INTRODUCTION TO BUSINESS

ACCOUNTING

STATEMENT OF CASH FLO

 After you have studied this
chapter, you should:
Understand how cash flow is
different from profits
Understand and implement the
format to be used for preparing
statements of cash flows
Understand direct and indirect
methods of preparing the
statement of cash flow
Be able to draw up a statement
of cash flow for any type of
organization
Understanding Financial
Statements

Balance Sheet

Income Statement

Cash-Flow
Statement
Why do we need cash flow
statements?
HOW MUCH CASH
DO WE HAVE?

CAN
CAN WE
WE FINANCE
FINANCE How much can
OUR
OUR ACTIVITY?
ACTIVITY? we spend on
fixed assets?
What does the statement of
cash flows provide?
It reports cash receipts and cash
payments of the business for a
particular period.
It explains why the cash has
increased or decreased.
It shows the sources of cash and
how this cash has been spent.
It talks about actual cash
received and actual cash paid

Cash is cash and
everything else is
accounting…
 What is Cash indeed?
◦ Cash includes: cash in
hand, cash at bank and
cash equivalents.
◦ Cash equivalents are
short- term, highly
liquid instruments that
can be quickly
converted into cash.

 Manufacturing account

Capital income
Trading account

Cash flow statement

Profit and Loss account

Capital expenditure

ofit and Loss appropriation account

Balance sheet
Types of Business Activities

 Normally any business engages

itself in three types of activities.
ØOperating Activities
ØInvesting Activities
ØFinancing Activities

The Financial
Statements
T h e statement of cash flows
reports
the company’s cash inflows and
outflows from operating,
investing,
and financing activities.
Operating Activities
Cash receipts from sale of goods.
Cash receipts from rendering a
service
Cash receipts from royalty,
commission and other revenue
Receipts from interest on loan,
dividends and stock investments.
Cash payment to supplier of goods.
Cash payment to employees
Payment of Tax
Cash payment for services like
power, electricity etc.

Investing Activities

These activities affect asset
accounts (such as Plant assets,
Investments and Notes
Receivable).

They increase and decrease the
long-term assets of the business

Financing Activities
They affect liability and stock-
holder's equity account.
(notes' payable, long-term
debt, bonds payable etc.)
Financing activities include
issuing stock, borrowing
money, paying dividends,
selling stock etc.

Format of the
Statement of Cash
Flow
 According to FASB No. 95,
Cash flow statements can
be reported under two
formats:
qThe Direct Method
qThe Indirect Method

 Typical Cash Inflows
Profits

Decrease in inventory
Decrease in
Accounts
Receivables

Loans received
What are Cash
Outflows?

LOSSES Cash
outflows
Typical Cash Outflows
Purchase of fixed assets

Increase in
Increase Accounts
in Inventory Receivables

Loans repaid,
dividends paid
The Direct Method
This method lists cash receipts
from specific operating activities
and cash payments each major
operating activity.
It is used by most government
organizations and some
insurance companies.

Cash Flows from
Operating Activities
 Under this method it is required
to disclose the following operating
cash receipts and payments:
ØCash collected from customers
ØCash paid to employees
ØPayment to suppliers
ØInterest expense and payments
ØTax expense and payments
ØDividends payments
ØInterest and Dividend received

The Indirect Method
This method starts with net
income and reconciles to cash
flows from operating activities.
Hence, it also called as
reconciliation method.
It makes easy computing cash
flow from operating activities by
a shortcut method.
It shows the link between net
income and operating cash
flow better than the direct
Cash Flows from Operating
Activities
Operating Profit/ Net income
+ Depreciation
+ Loss on sale of Fixed Assets
+ Increase in provision for bad
debts
+ Decrease in stock
+ Decrease in debtors
+ Increase in creditors
Net Cash Inflow/ (Outflow)
from Operating Activities

 Constructing a Cash Flow
Statement-I
 Extract the operating (or trading) profit from
the profit and loss account (or balance
sheet) for the current year


Referring to the two balance sheet periods,

calculate the movement between the
following operating working capital
balances:
(a)Stock
(b)debtors
(c)prepayments
(d)creditors
Constructing a Cash Flow
Statement-II
Next, determine whether in respect of
each movement, there has been
either an increase or a decrease in
cash during the period. (Refer
Table)

If the cash movement has had the
effect of increasing the cash for the
period, add the difference to the
operating for the year. If it has had
the effect of decreasing the cash
then deduct it from the operating
Constructing a Cash Flow
Statement-III


Inspect the profit and loss account for any

non-cash items. These should either be
added to, or deducted from, the
operating profit.

Totalthe items included in the
reconciliation. The balance should now
represent the net cash inflow (or
outflow) from operating activities.


 Increase Table
Item Movement Effect on cash
Stock Increase Down (more cash has
been spent on stocks)

Debtors
and Increase Down (less cash has been
prepayments received)

Creditors and Increase Up (less cash has been

accruals spent)
 Decrease Table
Item Movement Effect on cash
Stock Decrease Up (less cash has been
spent on stocks)

Debtors
and Decrease Up (more cash has been
prepayments received)

Creditors and Decrease Down (more cash has

accruals been paid)
Some examples of cash
flows from investing
activities are: for the acquisition
Cash payments
of fixed assets
Cash receipts from sale of fixed
assets
Cash payments for acquiring long
term investments
Cash receipts from sale of long
term investments
Cash advances and loans made
and collected.
 Cash Flows From
Financing Activities
Cash from issue of stocks and
debentures
Expenses on issue of stock
Redemption of stocks and
debentures
Payment of cash dividend

 Classify each of these
transactions by type of cash
flow activity
1.Issued 100,000 shares of $5 par value
ordinary stock for $800,000 cash.
2.Borrowed $200,000 from SL Bank,
signing a 5-year note bearing 8%
interest.
3.Purchased two semi-trailer trucks for
$170,000 cash.
4.Paid employees $12,000 for salaries
and wages.
5.Collected $20,000 cash for services
rendered.
Solution
1. Financing activity
2. Financing activity
3. Investing activity
4. Operating activity
5. Operating activity

Reconciliation
The reconciliation shows how
the company's net income is
related to net cash flow from
operating activities.

State whether each of the
following statements is true or
false
Operating activity reflect total
cash inflows.
Depreciation decreases the cash
position.
Tax paid decreases the tax
position.
A proposed dividend increases
the cash position.

State whether each of the
following statements is true or
false
A decrease in debtors increases
the cash position.
An increase in creditors decreases
the cash position.
Cash Flow Statement, as per
FRS1.


 Specific headings:
(a) Net cash flow from
operating
activities)
(b) Net cash flow from
return on
investment and
servicing finance.
c. Net cash flow from
taxation.
(d. Net cash flow from
investing
activities.
Note)

(i. Long term
investments.
These are treated as
part of fixed assets.
i.e. part of net cash
flow from investing
activities.
(ii) )hort Term
investments.
These are treated as
current assets.
These investments will
be treated as cash or
cash equivalents.

 Format for the cash flow
statement


$
 Net cash flow form operating activities
x
 Net cash flow from Return on investment
 and servicing finance
x

 Net cash flow from taxation
x
 Net cash flow from investing activities
x

 Net flow before financing activities
x

Practical example
Assets Dec. 31, 2007 Jan.1,2007

Eqmt. $10,000 0
A.R. 30,000 0
Cash 34,000 0
Liabilities
A.P. $4,000 0
Stock Equity
Ord. shares 50,000 0
R.E. 20,000 0
 Income statement
Revenues $85,000
Operating exp. 40,000
Income tax expense 10,000
Net Income 35,000
Additional Information:
A dividend of $15,000 was declared
and paid.
The equipment was purchased at
the end of 2007. No depreciation
was taken in 2007.
Statement of cash flow.
Dec. 31, 2007
Cash flow from oper. activ.
Net income $35,000
Adjustments to reconcile net income
to net sash provided by operating
activities:
Increase in A. R. $(30,000)
Increase in A.P. $ 4,000
$(26,000)
Net cash provided
 by operating activities 9,000
Cash flow from investing activities
Purchase of equipment
$(10,000)
Net cash used
by investing activities
(10,000)
Cash flow from financing activities
Issuance of ordinary stock
$50,000
Payment of cash div.
(15,000)
Net cash provided by f-ing. activ.
35,000

Reconciliation of operating profit to
net cash inflow from operating
activities
Operating profit (£40-30) 10
Depreciation charges 20
Increase in stocks (30)
Decrease in Debtors 110
Decrease in creditors (40)
Net cash inflow from
operating activities 70

===
 
 Net cash flow from operating activities
70
 Management of liquid
 resources and financing
Issue of debenture loan 60
Purchase of investments

(100)
Increase in cash 30


===




 Reconciliation of net cash
flow to movement in net debt
Increase in cash in the period 30
Cash inflow from increase in debt (60)
(30)
Net debt at 1.3.08 (20)
Net debt at 28.2.09 (50)


 Analysis of changes in net
debt
 at 1.3.08 Cash flows at
28.2.09
Cash at bank (20) 30 10
Debt due

after 1 year - (60) (60)

 ----- ------ ------
Total (20) (30) (50)
 ==== ====
====
What does it tell to the
managers of the company?
I.The company increased its cash
position by £30,000;
II.Its operating activities generated
£70,000 in cash;
III.The company issued £60,000 of
debenture stock making the
total increase in cash
£130,000;
IV.£100,000 of cash was used to
purchase some investments;
Thank you, but there is
still one more chapter
left…

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