x
Cash and cash equivalents at beginning of period (Note) x
____
Cash and cash equivalents at end of period (Note) x
____
5.2
Indirect method
$
Cash flows from operating activities
Profit before taxation x
Adjustments for
Depreciation x
Investment income (x)
Interest expense x
____ Operating profit before working capital changes x Increase in trade and other receivables (x)
Decrease in inventories x
Decrease in trade payables (x)
____
Cash generated from operations x
…remainder as for the direct method
5.3
Notes to the statement of cash flows
(Direct and indirect methods)
Cash and cash equivalents
Cash and cash equivalents consist of cash on hand and balances with banks, and investments in money market instruments. Cash and cash equivalents included in the statement comprise the following amounts.
2007 2006
$ $
Cash on hand and balances with banks x x
Short-term investments x x
____ ____
x x
Example 3
Antipodean statements of financial position at
2007 2006
$ $ $ $
Non-current assets (at written down value)
Premises 37,000 38,000
Equipment 45,800 17,600
Motor vehicles ______ 18,930 4,080
101,730 ______ 59,680
Investments _______ 25,000 ______ 17,000
126,730 76,680
Current assets
Inventories 19,670 27,500
Trade receivables 11,960 14,410
Short-term investments 4,800 3,600
Cash and bank balances ______ 700 1,800
37,130 ______ 47,310
_______ _______
Total assets _______ 163,860 _______ 123,990 Capital and reserves
Capital 78,610 75,040
Non-current liabilities
Interest-bearing borrowings 25,000 28,000
Current liabilities
Trade payables 32,050 20,950
Bank overdraft ______ 28,200 –
60,250 ______ 20,950
_______ _______
163,860 123,990
_______ _______
Profit for the year ended 31 December 2007 ($25,200) is after accounting for
Depreciation $
Premises 1,000
Equipment 3,000
Motor vehicles 3,000
Profit on disposal of equipment 430
Loss on disposal of motor vehicle 740
Interest expense 3,000
The written down value of the assets at date of disposal was $
Equipment 5,200
Motor vehicles 2,010
Interest accrued at 31 December 2007 is $400.
The company has made a substantial distribution out of capital during the year.
Required:
Proforma solution
$ $
Cash flows from operating activities
Profit before taxation Adjustments for
Depreciation Loss on disposals
Interest expense _______
Operating profit before working capital changes Decrease in trade receivables
Decrease in inventories
Increase in trade payables _______
Cash generated from operations
Interest paid _______
Net cash from operating activities
Cash flows from investing activities
Purchase of long-term investments Purchase of equipment and cars
Proceeds from sale of equipment and cars _______
Net cash used in investing activities
Cash flows from financing activities
Capital repayment
Borrowings repayment _______
Net cash used in financing activities _______
Net decrease in cash and cash equivalents
Cash and cash equivalents at beginning of period _______
Example 4
Alma has the following statement of comprehensive income for the year ended 31 December 2007 and statement of financial position extracts at that date.
Statement of comprehensive income
$000
Revenue 2,880
Cost of sales (2,016)
_____
Gross profit 864
Expenses (288)
_____
Profit 576
_____
Statement of financial position extracts
2007 2006
$000 $000
Current assets
Inventory 384 336
Trade receivables 622 564
Current liabilities
Trade payables 403 331
You are given the following information:
(1) Expenses include depreciation of $86,000, bad debts written off of $34,000 and employment costs of $101,000.
(2) During the year Alma disposed of some plant for $58,000 which had a net book value of $43,000, the profit being netted off against expenses.
Required:
(a) Show how the net cash flows from operating activities would be presented in the statement of cash flows using the direct method.
Proforma solution
(a) Cash-flows from operating activities
$000 Cash received from customers and employees (W1)
Cash paid to suppliers and employees _____
Cash from operating activities
_____ WORKINGS
(W1) Trade receivables
$000 $000
(W2) Trade payables
$000 Cash
Bal c/d
$000 Bal b/d
Purchases (W3)
(W3) $000
Opening inventory Purchases
Closing inventory _____
Cost of sales
_____ (W4)
Other cash expenses:
$000 From statement of comprehensive income
Adjustments for non-cash items Depreciation
Bad debts
Profit on disposal _____
(b) Reconciliation of operating profit to net cash flows from operating activities
$000 Profit before tax
Depreciation Profit on disposal Increase in inventory Increase in receivables Increase in payables
_____ _____
6
DISCLOSURES
¾
There are a number of extra disclosures which should be made in most cases to support the main statement of cash flows: Analysis of cash and cash equivalents; Major non cash transactions;
Cash and cash equivalents held by the group; Reporting futures, options and swaps;
Voluntary disclosures.
6.1
Analysis of cash and cash equivalents
¾
A note should be presented that reconciles amounts held as cash and cash equivalents at the start and end of the period.Cash and cash equivalents
Illustration 3
2007 2006 Change
$ $ $
Cash on hand – 1,300 (1,300)
Bank overdraft (11,000) – (11,000)
6.2
Major non cash transactions
¾
Non cash transactions should be excluded from the main statement. However some of these do have a major impact on investing and financing activities and should be disclosed in a note.¾
Examples of such transactions could include: the issue of shares in order to acquire assets; the conversion of debt to equity;
the inception of significant lease arrangements.
¾
In each case a brief description of the nature and purpose of the transaction should be given.6.3
Reporting futures, options and swaps
¾
Cash payments for and receipts from such contracts should normally be classified as investing activities. There are two exceptions to this: The instrument is held for trading purposes and thus is part of operating activities. The cash flows are considered to be financing in nature and should be reported as
such.
6.4
Voluntary disclosures
¾
The standard encourages the disclosure of other information which may be relevant to users seeking to assess the financial health of a business. These are: the amount of undrawn borrowings that are available and any restrictions on their
future use.
the amount of cash flows that represent increases in capacity rather than
maintenance of existing capacity.
a segment analysis, by industry and region, of cash flows arising from each major
activity. This information should be presented by way of a note and could appear as follows:
Cash flows Segment 1 Segment 2 Total
Operating
activities x x X
Investing activities x x X
Financing
activities x x X
___ ___ ___
x x X
FOCUS
You should now be able to:
¾
prepare a statement of cash flows for a single entity in accordance with relevant accounting standards using the direct and indirect method;¾
compare the usefulness of cash flow information with that of a statement of comprehensive income;EXAMPLE SOLUTIONS
Solution 1 — Investing activity
Balance b/f 9,000
Depreciation (1,000)
Disposals (100)
Additions (Balancing figure) 2,100
______
Balance c/f 10,000
______
Solution 2 — Financing activity
Share
capital premium Share
Balances at the year end 150 48
Add back expenses of the share issue -
______ ______ 1
150 49
Less non cash transaction (10)
______ ______ (2)
140 47
Less balances at the start of the year (100)
______ ______ (40) 40
______ ______ 7
Solution 3 — Cash flow statement
$ $
Cash flows from operating activities
Profit before taxation 25,200
Adjustments for
Depreciation 7,000
Net loss on disposals 310
Interest expense ______ 3,000
Operating profit before working capital changes 35,510
Decrease in trade receivables 2,450
Decrease in inventories 7,830
Increase in trade payables ((32,050 – 400) – 20,950) 10,700 ______
Cash generated from operations 56,490
Interest paid $(3,000 – 400) ______ (2,600)
Net cash from operating activities 53,890
Cash flows from investing activities
Purchase of long-term investments $(25,000 – 17,000) (8,000) Purchase of equipment and cars
$(36,400 (W1) + 19,860 (W2)) (56,260) Proceeds from sale of equipment and cars (W3) ______ 6,900
Net cash used in investing activities (57,360)
Cash flows from financing activities
Capital repayment (21,630)
Borrowings repayment ______ (3,000)
Net cash used in financing activities (24,630) ______
Net decrease in cash and cash equivalents (28,100)
Cash and cash equivalents at beginning of period $(3,600 + 1,800) ______5,400
Cash and cash equivalents at end of period $(4,800 + 700 – 28,200) (22,700) ______
WORKINGS
(1) Equipment (WDV)
$ $
Bal b/d 17,600 Disposal 5,200
Depreciation 3,000
Additions (β) ______36,400 Bal c/d ______45,800
54,000 54,000
______ ______
(2) Motor vehicles (WDV)
$ $
Bal b/d 4,080 Disposal 2,010
Depreciation 3,000
Additions (β) ______19,860 Bal c/d ______18,930
23,940 23,940
______ ______
(3) Disposals
$ $
Equipment 5,200
Motor vehicle 2,010 Loss on disposal (vehicles) 740 Profit on disposal (equipment) ______430 Proceeds (β) ______6,900
7,640 7,640
______ ______
Solution 4 — Net cash flows
(a) Cash-flows from operating activities
$000
Cash received from customers 2,788
Cash paid to suppliers and employees (1,992 + 183) ______(2,175)
WORKINGS
Trade receivables
$000
Bal b/d 564
Revenue 2,880
_____
3,444
_____
$000
Bad debt 34
Cash 2,788
Bal c/d _____622
3,444
_____
$000
Opening inventory 336
Purchases 2,064
Closing inventory ______(384)
Cost of sales ______2,016
Trade payables
$000
Cash 1,992
Bal c/d _____403
2,395
_____
$000
Bal b/d 331
Purchases _____2,064 2,395
_____
Other cash expenses:
$000
From profit or loss 288
Adjustments for non-cash items
Depreciation (86)
Bad debts (34)
Profit on disposal ______15
183 ______
(b) Reconciliation of operating profit to net cash flows from operating activities
$000
Profit before tax 576
Depreciation 86
Profit on disposal (15)
Increase in inventory (384 – 336) (48)
Increase in receivables (622 – 564) (58)
