LECTURE NOTES: CASH FLOW STATEMENTS
Reading: Chapter 14
LEARNING OBJECTIVES
Purpose of the cash flow statement (CFS)
Format of the CFS (direct method)
Major classifications of cash flows: operating, investing and financing activities
Conceptual differences between figures on statement of comprehensive
income (accrual) and CFS (cash basis)
Cash from operations section (direct method)
o Cash received from customers
o Cash paid to suppliers & employees
Cash paid to suppliers of inventory
Cash paid to other suppliers and employees
Cash from operations section (indirect method)
o Conceptual differences between operating profit and cash generated
from operations
o Conceptual differences between direct method and indirect method
Completing the operating activities section
Investing activities section
Financing activities section
Non-cash investing and financing activities
Example of entire CFS (direct and indirect)
WHAT IS THE CASH FLOW STATEMENT?
The cash flow statement (CFS):
reports the inflows and outflows of cash during the reporting period
is a summary of the bank account
categorises cash flows according to whether they are from operating, investing
or financing activities.
Allows the user to determine the “quality” of the profit: the extent to which
profit was the result of cash flows rather than accrual-based entries
PRESENTATION OF A CASH FLOW STATEMENT
How do we categorise cash flows into operating, investing and financing
activities on the CFS?
Operating activities
Cash flows relating to transactions that determine the profit or loss of the business,
and dividends paid
Investing Activities
Cash flows relating to non-current assets
Financing Activities
Cash flows relating to non-current liabilities and share issues
EXAMPLE 1
Company A
Bank account for the year ended 31/12/09
1/1 Balance b/d 34 000 1/2 PPE 50 000
Application & 80 000 31/4 Salaries & wages 20 000
Allotment
Loan 50 000 4/5 Inventory 20 000
31/3 Sales income 80 000 6/6 Interest expense 500
Trade receivables 40 000 30/6 SARS 20 000
(Income tax)
1/7 Asset disposal 15 000 28/8 Rent expense 25 000
28/9 Sales income 30 000 30/9 Trade payables 15 000
Trade receivables 20 000 4/10 Shareholders for 5 000
dividends
3/11 Interest expense 500
4/12 Loan 20 000
30/12 SARS (Income tax) 20 000
30/12 Inventory 15 000
31/12 Balance c/d 138 000
349 000 349 000
Additional Information
The shares were issued on 15 Feb 2009
1. What was the net cash flow during year ended 31 December 2009?
Closing balance as at 31 December 2009 R138 000
Less: Opening balance as at 1 January 2009 R34 000
Cash inflow during the year R104 000
2. Prepare the CFS for the year ended 31 December 2009.
Company A
Cash flow statement for the year ended 31 December 2009
Cash flows from operating activities
Cash received from customers 170 000
[80k + 40k + 30k + 20k]
Cash paid to suppliers and employees (95 000
[20k + 20k + 25k + 15k + 15k]
Cash generated by operations 75 000
Interest paid [500 + 500] (1 000)
Taxation paid [20k + 20k) (40 000)
Dividends paid (5 000)
Net cash outflow from operating activities 29 000 A
Cash flows from investing activities
Purchase of non-current assets (50 000)
Disposal of non-current assets 15 000
Net cash outflow from investing activities (35 000) B
Cash flows from financing activities
Repayment of long term loan (20 000)
Long term loan raised 50 000
Net proceeds from share issue 80 000
Net cash inflow from financing activities 110 000 C
Net increase in cash and cash equivalents [A+B+C] 104 000
Cash & cash equivalents at beginning of period [Bank a/c on SOFP 34 000
as at 31 Dec 2008]
Cash & cash equivalents at end of period [Bank a/c on SOFP as at 138 000
31 Dec 2009]
Note that the first three lines of the CFS are referred to as the cash from
operations section of the CFS
In preparing a real-world CFS, it is too time consuming to use the GL bank account.
Instead, the accountant will:
use the summarised information in the
o current year’s statement of comprehensive income
o current & prior years’ statements of financial position
to “work backwards” to find out what the cash flows relating to these accounts
must have been
often creating “summary” ledger accounts to do this
CASH RECEIVED FROM CUSTOMERS (CRFC)
We begin with SALES INCOME on the statement of comprehensive income
Why is CRFC not equal to sales income?
1. Some of this year’s sales may still be owing i.e. cash has not yet been
received for some credit sales included in sales income
2. We may have received cash for prior years’ sales, which are not included in
current year’s sales income.
3. We may have reported sales income for debtors who went bad during the
current year.
LECTURE EXAMPLE 2
Part A
A business has sales income during the year of R100 000. The statement of financial
position reports an opening balance on trade receivables of zero, and a closing
balance of R10 000. There were no bad debts during the year. What was the CRFC
during the year?
If all customers had paid, we could have received: R100 000 But at year-end we
were still owed: R10 000
So CRFC = R100 000 – R10 000 = R90 000
Part B
What if the closing balance on trade receivables was
R10 000, and the opening balance was R3 000?
If all customers had paid, we could have received: R103 000 But at year-end we
were still owed: R10 000
So CRFC = R103 000 – R10 000 = R93 000
Part C
What if trade receivables increased from R3 000 to R10 000 during the year, and
bad debts written off were R5 000?
If all customers had paid, we could have received: R103 000 But at year-end we
were still owed: R10 000
And we also did not receive bad debts written off of: R5 000
So CRFC = R103 000 – R10 000 – R5 000 = R88 000
It is easiest to show workings for the CRFC calculation by drawing up a summary
trade receivables account, as follows:
Trade receivables
Opening balance 3 000 Bad debts 5 000
Sales 100 000 BANK 88 000
Closing balance 10 000
103 000 103 000
But what if there were cash sales? Surely we should not debit trade receivables with
the full amount of sales income?
Actually, it does not matter. This account is only being used to calculate cash
received from customers, and it does this even if we “cheat” and debit it with ALL
sales income, including cash sales.
To see this, suppose that R40 000 of the sales income were for cash. If we drew up
the account properly, it would appear as follows:
Trade receivables
Opening balance 3 000 Bad debts 5 000
Sales (R100k – R40k) 60 000 BANK 48 000
Closing balance 10 000
63 000 63 000
So, R48 000 would have been received from the credit customers. How much is
received from ALL customers?
R48 000 + R40 000 from cash customers = R88 000.
CASH PAID TO SUPPLIERS AND EMPLOYEES
Information in the statement of comprehensive income helps us to see that
“Suppliers” and “Employees” are made up of two groups:
Suppliers of other stuff (e.g. electricity,
Suppliers of inventory water, telephone, stationery, etc.) and
employees
Given the specimen statement of comprehensive income below, which figures would
start us off, to work out cash paid to these two groups?
Sales income R100 000
Cost of sales (R60 000)
Gross profit R40 000
Net operating costs (R26 000)
Operating profit R14 000
Interest expense (R6 000)
Profit before tax R8 000
Taxation expense (R3 000)
Net profit for year R5 000
Other comprehensive income:
Revaluation gain R10 000
Total comprehensive income R15 000
We would start to find the cash flows that make up CPTS&E using the following
figures:
Suppliers of inventory: Suppliers of other stuff & employees:
Cost of sales Net Operating Costs
CASH PAID TO SUPPLIERS OF INVENTORY
There are two reasons that cost of sales is not equal to the cash paid to suppliers of
inventory:
1. Cost of sales reports the cost of what has been sold this year, not the cost of
this year’s purchases
2. Even if cost of sales happens to be equal to the cost of purchases made this
year, purchases are not usually equal to the actual cash paid to suppliers of
inventory (If purchases are made on credit, the business may have paid for last
year’s purchases this year, or may not yet have paid for some of this year’s
purchases)
So we start with cost of sales, and use statement of financial position info to adjust
for the two reasons identified above.
To adjust for reason 1:
What figure in this year’s and the prior year’s statements of financial position tells us
the difference between cost of sales, and the cost of what has been purchased?
Inventory:
If closing inventory is higher than opening inventory, we sold less than we
purchased
If closing inventory is less than opening inventory, we sold more than we
purchased
To adjust for reason 2:
What figure in this year’s and the prior year’s statements of financial position will tell
us the difference between purchases and the cash paid to suppliers of
inventory?
Trade payables:
If closing trade payables is higher than opening trade payables, then cash paid
to suppliers of inventory is less than purchases
If closing trade payables is lower than opening trade payables, then cash paid to
suppliers of inventory is higher than purchases
LECTURE EXAMPLE 3
A business’s financial statements include the following information for the year
ended 31/08/2018:
2018 2017
Cost of sales R70 000 -
Inventory R5 000 R3 000
Trade payables R12 000 R8 000
What was the cash paid to suppliers of inventory?
Inventory levels increased by: R5 000 – R3 000 = R2 000,
So purchases were higher than cost of sales by: R2 000
So inventory purchased during the year = R70 000 + R2 000 = R72 000
We can show this using a summary inventory account:
Inventory
Opening balance 3 000 Cost of sales 70 000
PURCHASES 72 000 Closing balance 5 000
75 000 75 000
Trade payables increased by R12 000 – R8 000 = R4 000 So cash paid was less
than purchases by R4 000
So cash paid to suppliers of inventory was R72 000 – R4 000 = R68 000.
We can show this using a summary trade payables account:
Trade payables
BANK 68 000 Opening balance 8 000
Closing balance 12 000 Purchases 72 000
80 000 80 000
Note that, again, these accounts “cheat” a little: it may be that some purchases were
made for cash, and so the accounts may not have looked like this in reality. This is
why we use the word “Purchases” instead of the actual contra-accounts i.e. bank
and trade payables.
