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SESSION 26 – IAS STATEMENT OF CASH FLOWS OVERVIEW Objective To provide information about historical changes in cash and cash equivalents by means of a statement of cash flows which classifies cash flows during the period from operating, investing and financing activities INTRODUCTION Classification Applies to all entities Importance of cash flow Benefits of cash flow information Definitions PRESENTATION OF A STATEMENT OF CASH FLOW DISCLOSURES Analysis of cash and cash equivalents Major non cash transactions Reporting futures, options and swaps Voluntary disclosures OPERATING ACTIVITIES Direct method Indirect method Techniques Which method? INVESTING AND FINANCING ACTIVITIES Separate reporting Investing activities Financing activities PROFORMA Direct method Indirect method Notes to the cash flow statement 2601 SESSION 26 – IAS STATEMENT OF CASH FLOWS INTRODUCTION 1.1 Applies to all entities Users of financial statement are interested in cash generation regardless of the nature of the entity’s activities Entities need cash for essentially the same reasons: to conduct operations; to pay obligations; to provide returns to investors Profit is not the same as cash and profitability does not mean liquidity (even profitable companies “crash”) 1.2 Importance of cash flow To show that profits are being realised (e.g that trade receivables are being recovered) To pay dividends To finance further investment (which will generate more cash) 1.3 Benefits of cash flow information Provides information that enables users to evaluate changes in: net assets; financial structure (including its liquidity and solvency); ability to affect amounts and timing of cash flows(to adapt to changing circumstances and opportunities) Useful in assessing ability to generate cash and cash equivalents Users can develop models to assess and compare the present value of future cash flows of different entities Enhances comparability of reporting operating performance by different entities (by eliminating effects of alternative accounting treatments) Historical cash flow information may provide an indicator of the amount, timing and certainty of future cash flows Focus on cash management can also improve results (e.g with lower interest charges and having cash resources available on a timely basis (e.g for investment) 2602 SESSION 26 – IAS STATEMENT OF CASH FLOWS 1.4 Definitions Cash – cash on hand and demand deposits Cash equivalents – short-term, highly liquid investments: readily convertible to known amounts of cash; subject to an insignificant risk of changes in value; excluding equity investments unless they are, in substance, cash equivalents (e.g preferred shares acquired within a short period of their maturity and a specified redemption date) Cash equivalents are treated as cash because if they were not, the liquidity of entities which manage their cash effectively (e.g employing overnight deposit facilities, buying bonds etc) would not look as good as it actually was Illustration Notes to the consolidated financial statements (extract) Cash and cash equivalents Bank and cash consist of cash at bank and in hand Cash equivalents consist of highly liquid available-for-sale investments purchased with remaining maturities at the date of acquisition of three months or less Nokia in 2006 Cash flows – inflows and outflows of cash and cash equivalents Operating activities – principal revenue-producing activities and other activities that are not investing or financing activities Investing activities – acquisition and disposal of long-term assets and other investments not included in cash equivalents Financing activities – result in changes in the size and composition of equity capital and borrowings Bank borrowings generally included Where bank overdrafts are repayable on demand and form an integral part of cash management (characteristically balance fluctuates from positive to overdraft) they are included in cash and cash equivalents 2603 SESSION 26 – IAS STATEMENT OF CASH FLOWS PRESENTATION OF A STATEMENT OF CASH FLOWS A statement of cash flows is essentially a list of cash in and cash out reconciling opening and closing cash balances 2.1 Classification IAS requires cash inflows and outflows to be analysed across three headings: Operating Key indicator of sufficiency of cash flows to: repay loans; maintain operating capability; pay dividends; Investing Separate disclosure is important – cash flows represent extent to which expenditures have been made for resources intended to generate future income and cash flows Financing Separate disclosure is useful in predicting claims on future cash flows by providers of capital make new investments without recourse to external sources of finance Useful in forecasting future operating cash flows Examples Payments to acquire/ receipts from sales of: Primarily derived from principal revenue-producing activities property, plant and equipment, intangibles; Generally result from transactions and events so included in profit or loss equity or debt instruments of other entities Examples Cash receipts from: sale of goods/rendering services; royalties, fees, commissions Cash payments to: suppliers for goods/services; and on behalf of employees 2604 Cash advances and loans made to other parties and repayments thereof Examples Cash proceeds from issuing: shares/equity instruments; Debentures, loans, notes, bonds, mortgages, other short or longterm borrowings Cash payments to owners to acquire or redeem own shares Cash repayments of borrowings SESSION 26 – IAS STATEMENT OF CASH FLOWS Illustration Bayer Group Consolidated Statements of Cash Flows € million Note 2005 2006 Income after taxes from continuing operations Income taxes Non-operating result Income taxes paid Depreciation and amortization Change in pension provisions (Gains) losses on retirements of noncurrent assets Non-cash effects of the remeasurement of acquired assets (inventory work-down) Gross cash flow 1,374 538 602 (463) 1,608 (501) (44) 1,526 454 782 (763) 1,913 (295) (133) – 3,114 429 3,913 Decrease (increase) in inventories Decrease (increase) in trade accounts receivable (Decrease) increase in trade accounts payable Changes in other working capital, other non-cash items Net cash provided by (used in) operating activities (net cash flow), continuing operations Net cash provided by (used in) operating activities (net cash flow), discontinuing operations Net cash provided by (used in) operating activities (net cash flow), total (130) 211 (117) 149 (155) (201) 130 241 [33] 3,227 3,928 [7.2] 275 275 3,502 4,203 (1,389) 105 293 1,189 (2,188) 451 (202) (1,741) (1,876) 185 489 850 (15,351) 686 287 (14,730) 1,174 (440) 2,005 (2,659) (787) (1,881) (535) 13,931 (3,216) (1,155) 10,199 Change in cash and cash equivalents due to business activities (total) (120) (328) Cash and cash equivalents at beginning of year 3,570 3,290 Change in cash and cash equivalents due to changes in scope of consolidation Change in cash and cash equivalents due to exchange rate movements (196) 36 (2) (45) Cash and cash equivalents at end of year 3,290 2,915 Cash outflows for additions to property, plant, equipment and intangible assets Cash inflows from sales of property, plant and equipment and other assets Cash inflows from divestitures Cash inflows from noncurrent financial assets Cash outflows for acquisitions less acquired cash Interest and dividends received Cash inflows (outflows) from current financial assets Net cash provided by (used in) investing activities (total) Capital contributions Bayer AG dividend and dividend payments to minority stockholders, reimbursements of advance capital gains tax payments Issuances of debt Retirements of debt Interest paid Net cash provided by (used in) financing activities (total) [34] [35] [36] 2005 figures restated 2605 SESSION 26 – IAS STATEMENT OF CASH FLOWS OPERATING ACTIVITIES There are two ways permitted to present cash flows from ordinary activities: 3.1 Direct method Either Or Discloses major classes of gross cash receipts and gross cash payments 3.2 Indirect method Adjusts profit or loss for effects of: Information obtained either from accounting records; or By adjusting sales, cost of sales for: changes during period in inventories and operating receivables and payables; other non-cash items; non-cash transactions (e.g depreciation); any deferrals or accruals of past or future operating cash receipts or payments; items of income or expense associated with investing or financing cash flows other items for which cash effects are investing/financing cash flows 3.3 Techniques Direct method Steps Cash receipts from customers Less cash paid to suppliers and employees ⇒ Cash generated from operations Step Payments for interest and income taxes ⇒ Net cash from operating activities Indirect method Step 1(a) Start with profit before tax, or profit before interest and tax Step 1(b) Adjust for non-cash items and investing and financing items accounted for on the accruals basis ⇒ Operating profit before working capital changes Step 1(c) Making working capital changes ⇒ Cash generated from operations (same as figure calculated under direct method) 2606 SESSION 26 – IAS STATEMENT OF CASH FLOWS 3.4 Which method? IASB encourages, but does not require, the use of the direct method 3.4.1 Advantages of the direct method Reporting the major classes of operating cash receipts and payments better reveals an entity’s ability to generate sufficient cash from operations to pay debts, reinvest in operations, and make distributions to owners Thus it better fulfils information needs for decision-making purposes Commentary In particular, being able to see cash paid is particularly important to many users The format is simpler to understand 3.4.2 Disadvantages of the direct method Many entities not collect information that would allow them to determine the information necessary to prepare the direct method It effectively presents profit or loss information on a cash rather than an accrual basis This may suggest, incorrectly, that net cash flow from operations is a better measure of performance than profit per the statement of comprehensive income It requires supplemental disclosure of a reconciliation of net income and net cash (However, the incremental cost of providing the additional information disclosed in the direct method is not significant.) 3.4.3 Advantages of the indirect method It focuses on the difference between profit per the statement of comprehensive income and net cash flow from operations Commentary The indirect method is also sometimes called the reconciliation method It provides a useful link between cash flows, the statement of comprehensive income, and the statement of financial position Commentary The indirect method is much more widely used in practice 2607 SESSION 26 – IAS STATEMENT OF CASH FLOWS INVESTING AND FINANCING ACTIVITIES 4.1 Separate reporting Major classes of gross cash receipts and gross cash payments arising from investing and financing activities should be reported separately 4.2 Investing activities Purchase of property plant and equipment – this must represent actual amounts paid Proceeds from sales of tangible assets Example Statement of financial position extracts Non-current assets Further information Depreciation during the year Net book value of assets disposed of 2007 $m 2006 $m 10,000 9,000 1,000 100 Required: Calculate additions in the period 4.3 Financing activities Again the approach is to reconcile statement of financial position movements to identify the cash element Example Statement of financial position extracts Share capital Share premium $m 150 48 $m 100 40 During the period the following transactions affected share capital 1) The entity issued shares with a nominal value $10m (Share premium $2m) to acquire an interest in a subsidiary 2) The entity issued shares for cash The expense of the issue was $1m This has been debited to the share premium account Required: Calculate the cash raised from the share issue 2608 SESSION 26 – IAS STATEMENT OF CASH FLOWS Proforma solution Balances at the year end Add back expenses of the share issue Less non cash transaction Less balances at the start of the year Cash raised Share capital Share premium _ _ _ _ _ _ _ _ _ 2609 SESSION 26 – IAS STATEMENT OF CASH FLOWS PROFORMA 5.1 Direct method $ Cash flows from operating activities $ Cash receipts from customers Cash paid to suppliers and employees x (x) Cash generated from operations(see next for alternative) Interest paid Income taxes paid x (x) (x) Net cash from operating activities x Cash flows from investing activities Purchase of property, plant and equipment Proceeds from sale of equipment Interest received Dividends received (x) x x x Net cash used in investing activities x Cash flows from financing activities Proceeds from issuance of share capital Proceeds from long-term borrowings Dividends paid * x x (x) Net cash used in financing activities x Net increase in cash and cash equivalents Cash and cash equivalents at beginning of period (Note) x x Cash and cash equivalents at end of period (Note) x * Could be shown as an operating cash flow 2610 SESSION 26 – IAS STATEMENT OF CASH FLOWS 5.2 Indirect method Cash flows from operating activities Profit before taxation Adjustments for Depreciation Investment income Interest expense $ x x (x) x Operating profit before working capital changes Increase in trade and other receivables Decrease in inventories Decrease in trade payables x (x) x (x) Cash generated from operations …remainder as for the direct method x 5.3 Notes to the statement of cash flows (Direct and indirect methods) Cash and cash equivalents Cash and cash equivalents consist of cash on hand and balances with banks, and investments in money market instruments Cash and cash equivalents included in the statement comprise the following amounts Cash on hand and balances with banks Short-term investments 2007 $ x x 2006 $ x x x x 2611 SESSION 26 – IAS STATEMENT OF CASH FLOWS Example Antipodean statements of financial position at 2007 2006 $ $ $ $ Non-current assets (at written down value) Premises 37,000 38,000 Equipment 45,800 17,600 Motor vehicles 18,930 4,080 101,730 59,680 Investments 25,000 17,000 _ Current assets Inventories Trade receivables Short-term investments Cash and bank balances 126,730 19,670 11,960 4,800 700 Total assets 37,130 _ 76,680 27,500 14,410 3,600 1,800 47,310 _ 163,860 _ 123,990 _ Capital and reserves Capital 78,610 75,040 Non-current liabilities Interest-bearing borrowings 25,000 28,000 Current liabilities Trade payables Bank overdraft 32,050 28,200 60,250 _ 20,950 – 163,860 _ 20,950 _ 123,990 _ Profit for the year ended 31 December 2007 ($25,200) is after accounting for Depreciation $ Premises 1,000 Equipment 3,000 Motor vehicles 3,000 Profit on disposal of equipment 430 Loss on disposal of motor vehicle 740 Interest expense 3,000 The written down value of the assets at date of disposal was Equipment Motor vehicles $ 5,200 2,010 Interest accrued at 31 December 2007 is $400 The company has made a substantial distribution out of capital during the year Required: Prepare a statement of cash flows for the year ended 31 December 2007 in accordance with IAS Statement of Cash Flows 2612 SESSION 26 – IAS STATEMENT OF CASH FLOWS Proforma solution $ Cash flows from operating activities Profit before taxation Adjustments for Depreciation Loss on disposals Interest expense $ _ Operating profit before working capital changes Decrease in trade receivables Decrease in inventories Increase in trade payables _ Cash generated from operations Interest paid _ Net cash from operating activities Cash flows from investing activities Purchase of long-term investments Purchase of equipment and cars Proceeds from sale of equipment and cars _ Net cash used in investing activities Cash flows from financing activities Capital repayment Borrowings repayment Net cash used in financing activities _ _ Net decrease in cash and cash equivalents Cash and cash equivalents at beginning of period _ Cash and cash equivalents at end of period _ 2613 SESSION 26 – IAS STATEMENT OF CASH FLOWS Example Alma has the following statement of comprehensive income for the year ended 31 December 2007 and statement of financial position extracts at that date Statement of comprehensive income Revenue Cost of sales $000 2,880 (2,016) _ Gross profit Expenses 864 (288) _ Profit 576 _ Statement of financial position extracts Current assets Inventory Trade receivables Current liabilities Trade payables 2007 $000 2006 $000 384 622 336 564 403 331 You are given the following information: (1) Expenses include depreciation of $86,000, bad debts written off of $34,000 and employment costs of $101,000 (2) During the year Alma disposed of some plant for $58,000 which had a net book value of $43,000, the profit being netted off against expenses Required: (a) Show how the net cash flows from operating activities would be presented in the statement of cash flows using the direct method (b) Prepare the note reconciling the operating profit to net cash flows from operating activities 2614 SESSION 26 – IAS STATEMENT OF CASH FLOWS Proforma solution (a) Cash-flows from operating activities Cash received from customers and employees (W1) Cash paid to suppliers and employees Cash from operating activities $000 _ _ WORKINGS (W1) Trade receivables $000 $000 (W2) Trade payables $000 $000 Cash Bal c/d (W3) Bal b/d Purchases (W3) Opening inventory Purchases Closing inventory Cost of sales $000 _ _ (W4) Other cash expenses: From statement of comprehensive income Adjustments for non-cash items Depreciation Bad debts Profit on disposal $000 _ _ 2615 SESSION 26 – IAS STATEMENT OF CASH FLOWS (b) Reconciliation of operating profit to net cash flows from operating activities $000 Profit before tax Depreciation Profit on disposal Increase in inventory Increase in receivables Increase in payables _ _ DISCLOSURES There are a number of extra disclosures which should be made in most cases to support the main statement of cash flows: Analysis of cash and cash equivalents; Major non cash transactions; Cash and cash equivalents held by the group; Reporting futures, options and swaps; Voluntary disclosures 6.1 Analysis of cash and cash equivalents A note should be presented that reconciles amounts held as cash and cash equivalents at the start and end of the period Cash and cash equivalents Illustration Cash on hand Bank overdraft 2616 2007 $ – (11,000) 2006 $ 1,300 – Change $ (1,300) (11,000) (11,000) (1,300) (12,300) SESSION 26 – IAS STATEMENT OF CASH FLOWS 6.2 Major non cash transactions Non cash transactions should be excluded from the main statement However some of these have a major impact on investing and financing activities and should be disclosed in a note Examples of such transactions could include: the issue of shares in order to acquire assets; the conversion of debt to equity; the inception of significant lease arrangements In each case a brief description of the nature and purpose of the transaction should be given 6.3 Reporting futures, options and swaps Cash payments for and receipts from such contracts should normally be classified as investing activities There are two exceptions to this: The instrument is held for trading purposes and thus is part of operating activities The cash flows are considered to be financing in nature and should be reported as such 6.4 Voluntary disclosures The standard encourages the disclosure of other information which may be relevant to users seeking to assess the financial health of a business These are: the amount of undrawn borrowings that are available and any restrictions on their future use the amount of cash flows that represent increases in capacity rather than maintenance of existing capacity a segment analysis, by industry and region, of cash flows arising from each major activity This information should be presented by way of a note and could appear as follows: Cash flows Operating activities Investing activities Financing activities Segment Segment Total x x X x x x x X X _ _ _ x x X _ _ _ 2617 SESSION 26 – IAS STATEMENT OF CASH FLOWS FOCUS You should now be able to: prepare a statement of cash flows for a single entity in accordance with relevant accounting standards using the direct and indirect method; compare the usefulness of cash flow information with that of a statement of comprehensive income; interpret a statement of cash flows to assess the performance and financial position of an entity 2618 SESSION 26 – IAS STATEMENT OF CASH FLOWS EXAMPLE SOLUTIONS Solution — Investing activity Balance b/f Depreciation Disposals Additions (Balancing figure) 9,000 (1,000) (100) 2,100 Balance c/f 10,000 Solution — Financing activity Share capital Share premium Balances at the year end Add back expenses of the share issue 150 48 Less non cash transaction 150 (10) 49 (2) Less balances at the start of the year 140 (100) 47 (40) 40 Cash raised 47 2619 SESSION 26 – IAS STATEMENT OF CASH FLOWS Solution — Cash flow statement $ Cash flows from operating activities Profit before taxation Adjustments for Depreciation Net loss on disposals Interest expense 25,200 7,000 310 3,000 Operating profit before working capital changes Decrease in trade receivables Decrease in inventories Increase in trade payables ((32,050 – 400) – 20,950) 35,510 2,450 7,830 10,700 Cash generated from operations Interest paid $(3,000 – 400) 56,490 (2,600) Net cash from operating activities Cash flows from investing activities Purchase of long-term investments $(25,000 – 17,000) Purchase of equipment and cars $(36,400 (W1) + 19,860 (W2)) Proceeds from sale of equipment and cars (W3) 53,890 (8,000) (56,260) 6,900 Net cash used in investing activities Cash flows from financing activities Capital repayment Borrowings repayment $ (57,360) (21,630) (3,000) Net cash used in financing activities (24,630) Net decrease in cash and cash equivalents (28,100) Cash and cash equivalents at beginning of period $(3,600 + 1,800) 5,400 Cash and cash equivalents at end of period $(4,800 + 700 – 28,200) (22,700) It is been assumed that short-term investments are cash equivalents 2620 SESSION 26 – IAS STATEMENT OF CASH FLOWS WORKINGS (1) Equipment (WDV) $ Bal b/d 17,600 Additions (β) 36,400 $ Disposal Depreciation Bal c/d 5,200 3,000 45,800 54,000 (2) 54,000 Motor vehicles (WDV) $ Bal b/d Additions (β) 4,080 19,860 $ Disposal Depreciation Bal c/d 2,010 3,000 18,930 23,940 (3) 23,940 Disposals $ Equipment Motor vehicle Profit on disposal (equipment) 5,200 2,010 430 $ Loss on disposal (vehicles) Proceeds (β) 7,640 740 6,900 7,640 Solution — Net cash flows (a) Cash-flows from operating activities Cash received from customers Cash paid to suppliers and employees (1,992 + 183) $000 2,788 (2,175) Cash from operating activities 613 2621 SESSION 26 – IAS STATEMENT OF CASH FLOWS WORKINGS Trade receivables $000 Bal b/d Revenue 564 2,880 _ Bad debt Cash Bal c/d $000 34 2,788 622 _ 3,444 _ 3,444 _ Opening inventory Purchases Closing inventory $000 336 2,064 (384) Cost of sales 2,016 Trade payables $000 Cash Bal c/d 1,992 403 _ 2,395 _ Other cash expenses: From profit or loss Adjustments for non-cash items Depreciation Bad debts Profit on disposal Bal b/d Purchases $000 331 2,064 _ 2,395 _ $000 288 (86) (34) 15 183 (b) Reconciliation of operating profit to net cash flows from operating activities Profit before tax Depreciation Profit on disposal Increase in inventory (384 – 336) Increase in receivables (622 – 564) Increase in payables (403 – 331) $000 576 86 (15) (48) (58) 72 613 2622 ... compare the present value of future cash flows of different entities Enhances comparability of reporting operating performance by different entities (by eliminating effects of alternative accounting... compare the usefulness of cash flow information with that of a statement of comprehensive income; interpret a statement of cash flows to assess the performance and financial position of an entity... intangible assets Cash inflows from sales of property, plant and equipment and other assets Cash inflows from divestitures Cash inflows from noncurrent financial assets Cash outflows for acquisitions
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