Cash Flow Statement

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Cash Flow Statement
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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)

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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

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How does it differ from a PL 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 PL 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 PL 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

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How does it differ from a PL Account?

• The PL account summaries sales during the
  accounting period and the expenses linked to
  those sales.
• Sales are included in a PL 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 PL 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

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What is in the PL 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

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What is in a cash flow statement but not in the
PL?

• 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

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Cash flow statement v PL
Cash flow statement 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 years sales
Opening/closing stock Not included Part of calculation of gross profit
Expenses without any period of credit Included Included
Depreciation Not included Included as an expense
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Cash v profits

• Cash flow
• Cash inflow (cash paid)
• minus
• Cash outflow (cash received)

• Profit
• Income earned
• minus
• Expenses incurred

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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

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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 firms ability
  to repay debts than its profitability
• Cash is an easy concept for users to understand
• The PL 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

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Sources and uses of cash

• Sources
• 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

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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

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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 (100)
Financing 500
Increase/decrease in cash 400
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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

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Tescos 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)
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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

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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

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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)

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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

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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

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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

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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

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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

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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
• subsidiary companies
• associated companies
• interests in joint ventures

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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

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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

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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

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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

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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
  firms holdings of cash have risen
• If negative, then cash holdings have fallen

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A final thought

• Writing about the collapse of Enron in the USA
  Jack Welch, a successful American businessman
• Theres one thing you cant cheat on and thats
  cash and Enron didnt have any cash for the last
  three years. Accounting is odd, but cash is real
  stuff. Follow the cash
• (Guardian 27.2/02)