1. The third financial statement
Cash Flow Statements
The third financial statement

2. Why we need Cash Flow Statements
The Cash Flow Statement gives further information to users on
Liquidity and solvency
Changes in net assets
The businesses financial structure
Its ability to effect cash flow timings

3. WHY PREPARE A CASH FLOW STATEMENT?
Balance sheets, the income statement and statement of changes in capital are based on accrual accounting and provide only piecemeal information about flows of funds and cash
Cash flow statement identifies cash inflows and outflows from activities over the period
Statement helps answer questions such as:
Why is the company in a liquidity crisis when it has been profitable over the past few years?

4. CONTENT OF STATEMENT The statement must:
identify cash at beginning and end of period
separately disclose cash inflows and outflows
classify cash flows as arising from operating, investing or financing activities
Indian standard specifies either the direct or indirect method of reporting cash flows

5. Components of the Cash Flow Statement
There are six parts to every Cash Flow Statement:
1. Cash flows from operations
2. Cash flows from investing activities
3. Cash flows from financing activities
4. Total change in cash
5. Beginning cash
6. Ending cash
Items 5 & 6 must equal the amounts reported on the balance sheet

6. CONCEPT OF CASH
As transfers between ‘cash’ items do not appear in the statement it is essential to determine what makes up cash
Cash is defined in as cash and cash equivalents
Cash = cash on hand and demand deposits
Cash equivalents:
Highly liquid investments with short periods to maturity, which are readily convertible to cash and have minimal risk of value changes

7. CLASSIFICATION OF ACTIVITIES
Classify the activities into:
Operating activities
Investing activities
Financing activities
Treatment of item in financial statements does NOT determine cash flow statement classification

8. Cash flows from operating activities
Relate to principle revenue-producing activities not investing or financing activities
cash receipts from customers
cash payments to suppliers of services and inventory
Also include any activities which are not investing or financing

9. Examples of Operating Activities
Cash Inflows
Cash Outflows
Cash from sale of goods
Cash paid to suppliers
Cash from royalties, fees etc
Cash paid to employees
Refunds of tax unless from investing etc
Cash payment of an insurance company
Cash refunds of an insurance company
Cash payment of income taxes
Cash receipts relating to future, forward, swaps if for dealing
Cash payments relating to future, forward, swaps if for dealing

10. Cash flows from investing activities
Relate to acquisition and disposal of long-term assets and other investments
cash paid to buy new plant
cash received from sale of investment
Interest and dividends received on these investments are classified as operating activities

11. Examples of Investing Activities
Cash Inflows
Cash Outflows
Cash received from disposal of fixed assets
Cash payments to acquire fixed assets
Cash received from disposal of shares
Cash payments to acquire shares, warrants etc
Cash received from payments of advances
Cash advances or loans to third parties
Cash received from derivatives if held as trade goods
Cash payments for derivatives

12. Cash Flows from financing activities
Relate to changing size or composition of the equity and borrowings of an entity
cash received from new issue of share capital
cash used to repay mortgage loan
Cash dividends paid to shareholders are classified as financing activities

13. Examples of Financing Activities
Inflows
Outflows
Cash proceeds from issuing shares or other instruments
Cash paid repayments of amounts borrowed
Cash proceeds from issuing debentures, loans and other short or long term borrowings
Cash redemption of preference capital and repayment on share buy back

14. PREPARING THE CASH FLOW STATEMENT
There are two methods:
1. The Direct Method – This analyses the cash book and other accounting records or
2. The Indirect Method - Analyse the financial statements (The Indirect Method)
Both methods should produce the same cash inflows and cash outflows

15. PREPARATION OF THE CASH- FLOW STATEMENT-STEPS ARE:
1. Ascertain net cash used in operating activities
2. Ascertain net cash used in investing activities
3. Ascertain net cash used in financing activities
4. Ascertain net cash and cash equivalents increase (decrease) for the period
5. Reconcile cash and cash equivalents at the end of the year with that at the beginning of the period

16. CASH RECEIPTS FROM CUSTOMERS
Calculate as follows
Accrual-basis Sales + beginning balance of accounts receivable – ending balance of accounts receivable
= cash received from customers

17. ACCOUNT RECONSTRUCTION
ACCOUNTS RECEIVABLE
Open Bal (A/R) CASH
Sales Close Bal (A/R)
______ ______

18. CASH PAID TO SUPPLIERS AND EMPLOYEES
Requires two calculations which are then combined to given total cash flow:
Payments for inventory purchases
and
Payments to employees and other suppliers (relates to expenses other than cost of goods sold)

19. PAYMENTS FOR INVENTORY PURCHASES
Calculate as follows
1. Cost of Goods Sold + ending balance of inventory beginning balance of inventory
= Accrual purchases
2. Purchases + beginning balance of accounts and bills payable – ending balance of accounts and bills payable
= cash paid to suppliers for purchases

20. PAYMENTS FOR INVENTORY PURCHASES
Beginning balance Cost of goods sold
Purchases Ending balance
ACCOUNTS PAYABLE
Cash Payments Beginning Balance
Ending Balance Purchases

21. PAYMENTS FOR OTHER EXPENSES
Calculate as follows:
Other expenses
– non-cash items and non-operating items
+ beginning balance of accrued expenses
+ ending balance of prepaid expenses
– ending balance of accrued expenses
– beginning balance of prepaid expenses
= cash paid
Non-cash items include depreciation
Non-operating items are expenses associated with financing and investing activities such as cost of investment sold

22. CASH FLOWS FROM INVESTING ACTIVITIES
Interest paid and received and dividends received are all required to be shown separately
Cash flow = expense/revenue +/- beginning and ending balance of any prepayment or accrual accounts relating to these items

23. CASH FLOWS FROM INVESTING ACTIVITIES
Purchase and sale of non-current assets
Only payments made in cash and receipts of cash on sale are included
Watch for non-cash transactions such as trade-ins and purchase by instalment
Reconstruction of ledger accounts may be required to determine cash flows where depreciable assets have been sold

24. CASH FLOWS FROM FINANCING ACTIVITY
Ignore non-cash transactions such as share dividends and debt conversions to equity
Only dividends paid in cash are reported. Dividends paid =
beginning balance of provision for dividend + interim cash dividends paid
May need to reconstruct retained profits to determine interim dividends paid

25. ADVANCED ISSUES
Some adjustments may need to be made in the conversion process from accrual basis reports to the cash flow statement
Trade accounts receivable (bad debts, allowance for doubtful debts, discount allowed)
Trade accounts payable
Non-trade receivables and payables
Bills receivable and bills payable
Short-term investments
Dividends
Income Tax

26. ANALYSING THE CASH FLOW STATEMENT
Statements of cash flows help users evaluate a company’s ability to:
generate positive cash flows
meet its obligations to shareholders, creditors and governments
assess a company’s solvency and need for external financing
explain variances between reported accrual profit and cash flows from operating activities
Single statements are of limited use, a useful analysis requires statements covering five or more years.

27. LIMITATIONS OF THE STATEMENT
The usefulness of cash flow statements is limited due to the fact that they are:
based on historical cash flows
non-cash transactions are only disclosed in the notes
give only some of the information necessary to assess liquidity and solvency
may be manipulated by management
costs involved in its preparation