Statement of Cash flow Purpose of the statement of cash flows The purpose of the statement of cash flows is to show the effect of a company’s commercial transactions on its cash balance. It is thought that users of accounts can readily understand cash flows, as opposed to statements of profit or loss and other comprehensive income and statements of financial position which are subject to manipulation by the use of different accounting policies. Cash flows are used in investment appraisal methods such as net present value and hence a statement of cash flows gives potential investors the chance to evaluate a business. 5-1

Statement of Cash flow Cash & Cash equivalents Cash comprises cash on hand and demand deposits Cash equivalents are short-term, highly liquid investments that are readily convertible into known amounts of cash and which are subject to an insignificant risk of changes in value.

IAS 7 allows two possible layouts for the statement of cash Statement of Cash flow Formats IAS 7 allows two possible layouts for the statement of cash flows in respect of operating activities: The indirect method, where profit before tax is reconciled to operating cash flow. b) The direct method, where the cash flows themselves are shown. 5-3

Statement of Cash flow Sections of the statement IAS 7 Statement of Cash Flows splits cash flows into three sections: • Cash flows from operating activities • Cash flows from investing activities • Cash flows from financing activities

Statement of Cash flow Operating activities Cash flows from operating activities are primarily derived from the principal revenue producing activities of the entity. Therefore they generally result from the transactions or other events that enter into the determination of profit or loss. The amount of cash flows arising from operating activities is a key indicator of the extent to which the operations of the entity have generated sufficient cash flows to repay loans, maintain the operating capability of the entity, pay dividends and make new investments without recourse to external sources of finance

Statement of Cash flow Investing activities The cash flows included in this section are those related to the acquisition or disposal of any non-current assets, or trade investments together with returns received in cash from investments, i.e. dividends and interest. This section shows the extent of new investment in assets which will generate future income and cash flows.

Statement of Cash flow Financing activities Financing cash flows comprise receipts from or repayments To external providers of finance in respect of principal Amounts of finance. Examples of financing cash flows are: Cash proceeds from issuing shares Dividends paid to shareholders Cash proceeds from issuing loan notes Cash repayments of amounts borrowed Finance lease liability payments

Statement of Cash flow Interpretation of statements of cash flows Overall increase/decrease in cash. (b) What are the significant components in the cash flows? (c) How do the cash flows compare to expectations? E.g: Operating activities – key inflow Investing activities – key outflow Financing activities – how the business has financed acquisitions/purchases of assets. Cash generated from operations vs interest, income tax

Statement of Cash flow (d) Reconciliation of profit before tax to cash generated from operations impact of accounting policies, e.g. deferral of expenditure, recognition of income where no cash generated movements in working capital, e.g. Build up of inventories/receivables signs of overtrading

(e) Ratio analysis (examples of ratios): Statement of Cash flow (e) Ratio analysis (examples of ratios): • Cash return on capital employed =Cash generated from operations Total assets less current liabilities × 100% • Cash generated from operations to total debt = Cash generated from operations Total debt • Net cash from operating activities to capital expenditure = Net cash from operating activities × 100% Net capital expenditure