1. Cash flow statements

2. Contents Introduction – The cash flow statement
Usefulness of cash flow information
Cash flow cycles
Format and structure of the cash flow statement
Cash flow from operating activities
Cash flows from investing and financing activities
Direct and indirect method for operating cash flows
Constructing a cash flow statement
Disposal of fixed assets
Presentational differences

3. Cash flow statement
A cash flow statement presents information about the cash flows associated with the company’s main operations and those associated with its investing and financing activities of the period
A cash flow statement functions in conjunction with both the income statement (performance dimension) and the balance sheet (financial position)
IAS 7 Cash Flow Statements

4. Usefulness of cash flow information
Ability to generate adequate cash flows is a significant performance dimension
Cash flow information clarifies the dynamics of short-term liquidity and long-term solvency
Cash flow information is an essential input for economic decision models

5. Cash flow versus profit
Cash flow and profit are different economic phenomena
But linked through the mechanisms of accrual accounting!
Cash flows are factual details of incoming and outgoing flows of cash, while the balance sheet and income statement emanate from professional judgement and are not a direct projection of objective economic data

6. Liquidity/solvency and cash flows
Relates to “nearness to cash” of the structure of assets
Determined by capacity to convert current assets into cash
Solvency
Relates to future availability of cash in order to settle financial liabilities on due date
Determined by timing and uncertainty of expected future cash payments and cash receipts
Liquidity and solvency ratios are determined on static financial position data, while cash flows reflect changes in financial position

7. Relationship with BS and IS
Income statement
BS at start Cash flow BS at end
A cash flow statement reflects both “profit related” and “non-profit related” activities (investing and financing) with an impact on available cash over the period covered in the income statement

8. Related questions
From which sources did the company raise cash last year? How was this cash used?
Were the normal operating activities capable of satisfying its need for cash during the year?
If not, is the shortage of cash compensated by new borrowings, issuing new share capital or by selling fixed assets?
Is a surplus of cash used for repayment of debt, for investments or for distribution of dividends?
Why has the balance of cash available decreased, knowing that the company’s operations have been profitable?

9. Cash conversion cycles
Cash flows through the company continuously in a series of short-term and long-term conversion cycles
The ST - cash conversion cycle (operating cycle) relates to the main business operations
= OPERATING ACTIVITIES

10. Cash conversion cycles (cont.)
The LT- cash conversion cycles relate to the acquisition, renewal and disposal of intangible and tangible infrastructure and the long-term sourcing of funds
Productive capacity acquired for cash and subsequently consumed during several ST-operating cycles
Acquisition and disposal of infrastructure = INVESTING ACTIVITIES
External sourcing of funds = FINANCING ACTIVITIES

11. Fig. 10.1 Long-term and short-term cash flow cycles
Main operations
Inventory
Procurement
Work in Progress
Sales
Current payables
Inventory
Current receivables
Payments
Receipts
Cash and cash equivalents
Investing/ Productive infrastructure
External financing

12. Format and structure of the cash flow statement
Cash flows from operating activities
+ Cash flows from investing activities
+ Cash flows from financing activities
Net change in cash during period
+ Beginning cash balance
Ending cash balance

13. Cash flows from operating activities
Operating activities are primarily the revenue-generating activities of a company
“Operating cash flow” is conceptually most near to “net profit”
Main differences:
Non-cash expenses and non-cash revenues (f.i. depreciation expense)
Non-operating items (f.i. gain on disposal of tangible fixed assets)
Timing differences between net profit and underlying cash flow (f.i. changes in the level of inventories, receivables, creditors, etc.)

14. Operating cash flows: Examples
Receipts from sale of goods and rendering of services (cashing in of receivables included)
Receipts from taxes on sales and VAT
Receipts from royalties, fees, commissions,…
Payments to suppliers (payment of creditors included)
Payments to employees
Payments of taxes, VAT, fines, …

15. Operating cash flows – Direct versus indirect method
2 methods for identifying and presenting the operating cash flow:
Direct method: engenders the presentation of the most important categories of gross operating cash inflows and cash outflows
Indirect method: net operating cash flow is determined by adjusting the (net) profit figure for the 3 types of differences

16. Direct method - Example
Cash receipts from customers
30,150
Cash paid to suppliers and employees
(27,600)
Cash generated from main operations
2,550
Income taxes paid
(1170)
Net cash flow from operating activities
1,380

17. Indirect method - Example
Net profit before tax
3,350
Adjustments for:
Depreciation
490
Investment income
(100)
3,740
Working capital changes:
Increase in trade and other receivables
(500)
Decrease in inventories
1,050
Decrease in trade payables
(1,740)
Cash generated from main operations
2,550
Income taxes paid
Net cash flow from operating activities
(1170)
1,380

18. Cash flow proxy (xxxxxxxxxxxxxx) Net profit or loss after tax
Add back:
Depreciation charge for the year
xxxxxxxxxxxxxxx
Provisions created in year
Deduct:
Provisions released in year
(xxxxxxxxxxxxxx)
‘Cash flow proxy’

19. Cash flow proxy (bis) Net profit or loss after tax xxxxxxxxxxxx
Add back:
Depreciation for the year
xxxxxx
Provisions created in year
xxx
Deduct:
Provisions released
(xxxx)
Gain on asset disposal
(xxxxx)
Net change in non-cash working capital
‘Cash flow proxy’

20. Cash flows from investing activities
Investing activities relate to the acquisition and disposal of long-term tangible and intangible assets and other investments
Cash flows from investing activities are an indication of the expansion or downsizing of operating capacity
Examples:
Payments for newly acquired equipment
Receipts from the disposal of a building
Payments for new investments

21. Cash flows from financing activities
Financing activities relate to changes in the size and composition of contributed capital and financial debt of the company
Examples:
Receipts from issuing new shares or bonds
Receipts from new bank loan
Payments for buy-back of shares
Repayments of loans
Payments of interest and dividend

22. Constructing a cash flow statement
Determine the net change in cash
Compare beginning and ending balance
Identify all transactions of the period leading to a change in cash
Direct: analyze movements in the accounts of cash (equivalents) transaction by transaction
Indirect: explain net change of cash by analyzing all other accounts, knowing that each transaction with an impact on cash also affects a non-cash account
Use the information (of step 1 and 2) to construct a cash flow statement according to the formal rules

23. Applying step 2
Information for operating cash flow is primarily derived from balances in the IS, while information for the two other principal categories comes from the Balance Sheet (and details in the Notes)
Movements in the accounts indicate a change in financial position and further examination is needed to determine if they had a cash impact
Check if balances have been impacted by “accrual-based adjustments” or other “non-cash activities”

24. Fig. 10.2 Classifying balance sheet movements as inflows or outflows of cash
Assets
Equity/liabilities
Increase
Outflow
Inflow
Decrease

25. Illustration - Constructing a CFS (1)

26. Illustration - Constructing a CFS (2)

27. Disposal of fixed assets - Example
Disposal of equipment:
Acquisition cost
Accum. depreciation - 200
Net carrying value =  Sale at 135
Result (gain) on disposal = = 20
Incoming cash flow = 135, composed of a decrease in net carrying value of equipment in the BS (115) and gain on disposal in the IS (20)

28. Disposal of fixed assets
Net profit after tax
xxxxxxxxxxxx
Add back:
Depreciation
xxxxxx
Provisions created
Loss on disposal of assets
Deduct:
Provisions released
Gain on asset disposal
+/- Change in non-cash working capital
Net cash flow from operating activities

29. Incoming cash flows Cash + Other assets = Liabilities + Owners’equity
(1) + -
(2)
(3)

30. Outgoing cash flows - + Cash + Other assets = Liabilities +
Owners’equity
(1) - +
(2)
(3)

31. Presentational choices
Interest paid can be classified under either operating or financing activities
Interest and dividends received can be included in either operating or investing cash flows
Starting from net profit or operating profit under the indirect method (with implications for the adjustments to be made)

32. IAS 7 - Direct Method (Extract)
Source: IAS 7 – Cash Flow Statements, Appendices

33. IAS 7 - Direct Method (Extract)
Source: IAS 7 – Cash Flow Statements, Appendices

34. IAS 7 - Direct Method (Extract- cont.)
Source: IAS 7 – Cash Flow Statements, Appendices

35. IAS 7 - Indirect Method (Extract)
Source: IAS 7 – Cash Flow Statements, Appendices

36. IAS 7 - Indirect Method (Extract)
Source: IAS 7 – Cash Flow Statements, Appendices

37. IAS 7 - Indirect Method (Extract – cont.)
Source: IAS 7 – Cash Flow Statements, Appendices