STATEMENT OF CASH FLOW - Section -7
Why statements of cash flow?They are required by the IFRS SMEs and they show the cash generating potential of a firm. A profitable firm may lack cash. Cash flow statements show the difference between cash and profit.
Objective of Section 7: To explain the historical changes in cash and cash equivalents of an enterprise under the following activities; operating, investing and financing activities and changes in cash and cash equivalents. Operating activities:The main revenue-producing activities of the enterprise that are not investing or financing activities, so operating cash flows include cash received from customers and cash paid to suppliers and employees Investing activities:The acquisition and disposal of all long-term or non current assets and investment income received. Financing activities:Activities that alter the equity capital and long-term borrowing structure of the enterprise and dividends paid Cash & cash equivalents:Comprise cash on hand and demand deposits, together with short-term, highly liquid investments which have a maturity of three months or less from the date of acquisition. Bank overdrafts which are repayable on demand are also included as a component of cash and cash equivalents. NOTE:
➢ cash flows arising from taxes on income are normally classified as operating.
➢ investing and financing transactions which do not require the use of cash should be excluded from the cash flow statement
How then is profit different from cash flow?
1 – Non cash expenses/revenue items:
Profit uses some expenses which are not baked by cash outflow. Examples include:
➢ Depreciation and impairment expenses ➢ Bad debts
➢ Increase/decrease in provision for bad debts ➢ Gain / loss on disposal of non current assets
2 - Accrual or operating current asset and operating current liabilities differences:
Profit is prepared using the accrual basis of accounting i.e.
Cash revenue + revenue receivable (debtors)
Cash revenue – prepaid revenue (creditors)
Cash expenses + expenses owing (creditors & accruals)
Cash expenses – prepaid expenses (prepayments/debtors)
Cash flow statements only focus on the cash element of revenues and expenses.
The indirect method seeks to convert operating profit to net cash flow from operating activities by eliminating debtors, prepayments, creditors and accruals as well as undoing non cash items.
Ask the question: How would an increase or decrease in debtors, prepayments, creditors and accruals affect the cash position of a firm?
STEPS INVOLVED IN PREPARING A CASH FLOW STATEMENT
STEP 1State or calculate profit before tax (Profit for period add tax add less)
STEP 2Undo all items which must be disclosed under another activity (investment income, i.e. interest revenue and dividends revenue)
STEP 3Undo all items which must be disclosed separately (finance charge)
STEP 4Undo all non cash expenses and revenues (see above)
STEP 5Assess the impact of an increase or decrease in current assets and current liabilities related to operating activities on cash. (see above)
STEP 6Calculate and subtract interest and tax paid
STEP 7Sum steps 1-6 to get net cash flow from operating activities
STEP 1Add cash from investment revenue
STEP 2Calculate and add cash received from the sale of non-current assets