Accounting for Assets Cash Flows

Statement of Cash flows Learning outcomes: Explain the purpose of the statement of cash flows Identify the contents of the statement of cash flows Prepare a basic statement of cash flows Understand the usefulness of the statement of cash flows 7/29/2019

Overview IAS 7 Statement of Cash Flows requires an entity to present a statement of cash flows as an integral part of its primary financial statements. Does “profit” give a true picture of a company’s operations ? 7/29/2019

Objective of IAS 7 requires 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. 7/29/2019

Seeks to answer Where did the cash come from during the period? What was the cash used for during the period? What was the change in the cash balance during the period? 7/29/2019

Cash and Cash Equivalents Cash on hand Demand deposits Cash Equivalents Investments that are Short term, Highly liquid, and Easily converted to a known amount of cash Not subject to a significant change in value All references to Cash include Cash Equivalents when discussing the Statement of Cash Flows

Cash and cash equivalents Cash equivalents are held for the purpose of meeting short-term cash commitments rather than for investment or other purposes. NB: An investment normally qualifies as a cash equivalent only when it has a short maturity of, say, three months or less from the date of acquisition. Examples: Cash at hand, cash in bank, bank overdraft.

Definitions Operating activities Investing activities are the principal revenue-producing activities of the entity and other activities that are not investing or financing activities. Investing activities are the acquisition and disposal of long-term assets and other investments not included in cash equivalents. Financing activities are activities that result in changes in the size and composition of the contributed equity and borrowings of the entity.

Operating activities Do we have examples of cash flows from operating activities ? cash receipts from the sale of goods and the rendering of services; cash receipts from royalties, fees, commissions and other revenue; cash payments to suppliers for goods and services; cash payments to and on behalf of employees; cash receipts and cash payments of an insurance entity for premiums and claims, annuities and other policy benefits; f) cash payments or refunds of income taxes unless they can be specifically identified with financing and investing activities; and (g) cash receipts and payments from contracts held for dealing or trading purposes. 7/29/2019

Investing activities Do we have examples of cash flows arising from investing activities ? cash payments to acquire property, plant and equipment, intangibles and other long-term assets. cash receipts from sales of property, plant and equipment, intangibles and other long-term assets; c) cash payments to acquire equity or debt instruments of other entities d) cash receipts from the repayment of advances and loans made to other parties 7/29/2019

Financing activities Do we have examples of cash flows arising from financing activities ? cash proceeds from issuing shares or other equity instruments; cash payments to owners to acquire or redeem the entity’s shares; cash proceeds from issuing debentures, loans, notes, bonds, mortgages and other short-term or long-term borrowings; cash repayments of amounts borrowed; and cash payments by a lessee for the reduction of the outstanding liability relating to a finance lease. 7/29/2019

Statement of Cash Flows: Concept Operating activities Investing Financing Inflows Cash Pool Operating activities Investing Financing Outflows

Preparing a Statement of Cash Flows There are TWO methods of preparing the statement of cash flows: Indirect method Direct method The indirect method derives cash flows from accrual basis statements The direct method determines cash flows directly for each source or use of cash

Statement of Cash Flows: Indirect Method - Concept Earned Revenues Net Income + - Eliminate non-cash revenues Operating cash flow Eliminate non-cash charges Expenses Incurred

The Statement of Cash Flows: Indirect Method Accrual Basis Statements Cash Flow Statement Income Statement items and changes in Current Assets and Current Liabilities Operating activities: Adjust net income for accruals, non-cash charges and non- operating gains/losses Balance Sheet: Changes in Non-Current Assets Investing activities: Inflows from sale of assets and outflows from purchases of assets Balance Sheet: Changes in Non-Current Liabilities and Equity Financing activities: Inflows and outflows from loan and equity transactions

Direct Method (Operating Activities) Inflows Outflows From sales of goods or services From returns on loans (interest) and returns on equity securities (dividends) To suppliers for inventory To employees for services To government for taxes To lenders for interest To others for expenses

Investing and Financing Activities For the direct and indirect methods: the sections reporting investing and financing activities are the same The net inflows or outflows for each section (under the two methods) are identical The operating activities are reported differently

Using the Indirect method Why ? its Easier Net profit or loss is adjusted for : Changes during the period in inventories, receivables and payables. Non-cash items e.g. depreciation, provisions, profits/losses on the sale of assets 7/29/2019

Operating cash flows: indirect method Shs. ‘000’ Cash flow from operating activities:   Net profit before tax and extra-ordinary items X Adjustments for: Depreciation Foreign exchange loss Interest income (X) Dividend income Interest expense Operating profit before working capital changes Increase in trade & other receivables Decrease in inventories Decrease in trade payables Cash generated from operations Interest paid Incomes taxes paid Net cash from operating activities

Interest & Dividends Dividends paid can be classified into two ways either as: As a financing cash flow or As a component of cash flows from operating activities 7/29/2019

Operating cash flows: Direct method Shs. ‘000’ Cash flow from operating activities:   Cash receipts from customers X Cash paid to suppliers and employees (X) Cash generated from operations Interest expense Income taxes paid Net cash flow from operations

Presentation of the statement of cash flows Cash flows from operating activities (see previous slides) XX Cash flow from investing activities:   Purchase of fixed assets (X) Proceeds from sale of fixed assets X Purchase of investments Proceeds from sale of investments Interest received Dividend received Net cash from investing activities Cash flows from financing activities: Proceeds from issue of share capital Redemption of preference shares/debentures Long-term borrowings Repayment of long-term borrowings Interest paid Dividend paid Net cash from financing activities Net increase in cash and cash equivalents Cash and cash equivalents at beginning of period Cash and cash equivalents at end of the period

Special Items: Depreciation - Steps Prepare the T-Account for accumulated depreciation and determine the accumulated depreciation on asset sold Determine the cash flow from sale of equipment Determine any purchases of plant and equipment (at cost) Identify the inflows and outflows affecting the operating and investing sections

Reporting Significant Non-Cash Transactions Transactions not involving cash inflows or cash outflows are non-cash transactions They are not reported in the body of the cash flow statement If material, they are reported as notes to the statement or in a supplementary schedule to the financial statements Example: issue of bonds (payable) for the purchase of land

Financial Liquidity The higher the ratio the less likely the company will have liquidity problems Current Cash Debt Coverage Ratio = Net cash provided by operating activities/Average Current liabilities 7/29/2019

Financial Flexibility Cash Debt Coverage Ratio =Net cash provided by operating activities/Average Total liabilities 7/29/2019

Free cash flows Questions : Is the company able to pay its dividends without resorting to external financing ? If business operations decline will the company be able to maintain its needed capital expenditure ? What is the amount of discretionary C/flows that that can be used for additional investment, retirement of debt, purchase of treasury shares or addition to liquidity ? Free Cash flows = Net cash provided by Operating Activities – Capital Expenditures – Dividends 7/29/2019

Q & A 7/29/2019