Cash Flow Statements – Part 1

http://www.youtube.com/watch?feature=player_embedded&v=YZsClB_OOA0

Upon completion of this lesson you will be able to prepare statement of cash flows (Operating) for an entity using Direct method and compare the usefulness of cash flow information with that of an income statement.

Definition

A cash flow statement shows the change in cash and cash equivalents of a company under the category of operating, investing and financing activities.

Cash and cash equivalents include cash in hand, bank, short-term liquid investments (bonds, securities) that are freely switch into cash.

In other words

Cash flow statement also known as statement of cash flows evaluates the change in cash and cash equivalents during a period, it classifies the cash inflows and outflows in operating, investing and financing activities so that it can be analyzed clearly from which type of activity cash is flowing inwards and outwards, the format of cash flow statement is given later in these notes.

Any Items will not be included in cash flow statement that does not involve cash for e.g. depreciation expense. These are known as Non cash activities.

Why is it important?

Cash is the lifeblood of any business, this makes the statement of cash flow highly important for decision makers e.g. shareholders, potential investors etc. They will analyses the liquidity position, solvency and also the increase/decrease in cash and cash equivalents from the operations, investments and financing of an entity with the help of cash flow statement. Profits and cash are not same; therefore income statement solely is not sufficient for reporting purpose.

Statement of cash flows helps the decision makers for their future decisions e.g. further investment, divesting or simply retaining the current holding in the business.

IAS 7 Statement of Cash Flows requires an entity to present a statement of cash flows as an integral part of its primary financial statements.

Lecture Notes

Cash flow statement must be prepared in the following order:

(1) Operating activities.

(2) Investing activities.

(3) Financing activities.

Key principles specified by IAS 7 for the preparation of a statement of cash flows are as follows:

(1) Operating activities are the main revenue generating activities of the business; it contains cash received from customers and cash paid to suppliers and workers.

(2) Investing activities includes purchase and sale of long lived assets & other investments that are not cash equivalents.

(3) Financing activities are activities that alter the equity and debt structure of the company.

Note:

IAS allows Interest & dividends received and paid may be classified as operating, investing, or financing cash flows, provided that they are classified consistently from period to period but US GAAP strictly classifies these items as operating activities

The direct method of presentation is recommended for cash flows from operating activities, but the indirect method can be used.

The results will be the same using any method either direct or indirect.

• The operating cash flows of the cash flow statement (IAS 7: Direct Method)

Formulas to find out various operating cash inflows and outflows.

1) Cash Receipts from Customers

= Net Sales + Opening Accounts Receivable - Closing Accounts Receivable

2) Cash Payments to Suppliers

= Purchases + Closing Inventory Opening Inventory + Opening Payables Closing Payables

3) Cash Payments to Employees

= Opening Salaries Payable Closing Salaries Payable + Salaries Expense

4) Cash Payments for other operating expenses/ purchase of Prepaid Assets

= Closing Prepaid expense + Used expense Opening Prepaid expense

5) Interest Payments

= Opening Interest Payable Closing Interest Payable + Interest Expense

6) Income Tax Payments

= Opening Tax Payable Closing Tax Payable + Tax Expense for the year

Example: Direct Method

Prepare the cash flows from operating activities section using direct method:

December 31 20X2 20X1

$ $

Accounts Receivable 34,000 28,000

Prepaid Rent 20,000 25,000

Prepaid Insurance 6,500 6,000

Inventory 23,000 15,000

Accounts Payable 14,500 31,500

Salaries Payable 8,000 5,000

Interest Payable 700 300

Income Tax Payable 2,500 0

Additional Information:

Year Ended December 31, 20X2

Net Sales 64,000

Salaries Expense 8,000

Rent Expense 5,000

Insurance Expense 3,500

Interest...

Buy the full version of these notes or essay plans and more in our Accounting (Special Edition) Notes.