1 Cash Flow Statements Introduction to Business Accounting Week 6

2 Solvency The financial ability to pay debts when they become due. The solvency of a company tells an investor whether a company can pay its debts How can you assess this? Cash Flow Statements

3 Cash Flow Statement Financial document detailing the exchange of cash between a business and the outside world The flow is categorized as: flow "in" from Operations (cash the company made by selling goods and services) flow "in" from Financing (cash the company raised by selling stocks and bonds) flow "out" to Investing (cash the company spent investing in its future growth)

4 Cash Flow Statement Each of these flows can actually flow both ways. Investors like to see that the company can cover its spending with cash from operations, without having to turn to financing. The cash flow statement also has to reconcile the net effect of these flows with the difference in its cash holdings at the beginning and end dates of the reporting period

5 Financial Reporting Standard 1 Introduced 1991 – Revised November 1997 Objectives Report the cash generation and cash absorption for a period by highlighting the significant components of cash flow in a way that facilitates comparison with the cash flow performance of different businesses To assist in assessment of Liquidity Solvency Financial adaptability

6 plus or minus equals plus or minus Increase or decrease in cash over the period Net cash flow from operating activities Returns from investment and servicing of finance Taxation Capital expenditure Equity dividends paid Management of liquid resource Financing Standard layout of the cash flow statement – FRS 1

7 Mechanics of Cash Flow Statements Methods of Calculation Direct Indirect Both are addressed in 2 parts Net cash flows from operations Cash flows from all other sources Operating activities are the trading activities of the company So does this mean that the operating profit (or loss) that a company reports is equivalent to the cash flow from operations?

8 Mechanics of Cash Flow Statements As profit is not the same as cash, then No. We need to establish just what the cash inflow from operations is

9 Direct method OPERATING ACTIVITIES CASH RECEIVED FROM CUSTOMERS XXX CASH PAID TO SUPPLIERS(XXX) CASH PAID TO AND ON BEHALF OF EMPLOYEES(XXX) OTHER CASH PAYMENTS(XXX) NET CASH INFLOW/(OUTFLOW) FROM OPERATING ACTIVITIES XXX

10 Indirect method OPERATING ACTIVITIES OPERATING PROFIT XXX DEPRECIATION CHARGES XXX LOSS FROM SALE OF TANGIBLE FIXED ASSETS XXX PROFIT FROM SALE OF(XXX) TANGIBLE FIXED ASSETS INCREASE / DECREASE IN STOCKS(XXX) / XXX INCREASE / DECREASE IN DEBTORS(XXX) / XXX INCREASE / DECREASE IN CREDITORS XXX / (XXX) NET CASH INFLOW/(OUTFLOW) FROM OPERATING ACTIVITIES XXX / (XXX)

11 Mechanics of Cash Flow Statements The direct method would be totally accurate It shows the specific sources of operating cash receipts and payments which may be useful in assessing future cash flows The indirect method is by far the more common It highlights differences between operating profit and net cash flows from operating activities

12 The mechanics in practice Hound Ltd (see handout) HoundQ.doc Link_6.ppt

13 Review The cash flow statement : Uses information contained in the other two statements rearranged to provide an insight into the flow of cash through the business over the course of the year. Reconciles this movement to changes in the cash position of the business It helps users understand how a business has generated its cash where it has applied it provides a basis for appraising the future solvency of the business

14 Extensions of the Basic Idea Eastbourne Ltd Scote Ltd