1. Cash Flow Statement

2. Cash
Cash is king. It is relatively easy to “manufacture” profits but creating cash is virtually impossible
(UBS Philips and Drew Jan 1991.Accounting for Growth)

3. Cash flow statement
It is defined as a statement prepared periodically that summarises the cash flows into and out of a business
A cash flow statement records the inflow and outflow of cash over a period of time
The statement is required under FRS1
It differs from a cash flow forecast in that it concerns what has happened rather than what is expected to happen
It is different from a profit and loss account in that it concerns cash flow not accounting profit

4. How does it differ from a P&L Account?
A cash statement is concerned with movements of cash into and out of the businesses
A cash statements does not feature “promised” moneys or payments
It ignores non cash expenses. For instance, depreciation is a negative item on a P&L account but as it does not involve a flow of cash into or out of a business and therefore it is not part of a cash flow statement
A P&L account does not include spending on capital – but cash spending on capital items is recorded in a cash flow statement
The cash flow statement includes all movements of cash whether for operating or non-operating reasons

5. How does it differ from a P&L Account?
The P&L account summaries sales during the accounting period and the expenses linked to those sales.
Sales are included in a P&L when the sale occurs – not when the cash flows in. Credit sales in 2005 will raise the level of sales revenue in 2005 even if cash does not flow until 2006
A P&L account records income and expenses at the time of sales - not when cash flows
Stock purchases linked to those sales are included at the time of the purchase whether or not the stock has been paid for
In a cash flow statement we are only concerned with flows of cash at the time of the actual flow

6. What is in the P&L but not in a cash flow statement?
Sales on credit
Purchase of stock on credit
Tax charge not yet paid
Write off of bad debt and stock
Depreciation of fixed assets

7. What is in a cash flow statement but not in the P&L?
Cash purchase of stock not used during the year
Payments to creditors
Cash purchase of fixed asset
Payment of dividend
Cash payment for redemption of shares
Payment by credit customers
Cash from sale of fixed assets
Cash from loans received
Cash received from share issue

8. Cash flow statement v P&L
Profit and Loss Account
Sales
Only when cash received
Include all sales
Purchases of stock
Only when paid for
Include all purchases associated with the year’s sales
Opening/closing stock
Not included
Part of calculation of gross profit
Expenses without any period of credit
Included
Depreciation
Included as an expense

9. Cash v profits Cash flow = Cash inflow (cash paid) minus
Cash outflow (cash received)
Profit =
Income earned
minus
Expenses incurred

10. What the cash flow statement shows
How cash flows (either positive or negative) have been generated over the year
Major financing activities for the year
How the company met its obligations to service loans and pay dividends
How and in what way reported profits differ from related cash flows during the year

11. Advantages of cash accounting
Focuses attention on the critical issue of cash generation
Cash is more objective than profit
Creditors are more interested in a firm’s ability to repay debts than its profitability
Cash is an easy concept for users to understand
The P&L Account can be more easily window-dressed
Declared profits may give a false impression if sales are mainly credit sales
Cash and liquidity are essential for business survival

12. Sources and uses of cash
Cash from sales
Cash injections of capital
Long term borrowing
Cash proceeds from the disposal of fixed assets
Interest received from bank deposit accounts
Uses
Cash to meet trading expenses
Cash payments to suppliers
Cash payments for services
Cash purchase of new fixed assets
Repayment of long term loans
Interest paid on loans
Tax payments
Withdrawal of capital by owners

13. Headings in a cash flow statement
Net cash flow from operating activities
Returns on investment and servicing of finance
Taxation
Capital and financial investment
Acquisitions and disposals
Equity dividends paid
Management of liquid assets
Net cash flow before financing
Financing
Increase/decrease in cash

14. A simple cash flow statement - example
Net cash flow from operating activities
1100
Return on investment and servicing of finance
(100)
Taxation
(200)
Capital expenditure and financial investments
(900)
Net cash flow before financing
Financing
500
Increase/decrease in cash
400

15. Commentary on the example cash flow statement
There was a net cash inflow of £1,100,000 from normal trading operations
Interest paid net of interest received meant an outflow of £100,000
A tax bill of £200,000 was paid
There was expenditure of £900,000 on new fixed assets
So far there was a net outflow of £100,000
£500,000 was raised by a share issue
At the end of the accounting period there was a £400,000 increase in cash shown in the balance sheet

16. Tesco’s cash flow for 2005 (£m)
Net cash inflow from operating activities
3,004
Dividends from joint venture and associates
135
Net cash outflow from returns on investment and servicing of finance
(263)
Taxation
(483)
Net cash outflow from capital expenditure and financial investments
(1,458)
Net cash outflow from acquisitions and disposals
(228)
Equity dividend paid
(448)
Management of liquid reserves- decrease in short term deposits 97
Net cash outflow from financing
(235)
Increase in cash
(121)

17. Net cash flow from operating activities
This refers to cash flows from the normal trading activities of the business
Cash received from customers
Cash paid to suppliers
Cash paid to employees
Broadly it is equal to the operating profit (net profit, before deduction of interest) of the business before adjustments relating to
depreciation charge for the year
changes in debtors, creditors and stock

18. Cash flow from operating activities
This involves reconciliation between operating profits and net cash flow from operating activities
Convert operating profits into net cash flow by:
Adding back depreciation (a non-cash item)
Adjusting for changes in working capital

19. Net cash inflow from operating activities equals….
Net profit (before interest and tax)
Plus depreciation for the year
Plus decrease in debtors ( deduct increase in debtors)
Plus increase in creditors (deduct decrease in creditors)
Plus decrease in stock (deduct increase in stock)

20. Why the adjustments?
Depreciation is excluded because it does not represent a cash cost
Changes in creditor and debtor balances are included because they represent an inflow or outflow of cash to the business
Reduction in debtors = cash inflow
Increase in debtors = cash outflow
Increase in creditors = cash inflow
Decrease in debtors = cash outflow

21. Returns on investment and servicing of finance
Cash received from investments minus cash paid on loans and dividends. This shows dividend received together with interest paid and received
It is the net result of inflow from investments and outflow in the form of cost of finance
Inflows
Investment income
Interest received
Dividends received
Outflows
Interest paid
Dividends paid

22. Taxation Payments of taxes on profits, sales revenue and capital gains
Usually an outflow - corporation tax paid by limited companies during the year
On occasions it can be an inflow if the company has obtained a repayment of corporation tax
Not VAT - which comes under operating activities

23. Capital expenditure
Cash flows relating to the purchase and sale of fixed assets and investment
Cash Inflow from:
sale proceeds from fixed assets and investment
sale of plant and machinery
the sale of businesses
Cash Outflow from:
purchase cost of fixed assets and investments
cash outflow from the purchase of fixed assets and subsidiaries

24. Net cash outflow from capital expenditure
Expenditure on new fixed assets less receipts from sale or disposal of such items
Usually a negative (net outflow)
But can be positive if proceeds from sale exceed cash outflow

25. Acquisitions and disposals
Payments for the purchase or sale of other companies
Inflows: sale proceeds from investment and interests in
subsidiary companies
associated companies
joint ventures
Outflows-purchase costs of investments in
interests in joint ventures

26. Equity dividends paid An outflow
The amount of dividend paid to equity (ordinary) shareholders during the year
In the case of a sole trade or partnership the drawings will be shown

27. Management of liquid assets
Inflows
sale proceeds from short term investment that are almost as good as cash e.g. treasury bills and term deposits of up to a year with a bank
Outflows
purchase of short term liquid investments

28. Net cash flow before financing
This is the sum of all previous sections
Net cash flow from operating activities
Plus net cash flow from investments and servicing of finance
Plus net cash from capital expenditure
Minus taxation
Minus equity dividends paid
It is the net cash result of running the business in the period concerned after paying taxes and dividend
But if does not include any financing

29. Financing
Cash flows relating to the issue or buying back of shares or loan capital
Cash inflow from :
the issue of shares
the issue of debentures
new loans
Cash outflow:
repayment of loans
redemption of shares

30. Change in cash
The final total shows the absolute change in cash levels between the tow balance sheet dates
The subtotals from the previous areas of the statement activity are totalled to give the increase/ decrease in cash for the year
If this item is positive it will mean that the firm’s holdings of cash have risen
If negative, then cash holdings have fallen

31. A final thought
Writing about the collapse of Enron in the USA Jack Welch, a successful American businessman:
“There’s one thing you can’t cheat on and that’s cash and Enron didn’t have any cash for the last three years. Accounting is odd, but cash is real stuff. Follow the cash”
(Guardian 27.2/02)