Cash Flow Statement

Measures change in cash flows – organises cash management

Cash is king – companies need to be liquid. They can be highly profitable but still fail if you
cannot payout obligations in a timely manner.

Cash flow and profits go hand-in-hand.

Issuance of share capital, dividends is also not operating cash flow relevant – as it is a
transaction with the owner. It is not profit generating.

CFS history – not relevant from exam POV.

CFS is important from finance POV as it helps predict future cash flows, evaluate
management decisions. Ensures comparability.

Transaction Effect on profit Effect on cash

Repayment of No effect – as it is a finance Cash outflow
borrowings transaction does not come on IS
Making profitable sale Yes – we recognise revenue Not immediately as it is on
on credit credit
Buying non-current No effect – does not go into IS. No effect – does not go into
asset on credit Maybe only after it is used and IS
depreciation is incurred later –
but not at time of purchase
Receiving cash from No – does not have a profit effect Yes – increase
credit customer
Depreciation of non- Yes – it is a decrease No
current asset
Buying inventory of No Decrease
cash
No Increase

Three sections to CFS:

1. Operating cash flows – Revenue and expenses, gains and losses

2. Investing cash flows – Relate to non-current assets
3. Financing cash flows – Cash flows with investors and creditors (long-term
financers)
4. Non-cash activities disclosed in notes for example: purchasing non current asset
on credit, issue shares but not for cash.
Dividend payments – outflow of cash

Indirect method: Start with profit and make adjustments using accrual methods

Operating activities – includes payments to employees

- Direct method lists operating inflows and outflows to calculate operating cash
flows. Indirect method starts with net profit and makes adjustments. Adjustments
are absolute non-cash expenses.
- Indirect method starts with ‘net profit’ which is after interest adjustment - so it
allows us ease versus being very literal by allowing interest payments here. Even
though under literal interpretation, it should be under financing activities.
- Now for trading businesses, receipts for sale of loans, debt, equity are smaller
amounts so these may be in operating or a investing flows – that is up to us but this
wont come in the exam
- Dividend should not be shown here.
- Depreciation, etc can be shown here

Financing cash flows:

- Change in retained earnings will not feature here

- But inflow from lenders, inventors, outflow of dividends will feature here
- Now short form loans – is it a financing or non-financing
- Overdraft – negative cash balance

Recurring activities are the operatig activities. SO we are always looking for a strong
operating cash flow. OTher two are kind of one-off.

Direct and indirect methods only affects the operating section. Other two sections are not
any different.

Indirect method: Add back all non-cash expenses (depreciation)

Example 3:

NOP 165

Add back dep 41

Less: increase in inventories 1

Less: increase in debtors 3

Add: Increase in creditors 2

=204

Financing:

- Depreciation, what is reduced from carrying amount will also show in the financing
section as a decrease
- This is separate from the amount that is added back to net profit in the indirect
method

Tutorials

Difference between profit and cash can be because of – non profit expenses, accruals,
transactions such as investments that doesnt go through P&L, buying and selling of non-
current assets, borrowing money, issuing shares etc.

Questions

6.1

Cash is important cos it is more liquid and can be used for more than what just inventory
for example could be used for

6.2

Manner of calculation of operating cash flows differs for both

Indirect helps external person view the adjustments vis-a-vis the operating activities. It is
easier to be compare between business as it helps to understand the profit calculation
better.
6.3

Important to define what is as liquid as cash –all current assets may not be

6.4

It depends – for longer period of time, it may be close to each other. Over the lifetime of the
business it could be equal. However, for shorter period, it could vary largely.

Also depends on the type of business as if an entity is a service business, inventory could
be seen as working capital. If it is a cash business entirely, then no accruals so it may be
close.

Exercise 6.1

a) Depends on whether purchase is by cash or credit

b) Yes it would result in cash inflow
c) This is just a reclassification and there is no fresh inflow of cash here.
d) No because this reduces the value of inventories / loss of inventory
e) Transfer of equity, new owners but is not a business transaction. This is outside the
entity
f) It is a non-cash expense

Exercise 6.2

OP 187

Add back dep 55

Less: increase in inventories 4

Add: decrease in debtors 1

Add: Increase in creditors 2

=241

Exercise 6.3
 1. Heading: Cash flow statement of ____ for the year ended
2. Start with operating section:
Non-cash items:
a. Profit for the year – Use whatever is the last amount, even if it is after interest
and taxes. Ignore interest and tax here as we are assuming it to be operating
expenses. So 134
b. Non-cash items – Depreciation needs to be calculated as 325+67-314,
which is 78
Accruals:
c. Current assets and current liabilities: Inventories, trade payables, trade
receivables
- Add: decrease in inventories
- Less: decrease in trade recievables
- Add: decrease in trade payables
d. Note: Cash and bank balance, including overdraft will not show here. It is
either financing if borrowing increases or just cash balance to be shown in
the bottom for the CFS reconciliation
e. Taxation is not to be considered here
f. In this sum, also shows that interest payable is just an expense as it does not
feature in the balance sheet
g. Investing activiittes:
- Less: Purchase of plant and buildings 67
h. Financing activities:
- Less: Borrowing of loan notes 100
- Dividend says 60 so just put this as dividend
i. Now, the notes say that there was no share cash issue for the year. So there
was a reclassification of 40 and 60 in share premium and reval reserve to
increase capital. So this does not come in the CFS
j. Retained earnings need not be put in for now. This difference could amount
to dividend distribution adjusted with new profit, but they have given us
dividend anyway in the notes.

Exercise 6.4

Operating section:

1. Start with profit for the year 2018 – 19

2. Add: Depreciation for the year – 10 for LandB and 12 for PM
3. No gains or losses on disposals in the year
 4. Current assets and current liabilities:
a. Decrease in payables – decrease in cash
b. Decrease in taxation payable – decrease in cash
c. Increase in inventories – decrease in cash
d. Decrease in recievables – decrease in cash?

Investing section:

5. Less: Addition in land and building 30 and plant 6

6. No proceeds from disposals

Financing

7. Now retained earnings could be used to calculate the dividends, but if dividend is
given then not required as it is non-cash.
So 56 + 19 -18 = 57
8. Less: Dividend paid 18