1. FINANCIAL ACCOUNTING WEEK 11: LECTURE 11 Cash Flow Statement 1CHARA CHARALAMBOUS - CDA COLLEGE

2. LECTURE’S OUTCOMES 2CHARA CHARALAMBOUS - CDA COLLEGE 1.Difference between Profit and Cash 2.What is Cash 3.What is a Cash Flow Statement 4.Purposes of he statement of Cash Flows 5.Format of a statement of Cash Flows 6.Solve exercises

3. Difference between Profit and Cash Although cash is critical, people think in terms of profits instead of cash. We all do. When you and your friends imagine a new business, you think of what it would cost to make the product, what you could sell it for, and what the profits per unit might be. We are trained to think of business as sales minus costs and expenses, which is profits. Unfortunately, we don’t spend the profits in a business. We spend cash. Profitable companies go broke because they had all their money tied up in assets and couldn’t pay their expenses. Many start-ups and small businesses fail despite being nominally profitable. When it is time to pay the bills, cash is king. 3CHARA CHARALAMBOUS - CDA COLLEGE

4. Main differences 1)Profit is the surplus after total costs have been deducted from total revenue, whereas cash is money at bank or in hand, readily available for use. 2)Profits are calculated in the trading, profit and loss account whereas cash is shown in the cash flow forecast or cash flow statement. 3)Cash is only recorded when money changes hands, that is, it will only be recorded in the statement once the business has 'actually' received money, rather than what it is 'promised' to received. 4CHARA CHARALAMBOUS - CDA COLLEGE

5. For instance, if a business makes sales which are 20% on cash and 80% on credit, then the cash flow statement will only record the money received for the "20%" of sales and it will record the rest of the "80%" when it has 'actually' received this money. On the other hand, because of our "accruals concept" in the same example above, when we will calculate profit, we will include the cash as well as credit sales, which means all of the sales made. Now this shows that though the business will show "profitable in books" it will actually be short on cash.. 5CHARA CHARALAMBOUS - CDA COLLEGE

6. Some other cases where profitable business can run out of cash are : a: purchase of a fixed asset (through cash) b: over-trading Therefore, cash is important in the short run as it is needed to pay creditors and workers. Without sufficient cash, creditors (in extreme cases) can take you to the court and declare you bankrupt or insolvent in case of companies. Workers who will not be paid on time will be demotivated, resulting in poor productivity, high absenteeism and labour turnover.. 6CHARA CHARALAMBOUS - CDA COLLEGE

7. 7 What is Cash? Cash on hand Cash in the bank Cash equivalents - highly liquid, short- term investments that can be converted into cash with little delay CHARA CHARALAMBOUS - CDA COLLEGE

8. What is a Cash Flow Statement? The cash flow statement is concerned with the flow of cash in and out of the business. The statement reports both the current operating results and the changes happening together the operating activities in the balance sheet. As an analytical tool, the statement of cash flows is useful in determining the short- term ability of a company to pay bills The statement of cash flows is one of the main financial statements. (The other financial statements are the balance sheet, income statement.) The cash flow statement reports the cash generated and used during the time interval specified in its heading. The period of time that the statement covers is chosen by the company. For example, the heading may state "For the Three Months Ended December 31, 2012" or "The Fiscal Year Ended September 30, 2012". CHARA CHARALAMBOUS - CDA COLLEGE8

9. Because the income statement is prepared under the accrual basis of accounting, the revenues reported may not have been collected. Similarly, the expenses reported on the income statement might not have been paid. You could review the balance sheet changes to determine the facts, but the cash flow statement already has integrated all that information. As a result, business people and investors use this important financial statement. The purchasing of new equipment shows that the company has cash to invest in inventory for growth. Finally, the amount of cash available to the company should ease investors' minds regarding the notes payable, as cash is plentiful to cover that future loan expense.. Analyzing changes in cash flow from one period to the next gives the investor a better idea of how the company is performing, and whether or not a company may be close to bankruptcy or success.. A company can use a cash flow statement to predict future cash flow, which helps with matters in budgeting. For investors, the cash flow reflects a company's financial health: basically, the more cash available for business operations, the better.. CHARA CHARALAMBOUS - CDA COLLEGE9

10. 10 Purposes of the Statement of Cash Flows 1)Predict future cash flows - a satisfactory cash level in the long run is important to allow asset replacement, repayment of dept and fund further expansion 2)Evaluate management decisions 3)Determine the ability to pay dividends to stockholders’ and payments to creditors 4)Show if the company will be able to face unexpected events CHARA CHARALAMBOUS - CDA COLLEGE

11. Cash inflows usually arise from one of three activities: Operations Investing Financing CHARA CHARALAMBOUS - CDA COLLEGE11

12. Cash Flow from operating activities: € Cash received from customers X Cash paid to suppliers and employees (X) Other operating expenses (X) Cash generated from operations X Interest paid (X) Dividends paid (X) Income taxes paid (X) Net cash flow from operating activities X Cash flows from investing activities: Proceeds of sale of equipment X Interest received X Dividends received X Purchase of property, plant and equipment (X) Net cash used in investing activities X Cash flows from financing activities: Proceeds of issue of shares X Repayment of loans (X) Net cash used in financing activities X Net increase in cash X Cash at the beginning of the year X Cash at the end of the year X 12 FORMAT OF A STATEMENT OF CASH FLOWS CHARA CHARALAMBOUS - CDA COLLEGE If e.g €410 If e.g €120

13. 13 Operating, Investing, and Financing Activities Operating activities are the main revenue of the business Investing activities are spent on fixed assets, proceeds of sale of fixed assets and income from investments. Financing activities obtain cash from investors: issue of shares and long term loans received and repaid. CHARA CHARALAMBOUS - CDA COLLEGE

14. IAS 7 IAS 7 requires a note to the statement of cash flows giving details of the make-up of cash: E.g: Cash and cash equivalents At the end of the year At the beginning of the year Cash in hand and Bank 40 25 Short-term investments 370 95 410 120 CHARA CHARALAMBOUS - CDA COLLEGE14

15. Cash generated from Operations There are two methods of calculating cash from operations: – The Direct Method – The Indirect Method The method used will depend upon the information provided within the question Direct method: uses information from the ledger accounts (as in the example-slide 9) Cash sales X Cash received from debtors X LESS: Cash Purchases (X) Cash paid to credit suppliers (X) Cash expenses (X) Cash generated from operations x 15CHARA CHARALAMBOUS - CDA COLLEGE

16. Exercise 1: Gatis has the following Income statement for the year ended 31 Dec 2012: Sales revenue 1,200,000 Cost of sales (840,000) GROSS PROFIT 360,000 Administrative expenses (120,000) Profit from disposal 6,000 Net Profit before tax 246,000 Balance sheet extract for the two last years Current Assets 2012 2011 Stock 160,000 140,000 Debtors 259,000 233,000 Current Liabilities Creditors 168,000 138,000 CHARA CHARALAMBOUS - CDA COLLEGE16 €

17. Further information: a)Administration expenses include: depreciation €36000, Bad Debts € 14000 and salaries paid € 42000. b)During the year Gatis disposed of a fixed asset for €24000 which had a book value of €18000 Required: Prepare a cash flow statement including the above data using the direct method. CHARA CHARALAMBOUS - CDA COLLEGE17

18. Workings required: Debtors a/c B/ce b/d 235000 Bad Debts 14000 Sales 1200000 Cash paid 1162000 B/ce c/d 259000 1435000 1435000 Cost of sales Op. Stock 140000 Purchases 860000 -Cl. Stock (160000) 840000 CHARA CHARALAMBOUS - CDA COLLEGE18

19. Workings required: Creditors a/c B/ce b/d 138000 Cash paid 830000 Purchases 860000 B/ce c/d 168000 998000 998000 CHARA CHARALAMBOUS - CDA COLLEGE19

20. Cash Flow from operating activities: € Cash received from customers 1162000 Cash paid to suppliers (830000) Cash paid to employees (42000) Other operating expenses (120000-36000-14000-42000) ( 28000) Net cash flow from operating activities 262000 Cash flows from investing activities: Proceeds of sale of equipment 24000 Net cash used in investing activities 24000 Cash flows from financing activities: 0 Net increase in cash 286000 CHARA CHARALAMBOUS - CDA COLLEGE20

21. Calculation of Interest and Income taxes paid The cash flow should be calculated by reference to: – The charge to profits for the item (shown in the Income Statement) and – Any opening or closing payable balance shown on the Balance Sheet. Note the income taxes are the taxes paid on the profits 21CHARA CHARALAMBOUS - CDA COLLEGE

22. Interest payable a/c Interest due b/d X Cash paid X P&L Interest charge X Interest due c/d X X X CHARA CHARALAMBOUS - CDA COLLEGE22

23. Calculation of Dividends Paid The cash flow should again be calculated by reference to the charge to profits and the opening or closing dividend shown in the Statement of Financial Position. Note that the charge to profits for dividends is not shown in the Income Statement. A corporation’s dividends are not an expense and therefore will not appear on its income statement. The dividends are deducted from a corporation’s net income in order to arrive at earnings available. 23CHARA CHARALAMBOUS - CDA COLLEGE

24. Calculation of Interest and Dividends Received Again the calculation should take account of both the income receivable shown in the Income Statement and any relevant receivables balance from the opening and closing statement of financial positions. 24CHARA CHARALAMBOUS - CDA COLLEGE

25. Interest receivable a/c Interest receivable b/d X P&L Interest receivable X Cash received X Interest receivable c/d X X X CHARA CHARALAMBOUS - CDA COLLEGE25

26. QUESTIONS? CHARA CHARALAMBOUS - CDA COLLEGE26