Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia 1 Accounting for Management Decisions WEEK 6 MEASURING AND REPORTING CASH FLOWS READING: TEXT CH 5

Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia 2 Learning Objectives Explain why cash is important to the reporting entity Define cash and cash equivalents Distinguish between accrual and cash-based transaction recognition Compare and contrast the roles of the three external financial reports (income statement, balance sheet, cash flow statement) three Discuss the three components of the cash flow statement (operating activities, investing activities, financing activities)

Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia 3 Learning Objectives cont’d non-cash Identify non-cash transactions Recognise the alternative approaches to preparing a cash flow statement Prepare a simple cash flow statement Prepare a reconciliation of net profit to cash flow from operations Explain how the cash flow statement can be useful for identifying cash flow management strengths, weaknesses and opportunities

Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia 4 The Importance of Cash and Cash Flow Learning Objective: Explain why cash is important to the reporting entity is because organisations and people will not normally accept any other form of settlement of claim against the business Businesses as a result of to find sufficient cash to settle their responsibilities These factors make cash a asset, and therefore the one analysts and others carefully in assessing the survival ability of the business and other factors

Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia 5 The Importance of Cash and Cash Flow Balance sheet and P+L reports show in wealth and the net in wealth for the period concerned The cash flow statement is required to be produced because the above 2 reports concentrate sufficiently on (cash flow) The nature of the above 2 reports is thought to the question of and a company is generating the cash it needs to continue operating?

Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia 6 Cash and Cash Equivalents Learning Objective: Define cash and cash equivalents represents ‘cash on hand’ and ‘demand deposits’ Cash represent short-term, highly liquid investments that can readily be to a fixed amount of cash Examples include: - Cash at Bank - Bank Overdraft - Short-term Money Market Deposits - Bank Bills

Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia 7 Cash vs Accrual transaction recognition Learning Objective: Distinguish between accrual-based and cash-based transaction recognition -based - is recognised when cash is and are recognised when cash is -based - is recognised when it is and are recognised when they are Accrual-based accounting removes the of the entity’s performance from the cash-based system and reflects the of what has been earned

Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia 8 Differences between the 3 major external financial reports Learning Objective: Compare and contrast the roles of the three external financial reports Balance Sheet – static report made at a given point in time and based on balances in A, L + OE normally based on transactions Income Statement (Profit & Loss) – measures the financial performance over a period of time - normally 1 year, related to revenues earned less expenses incurred ie transactions Cash flow statement – identifies all cash receipts and cash payments for the period. All account types are included and is based on cash, transactions

Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia 9 Differences between the 3 external financial reports cont’d Balance sheet at the of the accounting period Owners’ claim Cash Balance sheet at the of the accounting period Owners’ claim Cash Income statement Cash flow statement Figure The relationship between the balance sheet, the income statement and the cash flow statement

Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia 10 The Cash Flow Statement Learning Objective: Discuss the three components of the cash flow statement The cash flow statement is basically an analysis of the business over the period concerned All payments of a are added together to give just one figure, which appears in the statement The net of the statement is the net in cash of the business over the period

Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia 11 The Cash Flow Statement cont’d The 3 components of the cash flow statement are: activities - represents net inflows from, only received and paid is featured, expenses and revenue (reflects events of Income Statement – cash sales, debtor & creditor payments, wages, cash expenses, etc) activities - concerned with cash payments to and cash receipts for of NCAs eg plant & machinery, land, investments, etc activities - deals with financing the business short-term credit eg debt and equity sources, share issues, repayment of long-term loans, etc

Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia 12 The Cash Flow Statement cont’d Net cash flows from activities activities Netcash flow from Net cash flow from activities activities Netcash flow from Net cash flow from activities activities Net increase/decrease in cash and cash equivalents over the period Figure Standard layout of the cash flow statement

Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia 13 Non-cash Transactions Learning Objective: Identify non-cash transactions transactions are transactions that directly involve cash relate to the ‘operating activity’ section of the cash flow statement and are linked to the between cash-based and accrual- based transactions eg depreciation, doubtful debts, accruals (receivables, inventory, prepayments, payables, revaluations etc) However, relate to the ‘ and activity’ sections too eg direct exchanges such as shares for assets, non- current assets for reduction in debt, bonus issues from reserves

Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia 14 Preparation of a Cash Flow Statement - an overview Learning Objective - Recognise the alternative approaches to preparing a cash flow statement Can be produced in 2 ways: 1.Independently viewing the cash receipts and cash payments for the period and transactions to the activities and categories the income statement by the in the balance sheet for the period and any transactions so that transactions, forming the basis for preparing the cash flow statement

Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia 15 Preparation of a Cash Flow Statement – an overview cont’d Of these 2 ways the 2 nd method (reconstructing the income statement) is most often used. For the reconstruction, alternative approaches are used: using additions and subtractions; 2.Ledger reconstructions; 3.Worksheets. Only the (schedule approach) will be discussed in this chapter as it does not require an understanding of the formal double-entry accounting framework

Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia 16 Preparation of cash flow statement - simple example Learning Objective: Prepare a simple cash flow statement Refer to Example 5.1 on p. 231 Deducing cash flows from activities 1. Calculate cash receipts from customers: balance of 15 + sales for the period +100 gives amount expected to receive from the period balance debtors (20) = from customers$

Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia 17 Preparation of cash flow statement - simple example cont’d Refer to Example 5.1 on p. 231 Deducing cash flows from activities 2. Calculate payments to creditors for inventory purchases: balance of 10 + of inventory for the period+ 68 = amount to be paid for the period78 - balance creditors (15) = cash to creditors $ $$ $

Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia 18 Preparation of cash flow statement - simple example cont’d Deducing cash flows from activities 3. Calculate interest paid relating to interest : balance of interest payable X + for the period + X gives the amount expected to pay for the period X - balance of interest payable (X) = the interest X

Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia 19 Preparation of cash flow statement - simple example cont’d Refer to Example 5.1 on p. 231 Deducing cash flows from activities 4. Calculate interest paid relating to interest: balance of interest 0 + for the period + 3 gives the amount to be paid for the period 3 - balance of prepaid interest (0) = the$

Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia 20 Preparation of the cash flow statement - a simple example cont’d Refer to Example 5.1 on p. 231 Completing the ‘ ’ section 5. Complete ‘cash flows from operating activities’: Cash from 95 Cash to (63 + other exp 17) (80) paid (3) Income paid (2008 liability) (4) Net cash by operating activities$

Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia 21 Preparation of cash flow statement - simple example cont’d Refer to Example 5.1 on p. 231 Deducing cash flows from activities: 1. Complete the cash flows from investing section: of property, plant and equipment ( ) (20) from of property, plant & equipment (0) Net cash in investing activities$

Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia 22 Preparation of the cash flow statement - a simple example cont’d Refer to Example 5.1 on p. 231 Deducing cash flows from financing activities: 1. Complete the cash flows from financing section: from of share capital from of share capital of long-term of long-term 5 of long-term borrowings of long-term borrowings (0) (0) Dividends(15) Net cash by financing activities $

Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia 23 Preparation of Cash Flow Statement; eg 5.1, p.235 statement for $m operating Cash flows from operating activities Cash receipts from customers 95 Cash payments to suppliers & employees (63 + other expenses 17) (80) Interest paid (3) Income taxes paid (2008 liability) (4) Net cash provided by operating activities 8 investing Cash flows from investing activities Purchase of property, plant and equipment ( ) (20) Net cash used in investing activities (20) financing Cash flows from financing activities Proceeds from issue of share capital 15 Proceeds from long-term borrowings 5 Dividends paid (15) Net cash provided by financing activities 5 Net decrease in cash and cash equivalents held (7) Cash and cash equivalents at the beginning of the financial year 12 Cash and cash equivalents at the end of the financial year$

Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia 24 Reconciling cash from operations with operating profit Learning Objective: Prepare a reconciliation of net profit to cash flow from operations Purpose of reconciliation is to the net operating after tax with the cash flows from activities The point is the operating profit after tax We then effectively the charged in arriving at that profit and this total by in non-cash current asset and current liability accounts to arrive at cash flow from operations

Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia 25 Reconciling cash from operations with operating profit cont’d Refer Example 5.1 on page 231 for data Reconciliation would be as follows: $m Operating profit after tax Depreciation +5 Increase in inventory (8) Increase in accounts receivable (5) Increase in accounts payable +5 Increase in tax payable +1 Net cash flow provided by operating activities $

Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia 26 What does the cash flow statement tell us? Learning Objective: Explain how the cash flow statement can be useful for identifying cash flow management strengths, weaknesses and opportunities The cash flow statement tells us the business during the period and where that cash has Shows the /origins and uses of cash over time, which is indicative of trends and useful for future and patterns of cash flow Provides an into management Is good indicator of management practices Identifies flows