Chapter 4 Cash flows Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies Slides prepared by Laura Hopkins

Learning objectives Completion of this topic should enable you to describe what is meant by cash flow outline the structure of the cash flow statement classify the categories of cash inflows and cash outflows that comprise the cash flow statement illustrate how both the direct and indirect cash flow approaches are used to derive net cash flows from operating activities Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies Slides prepared by Laura Hopkins

Learning objectives cont. Completion of this topic should enable you to prepare a cash flow statement explain the links between the cash flow statement and the balance sheet explain the links between the cash flow statement and the income statement Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies Slides prepared by Laura Hopkins

What the cash flow statement tells us Change in cash between start and end of the period Amount of cash generated and from where What the cash was used for Cash consists of cash on hand deposits that are payable on demand cash equivalents Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies Slides prepared by Laura Hopkins

Cash inflows and outflows Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies Slides prepared by Laura Hopkins

What information the cash flow statement provides Information on how much cash was generated from the entity trading came from sources external to the entity was needed to fund new working capital was spent on new assets came from new borrowing was used to repay debt Information used for the statement is factual and verifiable Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies Slides prepared by Laura Hopkins

The structure of the cash flow statement Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies Slides prepared by Laura Hopkins

The structure of the cash flow statement cont. Users need detailed information to evaluate the ability of the entity to generate cash from its activities the changes in the net assets of the entity the entity’s financial structure liquidity solvency Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies Slides prepared by Laura Hopkins

The presentation of the cash flow statement A more informative presentation describes  operating activities cash flow from the revenue-producing activities  investing activities cash flows from acquisition/disposal of long-term assets and other investments  financing activities cash flows from changes in the debt and equity structure Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies Slides prepared by Laura Hopkins

The presentation of the cash flow statement cont. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies Slides prepared by Laura Hopkins

Operating activities A key indicator of entity’s ability to generate enough cash to maintain operating capacity without borrowing Should result in a net cash inflow Cash flow results from income statement items will only include cash items accrual-based will not affect cash flow Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies Slides prepared by Laura Hopkins

Operating activities cont. Cash flows include cash received from customers for sale of goods and services royalties, fees and commissions cash paid to suppliers for purchased goods and services to employees for other operating activities Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies Slides prepared by Laura Hopkins

Investing activities Expenditure to acquire resources to be used to generate future income and cash flows Includes acquiring and disposing of non-current assets Generally results in a net cash outflow Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies Slides prepared by Laura Hopkins

Investing activities cont. Cash flows include cash received from sale of property, plant, equipment, intangibles, long-term assets sale of shares and other investments repayment of loans cash paid to acquire property, plant, equipment, intangibles, long-term assets shares and other investments to make loans Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies Slides prepared by Laura Hopkins

Financing activities Shows change in debt and equity structure of the entity Provides information on source of funding and claims on future cash flow by the providers of the funds Net cash flow can be inflow or outflow Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies Slides prepared by Laura Hopkins

Financing activities cont. Cash flows include cash received from issue of shares or capital invested long term loan or mortgage cash paid to repay borrowings Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies Slides prepared by Laura Hopkins

Specific considerations Interest and dividends Income taxation Goods and Services Tax (GST) Non-cash transactions and events Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies Slides prepared by Laura Hopkins

Preparation of the cash flow statement Information required for preparing the statement will come from the balance sheet to determine changes in the assets and liabilities during the reporting period the statement of changes in equity to determine changes during the reporting period the income statement for the period to determine the funds generated from operating activities other additional information Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies Slides prepared by Laura Hopkins

Preparation of the operating activities section Cash flows from operating activities use direct method adjust income statement items from accrual to cash Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies Slides prepared by Laura Hopkins

Preparation of the operating activities section cont. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies Slides prepared by Laura Hopkins

Preparation of the investing activities section Cash flows from investing activities determine change in the item between successive balance dates ascertain reason for the change and the effect on cash adjust for the non-cash element of the change Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies Slides prepared by Laura Hopkins

Preparation of the operating activities section Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies Slides prepared by Laura Hopkins

Preparation of the financing activities section Cash flows from financing activities determine the change in the item between successive balance dates determine reason for the change and the effect on cash Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies Slides prepared by Laura Hopkins

Preparation of the financing activities section cont. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies Slides prepared by Laura Hopkins

Reconciling net profit to cash from operating activities calculated on income statement calculated under accrual accounting Cash flow from operating activities calculated using income statement calculated under cash accounting These two amounts will be different. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies Slides prepared by Laura Hopkins

Reconciliation method Net profit after tax adjusted for investing items included in profit calculation finance items included in profit calculation non-cash items changes in current assets changes in current liabilities confirms the cash flow from operating activities figure Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies Slides prepared by Laura Hopkins

Reconciliation method cont. Items that arise from investing and financing activities gain or loss on disposal of a non-current asset Non-cash revenues and expenses depreciation, bad and doubtful debts Changes in current assets and current liabilities increase in current assets is a drain on cash so reduce net profit to adjust to the net cash flow Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies Slides prepared by Laura Hopkins

Reconciliation of net profit to cash from operating activities Net profit after tax Add/subtract items classified as investing/financing Add/subtract non-cash items Add/subtract movements in working capital = net cash flow from operating activities Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies Slides prepared by Laura Hopkins

Linking cash flows to the main financial statements Operating cash flows based on information from the income statement and balance sheet Investing cash flows derived from information from the balance sheet and income statement Financing cash flows derived from the balance sheet for debt information and statement of movements in equity for equity information Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies Slides prepared by Laura Hopkins