Financial Reporting - Cash Flow Statement

Cash Flow Statement

What's the difference between cash and profit? Ok yeah, you know the answer, but could you actually say it in an exam question type way?

So: Profit = Total Revenue - Total Expenses

And, Cash = Cash In - Cash Out

Cash vs Profit

Remember though, total revenue is not the same as cash in, as revenue can also come from credit sales.

Similarly, total expenses is not the same as cash out, because when an expense is incurred it isn't always paid right away, and some expenses are prepaid.

Here are some other reasons why cash is not profit:

• Depreciation affects profit, but doesn't involve cash movement


• If you buy a non-current asset, like a van, cash decreases, and non-current assets increase, but profit will not be affected immediately


• The same applies with taking out or repaying a loan.

Cash Flows

Some terms:

Cash inflows: All the cash coming into the business.

Cash outflows: All the cash going out of the business.

Net Cash Flow: Cash inflows - Cash Outflows.

Net Cash Flow will be positive if more money is going in than going out, or negative if more money is being payed out than is coming in.

Cash Flow Cycle

Buy some supplies on credit

↓

Manufacture a product

↓

Pay the suppliers

↓

Sell your product to customers on credit

↓

Pay your employees

↓

Pay other expenses

↓

Receive cash from the customers

↓

Go back to the start!

Harsh Economical Times

The cycle can change during a harsher economic time for the business.

The suppliers will want their payment quicker.

And the customers will probably need longer payment times.

So here is how the cycle might look during a time like this:

Purchase supplies on credit

↓

Pay suppliers

(they want their payments faster)

↓

Receive cash from customers

(repayments take longer than usual so start repayments early)

↓

Manufacture product

↓

Sell product to customers on credit

↓

Pay employees

↓

Pay other expenses

↓

Go back to the start!

Cash

• Cash is a current asset, and appears on the balance sheet


• It is important for the business's survival and for taking advantage of opportunities.


• It is nearly universally accepted

Late Payments

• Small businesses rely on credit because they don't have much capital


• In the recession, credit is harder to get, so they become late with payments

Why we need cash flow statements

• It gives a summary of the cash flows over a period of time


• It provides information of liquidity, viability and adaptability


• It reflects how important cash is to survival


• Basically linked to the value of the business

• If you have the cash assets part of the balance sheet for Year 1, and the cash flow statement for the period Year 1 - Year 2, you can then work out the cash assets for Year 2.

More on the cash flow statement

The cash flow statement includes cash flows from 3 things:

• Cash flows come from the business's operating activities, like payment for stock, receipts from debtors, paying wages, etc.


• Cash flows from investing activities, like selling or buying assets.


• Cash flows from financing activities, like loans, dividends etc

So the cash flow statement is:

Cash flows from operating activities

+

Cash flows from investing activities

+

Cash flows from financing activities

=

Net increase in cash over the period

Example cash flow statement

• Net cash from operating activities: £518m


• Net cash from investing activities: -£178.9m


• Net cash from financing activities: -£430m


• Decrease in cash in year: -£90.9

Making a cash flow statement (CFS)

Operating Activities

There are 2 methods to measure the cash flows from operating activities:

1. Direct method: Summarise all cash inflows and outflows from day to day operations directly


2. Indirect method: Start with the operating profit and then adjust it for non-cash amounts

Indirect method

• Start with pre tax profit


• Add the depreciation expense


• Add the interest expense


• Plus increase in inventories


• Plus increase in trade receivables


• Plus increase in trade payables


• Minus interest paid (amount actually paid)


• Minus tax paid (amount actually paid)


• Minus dividend paid


• Equals the net cash flow from operating activities

Depreciation

We include it as an expense in the income statement but it doesn't have a cash effect, which is why it is added back on

Trade Receivables

Credit sales need to be removed when making the cash flow from operations as they don't involve cash

General Rule

If there is an increase in current assets other than cash, like inventories, prepaid expenses, then deduct the increase from profit in the cash flow from operations section

If there is a decrease, then add it.

If there in an increase in current liabilities, like trade payables, accrued expenses, add the increase to profit in the cash flow from operations section.

If there is a decrease, then deduct it.

Interpreting the CFS

• The CFS shows the movements of cash from operating, investing, and financing activities


• Helps us understand where cash comes from and where it is used


• Explains the change in cash from one year to the next

Example

• CF from operating activities: £338


• CF from investing activities: -£280


• CF from financing activities: £140

So, the CF from operating activities is positive. This means the business is generating positive cash flows from it's main operations. This is good!

CF from investing activities is negative. This is usually negative because when the company buys new fixed assets there are large outflows.

CF from financing is positive. This can be either, depending on whether the company is borrowing a lot, and raising capital (making it positive) or paying off loans (making it negative)

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