AIC - WK 13 Discussion Qs

7.5 What is the purpose of a statement of cash flows?

The purpose of the statement of cash flows is to provide users of financial statements with information about
the cash flows of the entity. It shows the cash receipts and payments, and the net effect. The statement of
cash flows can help a user evaluate the entitys potential to generate cash flows, meet its financial
commitments, fund its activities and obtain finance.

7.9 Outline some cash flow warning signals.

Some cash flow warning signals are:

Cash received less than cash paid
Operating outflow
Cash receipts from customers being less than cash payments to suppliers and employees
Cash from operating activities being lower then operating profit after tax
Proceeds of share capital being used to finance operating activities
Consistent inflows from investing activities
Proceeds from borrowings continually much greater than the repayment of borrowings.

7.12 Outline the difference between the direct method and the indirect method of reporting cash flows.
Why is it necessary to present the cash flows using both methods?

The direct method requires the statement of cash flows to show the separate cash inflows and outflows from
operating activities. The indirect method is a reconciliation between cash flows from operating activities and
operating profit showing adjustments in non-cash transactions and in current assets and liabilities.

In Australia, the relevant accounting standard prescribes the direct method to be used in the statement of
cash flows, and the indirect method to be presented in a note to the statement to ensure that users of
financial statements have full information regarding cash flow activities.

7.14 Outline the difference between the cash and accrual bases of accounting.

The recording of transactions to determine a profit or loss for a period is based on accrual accounting. That is
a matching of revenues and expenses. Cash flow is concerned with when receipts are received and payments
are made and not the underlying transaction.
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Coconut Plantations Pty Ltd

A creditor would examine the overall cash position. It has improved from 2013 to 2014.They would also be
interested in the cash from operations and receipts from customers as this would indicate an ability to pay
debts as and when they fell due. They would also be interested in whether any new loans were taken out as
this may affect the companys ability to pay their liability and also may affect the order in which creditors
would be paid out in the event of liquidation. (The company could have offered security to another
credit/debt provider.) Generally a creditor would be positive about the statement of cash flows of Coconut
Plantations Pty Ltd.

An employee would be interested in the items discussed above as well as the purchase of new equipment. If
there are new assets purchased this indicates at the minimum that the company wants to maintain existing
operations and depending on the amount of new investment maybe expanding. For an employee, this means
stable employment. Employees would interpret the Coconut Plantations Pty Ltd statement of cash flows
positively.

A n investor, apart from being interested in all the above would also be interested in the distribution of
dividends and the debt to equity structure. The distribution of dividends represents income they will receive.
The debt to equity structure represents how much of the business the investors own (equity) compared
to how much is owned by entities the business has borrowed from (debt). Depending on the investors
risk profile they may prefer a large proportion of the company being owned by investors. Also new share
offerings can alter the proportion of existing investors ownership percentage in the future. Current investors
would interpret the Coconut Plantations Pty Ltd statement of cash flows positively