Chapter 39 Statements of cash flows

Learning objectives After you have studied this chapter, you should be able to: Draw up a statement of cash flows for any type of organisation Explain how statements of cash flows can give a different view of a business to that simply concerned with profits

Learning objectives (Continued) Describe the contents of International Accounting Standard 7 (IAS 7) and the format to be used when preparing cash flow statements using IAS 7 Describe some of the uses that can be made of statements of cash flows

The importance of cash Cash is one of the most important factors in business, because even a profitable business can fail if it doesn’t have cash. It is particularly important to have cash to pay creditors and employees. Even large, established, profitable businesses must have the means to raise cash if necessary, without resorting to selling stock and calling in debts.

The need for statements of cash flows The income statement shows the profits of a business. The statement of financial position shows the assets, liabilities and capital at a point in time. The statement of cash flows shows where cash has come from during the year, and exactly what we have done with it.

Where from and where to

Where from and where to (Continued) Profits bring cash flow into the business but losses take cash out. Sales on non-current assets bring cash into the business but a purchase takes cash out. Reducing inventory levels brings cash into the business but increasing levels ties cash up. Reducing accounts receivable brings cash into the business but increasing the figure ties cash up.

Where from and where to (Continued) An increase in capital or an issue of shares brings cash into the company but drawings and dividends take cash out. Loans received by the business bring cash into the company but repayments take cash out. An increase in accounts payable keeps cash in the business but a decrease in accounts takes cash out.

Construction of a statement of cash flows

Construction of a statement of cash flows (Continued)

Adjustments needed to net profit The net profit figure has to be adjusted to take account of items included which do not involve a movement of cash in the period covered by the statement of cash flows, such as: Depreciation – add back because it isn’t a cash flow Allowances for doubtful debts – add back because the cash flow occurs when the debt is paid Profits/losses on the disposal of non-current assets – adjust, because these are merely book values

Activity

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Users of statements of cash flows Who will want to use a statement of cash flow? A businessman, who wants to know why he has an overdraft. A businessman, who wants to know why his bank balance has risen. The partners in a business who have invested capital and yet the bank balance has still fallen.

The use of a statement of cash flow? A statement of cash flow can be used to assess: The cash flows which the business may be able to generate in the future How far the business will be able to meet future commitments How far future share issues may be needed A valuation of the business

Learning outcomes You should have now learnt: Why statements of cash flows provide useful information for decision-making. A range of sources and applications of cash. How to adjust net profit for non-cash items to find the net cash flow from operating activities. How to prepare a statement of cash flows as defined by IAS 7.

Learning outcomes (Continued) How to present the net cash flow from operating activities using the indirect method. Some of the uses that can be made of statements of cash flows.