THE CASH

S FLOW
O STATEMENT &
OTHER REPORTS
LECTURE 5

LEARNING OBJECTIVES
Understand the difference between cash flow and profit
Revisit the accruals concept
Understand and interpret
p the cash flow statement

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Get familiar with the structure of and items in cash flow

statements

Understand how to compare balance sheets to explain

changes in cash

Link changes in cash to cash flow statement

Produce cash flow statements in a form suitable for

publication
Discuss other financial statements and reports

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Panagiotis Dontis Charitos

WBS, 2013-14

IN TODAYS LECTURE...
Topics

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Cash flow and profit

The accruals concept revisited
The cash flow statement
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Other financial statements

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Understanding and interpretation

R l i hi with
Relationship
i h bbalance
l
sheet
h
Preparation of
Directors report
Auditors report
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Notes to the financial statements

Panagiotis Dontis Charitos

WBS, 2013-14

CASH FLOW VS. PROFIT

Profit not determined by cash

Cash inflows cash outflows not profit

Increasing cash balance

Does not imply success

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Sale of assets
Massive borrowing

Decreasing cash balance

Does not imply failure

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Investment in assets

IImportant to understand
d
d difference
diff
between
b
profit
fi and
d
cash flow

Panagiotis Dontis Charitos

WBS, 2013-14

ACCRUALS CONCEPT: REVISITED

Profit

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Revenues earned less costs incurred in earning those revenues

Cash receipts and payments are irrelevant to profit
measurement
Accruals and matching principle

Panagiotis Dontis Charitos

WBS, 2013-14

ACCRUALS CONCEPT: REVISITED

Not all expenses have cash effects

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Depreciation
Accruals

N t allll revenues have

Not
h
cashh effects
ff t

Credit sales

Not all cash payments are expenses

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Purchase of non-current assets

Investments in other firms
Prepayments

Not all cash receipts

p are revenues

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Sale of non-current assets

Borrowing money
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WBS, 2013-14

EXAMPLE 1
Omega ltd sells a piece of machinery to another company
for 100,000 in March 2010 and receives full amount of
cash upon the sale. The cost of purchasing this asset back
i 2009 was 94,000.
in
94 000

What is the effect of this sale on the income statement for the
year ending 2010
2010, and what is the respective effect on the cash
flow statement for the same period?

Only the profit from the sale (6,000) is going to be added

on the income statement. The full amount of cash
received would not count towards profit, but will be shown on
the cash flow statement as a cash inflow.
Panagiotis Dontis Charitos

WBS, 2013-14

EXAMPLE 2

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WBS, 2013-14

CASH FLOW STATEMENT

Cash Flow

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Movement of money into and out of the business

Cash receipts and cash payments during the period

Cash Flow Statement

Aggregate data on all cash inflows and cash outflows

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Facilitates reconciliation between

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Cash inflows (outflows) are decreases (increases) in assets and/or

increases (decreases) in liabilities
Shows origin (target) and amount of cash received (paid)
Amount
ou o
of p
profit
o ge
generated
e a ed du
during
g pe
period
od
Amount by which cash balances have increased (decreased)
during period
Panagiotis Dontis Charitos

WBS, 2013-14

CASH FLOW STATEMENT

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Cash and cash equivalents at the start of year

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= Cash and cash equivalents at the end of year

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Add cash inflows

Deduct cash outflows
Cash equivalents are short term investments that can be
turned into cash quickly

Activities that generate cash

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Operating
Investing
Financing

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WBS, 2013-14

ACTIVITIES AFFECTING CASH

OPERATING

INVESTING
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FINANCING
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OPERATING ACTIVITIES
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Any transaction that determines net income

Cash inflows
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EBIT
Depreciation
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Add Interest received

Changes in working capital
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Added back as it is not a cash outflow

Add decrease in inventories and receivables

Add increase in payables

Add tax rebate

Panagiotis Dontis Charitos

WBS, 2013-14

OPERATING ACTIVITIES
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Any transaction that determines net income

Cash outflows
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EBIT (only if negative)

Deduct interest paid
Changes in working capital
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Deduct
D
d
tax paid
id
Deduct dividends paid
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Deduct increase in inventories and receivables

Deduct decrease in payables

Typically under financing activities

Panagiotis Dontis Charitos

WBS, 2013-14

OPERATING ACTIVITIES: CHANGES IN WORKING

CAPITAL & CASH FLOW
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What are the cash effects of changes in working capital

items?

WC = Current Assets Current Liabilities

Inventory increase means cash spent

Receivables decrease means cash received
Payables decrease means cash spent

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WBS, 2013-14

INVESTING ACTIVITIES
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Any transaction related to acquisition or sale of noncurrent assets

Cash inflows
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Sale of property plant or equipment

Collection of loans to other entities
Sale of non-cash equivalent securities
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Long-term investments (stocks, bonds)

Cash outflows
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Purchase of property plant or equipment

Lending of money to subsidiary
Purchase of non-cash equivalent securities
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WBS, 2013-14

FINANCING ACTIVITIES
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Any transaction related to borrowing from creditors or

involving owners
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Excludes interest payments

Cash inflows
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Share issues
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Short term borrowing

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Additional capital
N
Notes,
bonds,
b d mortgages etc.

Cash outflows
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Payment off cashh dividends

P
di id d
Share repurchases
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WBS, 2013-14

CASH FLOW STATEMENT: AN EXAMPLE

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WBS, 2013-14

CASH FLOW STATEMENT: PREPARATION

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Important to use balance sheet and income statement

Collect items from income statement
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EBIT
Depreciation (if does not appear on IS, find on notes)
Amortisation
Provisions
Profit from sale of assets (deduct from EBIT)
Interest
Tax

Panagiotis Dontis Charitos

WBS, 2013-14

CASH FLOW STATEMENT: PREPARATION

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Important to use balance sheet and income statement

Collect items from balance sheet
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Change in inventory (stock)

Change in receivables (debtors)
Change in payables (creditors)
Change in long-term borrowings

Problem items
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Share issues
Purchase or disposal of non-current assets
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Detailed info on notes to the balance sheet

Panagiotis Dontis Charitos

WBS, 2013-14

CASH FLOW STATEMENT: PREPARATION

EBIT
AddDepreciation
Deduct(Increase)/Add(decrease)in
inventories
Deduct(increase)/Add(decrease)in
tradereceivables
Add(increase)/Deduct(decrease)in
tradepayables
DeductInterestpaid
Deducttaxpaid
D d t di id d
Deductdividendspaid
id
Netcashflowfromoperating
activities

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Panagiotis Dontis Charitos

WBS, 2013-14

CASH FLOW STATEMENT: INTERPRETATION

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Free Cash Flow

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Net cash arising from operating activities

Can be used to pay dividends, investments, pay loans
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What about essential upgrades investments?

Cash Flow Ratios

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Interest and dividend cover

Free Cash Flow Cash Flow ffor Interest
,
Dividend
Interest

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Cashh return on capitall employed

C
l d
Cash flow per share
Panagiotis Dontis Charitos

WBS, 2013-14

CASH FLOW STATEMENT: INTERPRETATION

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Important areas
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Cash flow from operating activities

Changes in working capital and how they are financed
Investing activities and finance
Financing activities
Dividends coverage by net operating cash flows
Cash balance at beginning of year vs. cash balance at end of
year
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Investigate reasons for changes

Limitations
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Not to be used in isolation necessary to use balance sheet

and income statement
Panagiotis Dontis Charitos

WBS, 2013-14

OTHER FINANCIAL STATEMENTS:

DIRECTORS REPORT
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States among other things

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Information about directors

Directors remuneration
Principal activities (and any changes)
Business review
Future developments
Research and development
Post balance sheet events
Market value of land and buildings
R
Recommended
d d dividend
di id d
Creditor payment
Panagiotis Dontis Charitos

WBS, 2013-14

OTHER FINANCIAL STATEMENTS:

AUDITORS REPORT
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Scope
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Outcomes
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Verifies that a corporation's financial statements comply with

accounting standards and that represent the companys
fi
financials
i l iin a t
true and
d fair
f i manner
Unqualified
U
lifi d report iis a clean
l
report
Qualified report shows reservation

Al includes
Also
i l d
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Statement of Directors responsibilities to make clear that

financial statements are the responsibilities of the directors

Panagiotis Dontis Charitos

WBS, 2013-14

OTHER FINANCIAL STATEMENTS:

NOTES TO THE FINANCIAL STATEMENTS
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Also known as footnotes

Additional notes and information
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Added to the end of the financial statements

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Important information that cannot be presented on balance

sheet and income statement
Supplement users with more information

Present
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Computation of specific items

Accounting methodologies used
Pension plan details
Stock option compensation information
List of subsidiaries controlling interest
Panagiotis Dontis Charitos

WBS, 2013-14

READING LIST
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Core reading
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Perks and Leiwy

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Chapter 6
Chapter 7 section 7.6

Further reading
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G
Gowthorpe
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Chapter 10

Panagiotis Dontis Charitos

WBS, 2013-14

NEXT WEEK IS ISL

Not Independent
p
Student Partying
y g ((ISP)) week...
Use responsibly!!
p
y
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Panagiotis Dontis Charitos

WBS, 2013-14