ACCT 5011

Accounting for Management M

Topic 5
Financial Statements:
Statement of cash flows

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Learning Objectives
1. Understand the importance of cash to an
entitys success;
2. Explain what the statement of cash flows is;
3. Understand the link between the statement
of cash flows with other financial reports;
4. Understand the presentation format of the
statement of cash flows;
5. Classify cash flows in the statement of cash
flows;
6. Understand cash flow warning signals.
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 Importance of cash
Entities can be quite profitable yet still fail
due to poor cash management
(e.g. income recognised but cash not received)
An entity needs to ensure it has enough cash
on hand to meet its financial commitments in
a timely fashion
(e.g. workers dont like waiting to be paid
their wages)
BCZ Cash is KING !!!

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Importance of cash

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 Importance of cash
Entities can also have lower profit compared
with their cash flows.
Possible reasons?
Items involved in cash flows but not profit
e.g. cash raised from a share issue
Cash raised from income received in advance
Items involved in profit but not cash flows
e.g. Accrued expense not yet paid
Depreciation/amortisation not involved in
cash flows

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Disadvantages of having too much
cash on hand
There are costs involved in this:
May have to pay unnecessary interest to
bank for loans
Missed investment opportunities

So the trick is to have an equilibrium of cash

to commitments

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Need a statement of cash flows

A statement of cash flows shows an entity:

what money came in (cash inflows e.g. sales
receipts, loans) and
what money went out (cash outflows e.g.
wages, electricity).
The difference between the two is called
net cash flow.

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Definition of Cash
Cash
Notes and coins held
Demand deposit held at financial institutions
Cash equivalents
Highly liquid investments, easily converted to
cash with short periods to maturity with little
risk of a change in value (e.g. Bank bills, deposit
on short-term money market)
Bank overdrafts, payable on demand

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Relationship to other financial
reports
A statement of cash flows provides users
information on the actual cash receipts,
cash payments and the net changes in
cash during a period, not the timing of
the underlying transaction
Income statement and balance sheet are
based on an accrual system, which
focuses on when a transaction takes
place, not when the payment for the
transaction occurs.

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Relationship to other financial
reports (cont.)
Cash is an entitys most liquid asset and it is an
integral component in assessing an entitys financial
position.
The statement of cash flows gives additional
information to assess an entitys ability to
generate cash flows, meet its financial
commitments, fund changes of its activities , obtain
external finance, etc.
Together, Income statement, Balance sheet and
Cash flow statement provide users with
information on an entitys: profitability, liquidity,
solvency.
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Relationship to other financial
reports (cont.)

Interesting reading: Cash flows vs. Earnings

Farshadfar, S., Ng, C. & Brimble, M. (2008) The

relative ability of earnings and cash flow data in
forecasting future cash flows: Some Australian
evidence. Pacific Accounting Review, 20(3), pp.
254-268

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 Format of CFS
The statement of cash flows contains:
net cash flows from operating activities
net cash flows from investing activities
net cash flows from financing activities
total net cash flow (increase or decrease
in cash held for the period)
the beginning cash balance
the ending cash balance

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 An Example of Cash flow statement
XXX Ltd
Statement of cash flows
For the Year Ended 30 June 201X
Cash flows from operating activities:
Cash received from customers $ 590,000
Payments to suppliers and employees (410,000)
Net cash from operating activities $180,000

Cash flows from investing activities:

Purchase of equipment $(140,000)
Net cash used in investing activities (140,000)

Cash flows from financing activities:

Payment of dividends $ (50,000)
Net cash used in financing activities (50,000)
Net decrease in cash $ (10,000)
Cash balance, beginning 104,000
Cash balance, ending $ 94,00013
 Three main sections of statement
of cash flows
1. operating activities day to day activities
that relate to the provision of goods or
services, and other activities not included in
investing or financing activities
(1) Receipts from customers (sell goods/services)
(2) Payments to suppliers and employees (purchase
goods/services, pay salaries)
(3) Other payments for expenses and receipts for
income (e.g. tax expense)
Healthy entities are expected to have positive
operating cash flows
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Three main sections of statement
of cash flows
(1) Receipts from customers

Cash received from customers

= opening accounts receivable
+ Sales revenue
closing accounts receivable

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Example received from customers
If $20000 is owed by customers at the
beginning of the year, $15000 is owed at the
end and credit sales are $100000, the cash
received from customers for the year is:
Cash received from customers
= opening accounts receivable
+ Sales revenue
closing accounts receivable
= $105,000

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Three main sections of statement
of cash flows
(2) Payments to suppliers and employees

(a) Cash paid to inventory suppliers

= opening accounts payable
+ Purchase
closing accounts payable

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 Example paid to suppliers
$45000 is owed to suppliers for inventory
purchases at the beginning of the year and
$24000 is owed at the end of the year. If annual
credit purchases of inventory are $120000, the
cash paid to suppliers for the year is:
Cash paid to inventory suppliers
= opening accounts payable
+ Purchase
closing accounts payable
= $141,000

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Three main sections of statement
of cash flows
(2) Payments to other suppliers and employees
(b) Cash paid to other suppliers (electricity,
insurance, etc.)
= other operating expenses (excl. depreciation)
+ opening accrued expenses
closing accrued expenses
opening prepaid expenses
+ closing prepaid expenses

(c) Cash paid to employees (salaries)

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 Example accruals and prepayments
Income statement shows
Administrative expenses $2,619,750
Depreciation expenses 52,500

Balance sheet shows:

. 2017 2016
Prepaid expenses $54,000 $21,000

Expenses payable 31,500 24,000

Required: Cash paid to other suppliers

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 Answers
Cash paid to other suppliers=

other operating expenses (excl. Dep.)

+ opening accrued expenses
closing accrued expenses
opening prepaid expenses
+ closing prepaid expenses

= $2,645,250

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Three main sections of statement
of cash flows
(3) Other payments for expenses and receipts
for income, including Tax paid, sometimes
interest and dividend paid and received.
Note: AASB 107
para 33.Interest paid and interest and dividends
received may be classified as operating cash flows
because they enter into the determination of net
profit or loss. Alternatively, interest paid and
interest and dividends received may be classified as
financing cash flows and investing cash flows
respectively, because they are costs of obtaining
financial resources or returns on investments.

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Three main sections of statement
of cash flows
Note: AASB 107
para 34 Dividends paid may be classified as a financing
cash flow because they are a cost of obtaining
financial resources. Alternatively, dividends paid may
be classified as a component of cash flows from
operating activities in order to assist users to
determine the ability of an entity to pay dividends
out of operating cash flows.

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Three main sections of statement
of cash flows
2. investing activities activities which relate
to the acquisition and/or disposal of non-
current assets, and investments (e.g.
Securities) that do not fall within the
definition of cash (this section of the cash
flows is reflected in the assets section of
the balance sheet)
Examples: purchase & sale of PPE
purchase & sale of share investments
lending of money & collection of loan investment
. Entities in expansion are expected to have
negative investing cash flows
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Three main sections of statement of
cash flows
3. financing activities activities which relate
to changing the size and/or composition of the
financial structure of the entity (i.e. equity),
and borrowings that do not fall within the
definition of cash (i.e. non-current liabilities).
(Again these activities can be traced back to
the balance sheet)
Examples are:
Cash received from the issue of shares or debt
Cash paid to shareholders or to repay debt
Entities in expansion are expected to have
positive financing cash flows.
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Eyeballing statement of cash flows
Cash flow warning signals include:
Cash received < cash paid (net decrease)
Operating outflow (negative cash flows from
operations)
Cash receipts from customers < cash
payments to suppliers and employees
Substantial difference between operating
cash flows and net profit

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Eyeballing statement of cash
flows
Proceeds of share capital are used to
finance operating activities
Inflows from investing activities are
inconsistent (e.g. selling off major assets
to pay debts)
Proceeds from borrowings are continually
greater than repayment of borrowings

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Eyeballing statement of cash
flows

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 Case study
ABC Learning Ltd was founded in 1988 and went public in
2001 owning 43 child care centres in Australia and New
Zealand. Due to attractive government childcare rebate,
childcare became a profitable business. Since 2004, the
company went through a super fast expansion journey,
from owning 327 childcare centres in 2004 to 2,328
centres in 2007. The company became the worlds
largest childcare service provider and its share price
soared to $8.60 per share. However, the disaster came
in Feb. 2008 after the company released its half year
financial reports ended 2007. Its share price tumbled
to only 54c a share. The company collapsed in August
2008 owing $1.8 billion debts.

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Eyeballing statement of cash
flows

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 Case study cont.
So, what information was disclosed in that half year
report that made investors panic?

(1) The net profit after tax was $37.1 million;

The operating cash flow was -$19.8 million.

ABC was still profitable, but what was the problem?

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 Case study cont.
(2) In the preceding year (i.e. 2006-07 financial year),
the companys report shows:

The net profit after tax was $143.1 million;

The operating cash flow was $206.9 million.

Was the problem serious?

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 Case study cont.
(3) Many analysts said the problem actually appeared
earlier when ABC reported excellent performance in
2006-07. Below are some extractions from CFS in
that outstanding year. What do you think?
2007 ($m) 2006 ($m)
Cash flows from investing activities

Payment for childcare licences (491.7) (354.6)

Payment for businesses (815.1) (358.3)
Net investing cash flows (1,579.4) (851.3)
Cash flows from financing activities

Proceeds from borrowings 1,629.5 5.5

Repayment of borrowings (113.5) (108.5)
Net financing cash flows 1,495.6 850.1

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 Case study cont.
Summary:
Cash is King! (net operating outflows)
Substantial difference between profit and operating
cash flows;
Significant decrease of operating cash flows;
High speed of investment and expansion, but almost
all were financed through borrowings;
Operating cash flows generated were significantly
less than the expansion needs;
Substantial increase of borrowings in one year, but
not repayment.
- ABCs last financial report in 2008 reclassified
massive borrowings of $1.8b from current to non-
current liabilities, but it was too late
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 Next Week

Interpretation of Financial Statements

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