CHAPTER 10

Cash flow statements

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

2005 Peter Walton and Walter Aerts
 Contents
Introduction The cash flow statement
Usefulness of cash flow information
Cash flow cycles
Format and structure of the cash flow statement
Cash flow from operating activities
Cash flows from investing and financing activities
Direct and indirect method for operating cash flows
Constructing a cash flow statement
Disposal of fixed assets
Presentational differences
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
2005 Peter Walton and Walter Aerts
 Cash flow statement
A cash flow statement presents information
about the cash flows associated with the
companys main operations and those
associated with its investing and financing
activities of the period
A cash flow statement functions in
conjunction with both the income statement
(performance dimension) and the balance
sheet (financial position)
IAS 7 Cash Flow Statements

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

2005 Peter Walton and Walter Aerts
 Usefulness of cash flow information

Ability to generate adequate cash flows

is a significant performance dimension
Cash flow information clarifies the
dynamics of short-term liquidity and
long-term solvency
Cash flow information is an essential
input for economic decision models

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

2005 Peter Walton and Walter Aerts
 Cash flow versus profit
Cash flow and profit are different economic
phenomena
But linked through the mechanisms of accrual
accounting!
Cash flows are factual details of incoming and
outgoing flows of cash, while the balance sheet
and income statement emanate from
professional judgement and are not a direct
projection of objective economic data

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

2005 Peter Walton and Walter Aerts
Liquidity/solvency and cash flows
Liquidity
- Relates to nearness to cash of the structure of assets
- Determined by capacity to convert current assets into cash
Solvency
- Relates to future availability of cash in order to settle financial
liabilities on due date
- Determined by timing and uncertainty of expected future cash
payments and cash receipts
Liquidity and solvency ratios are determined on
static financial position data, while cash flows
reflect changes in financial position

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

2005 Peter Walton and Walter Aerts
 Relationship with BS and IS
Income statement

BS at start Cash flow BS at end

A cash flow statement reflects both profit related and

non-profit related activities (investing and financing) with
an impact on available cash over the period covered in the
income statement

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

2005 Peter Walton and Walter Aerts
 Related questions
1. From which sources did the company raise cash last
year? How was this cash used?
2. Were the normal operating activities capable of
satisfying its need for cash during the year?
3. If not, is the shortage of cash compensated by new
borrowings, issuing new share capital or by selling
fixed assets?
4. Is a surplus of cash used for repayment of debt, for
investments or for distribution of dividends?
5. Why has the balance of cash available decreased,
knowing that the companys operations have been
profitable?

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

2005 Peter Walton and Walter Aerts
 Cash conversion cycles
Cash flows through the company
continuously in a series of short-term and
long-term conversion cycles
The ST - cash conversion cycle (operating
cycle) relates to the main business
operations
= OPERATING ACTIVITIES

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

2005 Peter Walton and Walter Aerts
 Cash conversion cycles (cont.)
The LT- cash conversion cycles relate to the
acquisition, renewal and disposal of
intangible and tangible infrastructure and the
long-term sourcing of funds
Productive capacity acquired for cash and
subsequently consumed during several ST-
operating cycles
Acquisition and disposal of infrastructure =
INVESTING ACTIVITIES
External sourcing of funds = FINANCING
ACTIVITIES
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
2005 Peter Walton and Walter Aerts
 Fig. 10.1 Long-term and short-term cash
flow cycles
Main operations
Inventory

Procurement Work in Progress Sales

Current payables Inventory Current receivables

Cash and cash

Payments Receipts
equivalents

Investing/ Productive
External financing
infrastructure
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
2005 Peter Walton and Walter Aerts
Format and structure of the cash
flow statement

Cash flows from operating activities

+ Cash flows from investing activities

+ Cash flows from financing activities

Net change in cash during period
+ Beginning cash balance
Ending cash balance

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

2005 Peter Walton and Walter Aerts
 Cash flows from operating
activities
Operating activities are primarily the revenue-generating
activities of a company
Operating cash flow is conceptually most near to net
profit
Main differences:
1. Non-cash expenses and non-cash revenues (f.i.
depreciation expense)
2. Non-operating items (f.i. gain on disposal of tangible
fixed assets)
3. Timing differences between net profit and underlying
cash flow (f.i. changes in the level of inventories,
receivables, creditors, etc.)

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

2005 Peter Walton and Walter Aerts
 Operating cash flows: Examples
Receipts from sale of goods and rendering of
services (cashing in of receivables included)
Receipts from taxes on sales and VAT
Receipts from royalties, fees, commissions,
Payments to suppliers (payment of creditors
included)
Payments to employees
Payments of taxes, VAT, fines,

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

2005 Peter Walton and Walter Aerts
 Operating cash flows
Direct versus indirect method
2 methods for identifying and presenting the
operating cash flow:

Direct method: engenders the presentation of the

most important categories of gross operating cash
inflows and cash outflows
Indirect method: net operating cash flow is
determined by adjusting the (net) profit figure for the
3 types of differences

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

2005 Peter Walton and Walter Aerts
 Direct method - Example

Cash receipts from customers 30,150

Cash paid to suppliers and employees (27,600)

Cash generated from main operations 2,550

Income taxes paid (1170)

Net cash flow from operating activities 1,380

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

2005 Peter Walton and Walter Aerts
 Indirect method - Example
Net profit before tax 3,350
Adjustments for:
Depreciation 490
Investment income (100)
3,740

Working capital changes:

Increase in trade and other receivables (500)
Decrease in inventories 1,050
Decrease in trade payables (1,740)
Cash generated from main operations 2,550
Income taxes paid (1170)
Net cash flow from operating activities 1,380

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

2005 Peter Walton and Walter Aerts
 Cash flow proxy

Net profit or loss after tax xxxxxxxxxxxxxx

Add back:
Depreciation charge for the year xxxxxxxxxxxxxxx
Provisions created in year xxxxxxxxxxxxxxx
Deduct:
Provisions released in year (xxxxxxxxxxxxxx)
Cash flow proxy xxxxxxxxxxxxxx

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

2005 Peter Walton and Walter Aerts
 Cash flow proxy (bis)
Net profit or loss after tax xxxxxxxxxxxx
Add back:
Depreciation for the year xxxxxx
Provisions created in year xxx
Deduct:
Provisions released (xxxx)
Gain on asset disposal (xxxxx)
Net change in non-cash working capital (xxxxx)
Cash flow proxy xxxxxxxxxxxx

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

2005 Peter Walton and Walter Aerts
 Cash flows from investing
activities
Investing activities relate to the acquisition
and disposal of long-term tangible and
intangible assets and other investments
Cash flows from investing activities are an
indication of the expansion or downsizing of
operating capacity
Examples:
Payments for newly acquired equipment
Receipts from the disposal of a building
Payments for new investments

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

2005 Peter Walton and Walter Aerts
 Cash flows from financing
activities
Financing activities relate to changes in the
size and composition of contributed capital
and financial debt of the company
Examples:
Receipts from issuing new shares or bonds
Receipts from new bank loan
Payments for buy-back of shares
Repayments of loans
Payments of interest and dividend

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

2005 Peter Walton and Walter Aerts
 Constructing a cash flow statement
1. Determine the net change in cash
Compare beginning and ending balance
2. Identify all transactions of the period leading to a change
in cash
Direct: analyze movements in the accounts of cash
(equivalents) transaction by transaction
Indirect: explain net change of cash by analyzing all
other accounts, knowing that each transaction with
an impact on cash also affects a non-cash account
3. Use the information (of step 1 and 2) to construct a cash
flow statement according to the formal rules

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

2005 Peter Walton and Walter Aerts
 Applying step 2
Information for operating cash flow is primarily
derived from balances in the IS, while information for
the two other principal categories comes from the
Balance Sheet (and details in the Notes)
Movements in the accounts indicate a change in
financial position and further examination is needed
to determine if they had a cash impact
Check if balances have been impacted by accrual-
based adjustments or other non-cash activities

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

2005 Peter Walton and Walter Aerts
Fig. 10.2 Classifying balance sheet
movements as inflows or outflows of cash

Assets Equity/liabilities

Increase Outflow Inflow

Decrease Inflow Outflow

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

2005 Peter Walton and Walter Aerts
 Illustration - Constructing a CFS (1)
X2 X1 Outflow Inflow

Assets
Fixed assets (at cost) 980 740 240 240
Acc. depreciation -350 -265 85 85
Inventories 180 171 9 9
Trade receivables 115 98 17 17
Cash 92 110 18 18
1017 854

Financing
Equity
__
Share capital 600 600
__
Reserves 90 90
__
X2 profit 50 50 50
Liabilities
Trade payables 62 59 3 3
LT debt 215 105 110 110
1017 854 266 266

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

2005 Peter Walton and Walter Aerts
Illustration - Constructing a CFS (2)
Operating activities
Net profit after tax 50
Add back depreciation 85
135
Changes in non-cash working capital 23
Net cash flow from operations (A) 112
Investing activities
Purchase of fixed assets (B) 240
Financing activities
New LT debt (C) 110
Net change in cash (A+B+C) 18
Cash balances
At beginning of year 110
At balance sheet date 92
Difference 18

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

2005 Peter Walton and Walter Aerts
 Disposal of fixed assets - Example
Disposal of equipment:
Acquisition cost 275
- Accum. depreciation - 200
Net carrying value = 115 Sale at 135

Result (gain) on disposal = 135 - 115= 20

Incoming cash flow = 135, composed of a decrease in

net carrying value of equipment in the BS (115) and
gain on disposal in the IS (20)

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

2005 Peter Walton and Walter Aerts
 Disposal of fixed assets
Net profit after tax xxxxxxxxxxxx
Add back:
Depreciation xxxxxx
Provisions created xxxxxx
Loss on disposal of assets xxxxxx
Deduct:
Provisions released xxxxxx
Gain on asset disposal xxxxxx
+/- Change in non-cash working capital xxxxxx
Net cash flow from operating activities xxxxxxxxxxxx
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
2005 Peter Walton and Walter Aerts
 Incoming cash flows
Cash + Other assets = Liabilities + Ownersequity

(1) + -

(2) + +

(3) + +

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

2005 Peter Walton and Walter Aerts
 Outgoing cash flows
Cash + Other assets = Liabilities + Ownersequity

(1) - +

(2) - -

(3) - -

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

2005 Peter Walton and Walter Aerts
 Presentational choices
Interest paid can be classified under either
operating or financing activities
Interest and dividends received can be
included in either operating or investing cash
flows
Starting from net profit or operating profit
under the indirect method (with implications
for the adjustments to be made)

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

2005 Peter Walton and Walter Aerts
IAS 7 - Direct Method (Extract)
20X2
Cash flows from operating activities
Cash receipts from customers 30,150
Cash paid to suppliers and employees (27,600)
Cash generated from operations 2,550
Interest paid (270)
Income taxes paid (900)

Net cash from operating activities 1,380

Cash flows from investing activities

Acquisition of subsidiary X, net of cash acquired (550)
Purchase of property, plant and equipment (350)
Proceeds from sale of equipment 20
Interest received 200
Dividends received 200

Net cash used in investing activities (480)

Cash flows from financing activities

Proceeds from issue of share capital 250
Proceeds from long-term borrowings 250
Payment of finance lease liabilities (90)
Dividends paid* (1,200)

Net cash used in financing activities (790)

Net increase in cash and cash equivalents 110

Cash and cash equivalents at beginning of period 120
Cash and cash equivalents at end of period 230
Source: IAS 7 Cash Flow Statements, Appendices
* This could also be shown as an operating cash flow.
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
2005 Peter Walton and Walter Aerts
 IAS 7 - Direct Method (Extract)
20X2
Cash flows from operating activities
Cash receipts from customers 30,150
Cash paid to suppliers and employees (27,600)
Cash generated from operations 2,550
Interest paid (270)
Income taxes paid (900)

Net cash from operating activities 1,380

Cash flows from investing activities

Acquisition of subsidiary X, net of cash acquired (550)
Purchase of property, plant and equipment (350)
Proceeds from sale of equipment 20
Interest received 200
Dividends received 200

Net cash used in investing activities (480)

Source: IAS 7 Cash Flow Statements, Appendices

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

2005 Peter Walton and Walter Aerts
IAS 7 - Direct Method (Extract- cont.)

Cash flows from financing activities

Proceeds from issue of share capital 250
Proceeds from long-term borrowings 250
Payment of finance lease liabilities (90)
Dividends paid* (1,200)

Net cash used in financing activities (790)

Net increase in cash and cash equivalents 110

Cash and cash equivalents at beginning of period 120
Cash and cash equivalents at end of period 230

* This could also be shown as an operating cash flow.

Source: IAS 7 Cash Flow Statements, Appendices

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

2005 Peter Walton and Walter Aerts
IAS 7 - Indirect Method (Extract)
20X2
Cash flows from operating activities
Profit before taxation 3,350
Adjustments for:
Depreciation 450
Foreign exchange loss 40
Investment income (500)
Interest expense 400
3,740
Increase in trade and other receivables (500)
Decrease in inventories 1,050
Decrease in trade payables (1,740)
Cash generated from operations 2,550
Interest paid (270)
Income taxes paid (900)

Net cash from operating activities 1,380

Cash flows from investing activities

Acquisition of subsidiary X net of cash acquired (550)
Purchase of property, plant and equipment (350)
Proceeds from sale of equipment 20
Interest received 200
Dividends received 200

Net cash used in investing activities (480)

Cash flows from financing activities

Proceeds from issue of share capital 250
Proceeds from long-term borrowings 250
Payment of finance lease liabilities (90)
Dividends paid* (1,200)

Net cash used in financing activities (790)

Net increase in cash and cash equivalents 110

Cash and cash equivalents at beginning of period 120
Cash and cash equivalents at end of period 230

* This could also be shown as an operating cash flow.

Source: IAS 7 Cash Flow Statements, Appendices

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

2005 Peter Walton and Walter Aerts
 IAS 7 - Indirect Method (Extract)
20X2
Cash flows from operating activities
Profit before taxation 3,350
Adjustments for:
Depreciation 450
Foreign exchange loss 40
Investment income (500)
Interest expense 400
3,740
Increase in trade and other receivables (500)
Decrease in inventories 1,050
Decrease in trade payables (1,740)
Cash generated from operations 2,550
Interest paid (270)
Income taxes paid (900)

Net cash from operating activities 1,380

Source: IAS 7 Cash Flow Statements, Appendices

Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5

2005 Peter Walton and Walter Aerts
IAS 7 - Indirect Method (Extract cont.)
20X2
Cash flows from investing activities
Acquisition of subsidiary X net of cash acquired (550)
Purchase of property, plant and equipment (350)
Proceeds from sale of equipment 20
Interest received 200
Dividends received 200

Net cash used in investing activities (480)

Cash flows from financing activities

Proceeds from issue of share capital 250
Proceeds from long-term borrowings 250
Payment of finance lease liabilities (90)
Dividends paid* (1,200)

Net cash used in financing activities (790)

Net increase in cash and cash equivalents 110

Cash and cash equivalents at beginning of period 120
Cash and cash equivalents at end of period 230

* This could also be shown as an operating cash flow.

Source: IAS 7 Cash Flow Statements, Appendices
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5
2005 Peter Walton and Walter Aerts