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There are five areas to consider when identifying whether or not the company has sufficient cash:

• Repayment of existing loans

All loans to be repaid in the next couple of years should be considered, including any convertible loans if the conversion rights
are unlikely to be exercised.

• Increase in working capital

If the business is expanding, working capital will also need to increase.

• Capital expenditure requirements

The note to the financial statements may disclose capital expenditure contracted for. It’s necessary to consider whether the company will have sufficient cash to meet this capital expenditure.

• Contingent liabilities

Most contingent liabilities do not crystallise, but if these liabilities are very high their crystallisation could real problems for the company. Some analysts compare the contingent liabilities with total shareholders’ funds to assess the materiality of those commitments. Any sharp increases in the amounts involved should act as a warning.

• Leasing commitments

If these are material, they should be carefully monitored in relation to the cash available. The financial statements should disclose both finance lease commitments (for new leases where repayments have not commenced) and also operating lease commitments.

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Non-cash transactions show that no cash flow in or flow out in the company, but these are incurred transactions.

Material transactions not resulting in movements of cash of the reporting entiry should be disclosed in the notes to the cash flow statement if disclosure is necessary for an understanding of the underlying transactions.

Consideration for transactions may be in a form other than cash. The purpose of a cash flow statement is to report cash flows. Non-cash transactions should not be reported in a cash flow statement. However, to obtain a full picture of the alterations in financial position caused by the transactions for the period, separate disclosure of materail non-cash transactions is also necessary.

Examples of non-cash transactions are:

• finance leases

Finance leases are accounted for by the lessee capitalising the fair value fo the related asset, or the present value of the minimum lease payments if lower. A liability and a corresponding asset are produced which do not reflect cash flows in the accounting period.

• conversion of debt to equity.

In this transactions, there’re no cash flow.

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Perhaps you need more than 25 mins to read the cash flow statement template and master it.

A cash flow statement is often prepared from the balance sheet and income statement of an enterprise, opening with a reconciliation between reported profit and operating cash flow.

The cash flow statement should be presented using standard headings. The standard headings are to ensure that cash flows are reported in a form that highlights the significant components of cash flow and facilitates comparison of the cash flow performance of different businesses.

To determine the net cash flow from operating activities, there are two methods to show cash flow statement template: indirect and direct methods.

The formula, format and template of cash flow statement: direct method

The formula, format and template of cash flow statement: indirect method

As known, the profit is basic on the accounting concepts of accruals, the cash flow is on cash basis. Profit represents an increase in net assets, which can be in cash or may be ‘tied up’ in other assets. For example:

• non-current assets may have been purchased
• there may be an increased amount of receivable
• there may be increased investment in inventory
• the liabilities of the business may have decreased, i.e. more cash has been spent this year in paying off suppliers more quickly than was the case last year.

We can reconcile profit to cash in an accounting period by taking into account these and other factors.

The direct method records the gross trading cash flows, the indirect method starts with profit, not cash, and adjusts profit for the non-cash expense of depreciation and for the movements in working capital. The information for the direct method could be found in the accounting records or derived from the other financial statements. The information for the indirect method is found in the other financial statements.

Especially, under indirect method, the standard headings shown in the statement are: operating activities, investing activities, financing activities. Figures for the cash flow statement will be derived either from the accounting records or from the other financial accounting statements: the balance sheet for the current year and the previous period, and the income statement for the period.

A single example of calculation using the indirect method

The summarised balance sheet of Aspring, a limited company, at 31 December 20X8 and 20X9 were as follows:

No non-current assets have been sold during the period under review. Depreciation provided for the year amounted to $2,000. There is non interest paid, dividends paid or taxation paid.

Now, we’ll prepare the cash flow statement for the year ended 31 December 20X9.

The analysis of cash flow statement: indirect method

Operating activities:

• Profit before tax: you can calculate it from the account “Reserves” (21,000 – 17,000 = 4,000).
• Depreciation: you can calculate it from the account “Depreciation” (10,000 – 8,000 = 2,000). Depreciation is a book write-off capital expenditure, therefore, it represents an addition to reported profit in deriving cash inflow.
• Increase in inventories: you can calculate it from the account “Inventory” (23,500 – 20,000 = 3,500). Inventory at the balance sheet date represents a purchase which has not actually been charged against current profit. However, as cash was spent on its purchase or a payable incurred, it does represent an actual or potential cash outflow.
• Increase in payables: you can calculate it from the account “Payables” (6,000 – 5,000 = 1,000). A purchase represents the incurring of expenditure and a charge or potential charge to the income statement. It does not represent a cash outflow until paid.

Investing activities:

• Payments to acquire non-current assets: you can calculate it from the account “Plant and machinery, at cost” (16,500 – 15,000 = 1,500). Cash paid for property, plant and equipment and other non-current assets represents a cash outflow.

The example shows the important information that can be directly given by a cash flow statement. Despite making a profit of $4,000 in the period, the business has suffered a $3,000 reduction in cash. This is largely due to the amount of profit tied up in increased working capital (inventory, receivables less payables).

Here is a comprehensive example shows both the indirect and direct methods of calculating operating cash flow. If you spend more than 15 – 20 mins to read this example , you will understand and master the formula, format and template of cash flow statements: indirect and direct methods.

The draft financial statements of A for the year ended 31 December 20X9 are as follows:

Note: Cash and cash equivalents are made up as follows:

The following additional information is also available.

• Interest expense was $400 of which $170 was paid during the period. $100 relating to interest expense of the prior period was also paid during the period. $200 of interest was received during the period.
• Dividends paid were $1,200.
• The liability for tax at the beginning and end of the period was $1,000 and $400 repectively. During the period, a further $20 tax was provided for.Withholding tax on dividend received amounted to $100, thus leading to the total tax expense of $20 + $100 = $120.
• During the period, the group acquired property, plant and equipment with an aggregate cost of $1,900 of which $900 was acquired by means of finance leases. Cash payments of $1,000 were made to purchase property, plant and equipment.
• $90 of capital repayment was paid under the finance leases.
• Plant with an orginal cost of $80 and accumulated depreciation of $60 was sold for $20.
• Accounts receivables as at the end of 20X9 include $100 of interest receivable.
• $250 was raised from the issue of share capital and a further $450 was raised from long-term borrowings.

Required

1. Prepare a cash flow statement for the year ended 31 December 20X9 using the indirect method and following the illustrative format (starting the cash flow statement with the profit before tax).
2. Show the calculation of operating cash flow using the direct method.

Approach to solution

Figures for the cash flow statement are derived from the differences between the opening and closing balance sheet figures, using information in the notes and in the income statement to make necessary calculations. One approach to developing the answer is to adopt a standard procedure. Here is a suggested procedure for the indirect method.

Step1

Set up the statement in outline (main headings only). Leave plenty of space to insert detail. A whole page will be needed.

Step2

Study the additional information and mark with a cross those items affecting balance sheet amounts.

Step3

Begin the cash flow statement by using the income statement to work down to operating profit before working capital changes.

Step4

Proceed line by through the balance sheets. If an item is not marked with a cross, the difference may be entered direct to the statement, if it is marked, a working is required. Use working ledger accounts to calculate missing figure. Insert the opening and closing balances from the balance sheets into the working accounts, then add information from the notes to complete the ledger account. Balancing figures on the working accounts are then transferred to the cash flow statement.

Solution

Cash flow statement for the year ended 31 December 20X9: indirect method.

Analysis of cash and equivalents

Workings:

• Net profit before tax: 3,350

You can find it in the income statement.

• Depreciation: 450

You can find it in the income statement for this period. Added back to profit because it’s a non-cash expense.

• Investment income: (500)

You can find it in the income statement for this period. Deducted because this income is not belong to operating activities.

• Interest expense: 400

You can find it in the income statement for this period. Added back because it’s not part of cash generated from operations (the interest actually paid is not belong to operating activities).

• Increase in trade receivables: (600)



Deducted because this is part of the profit not yet realised into cash but tied up in receivables

• Decrease in inventories: 950

You can calculate it from the account “Inventory” (1,950 – 1,000 = 950). Added on because the decrease in inventories liberates extra cash.

• Decrease in trade payables: (1,640)

You can calculate it from the account “Trade payables” (1,890 – 250 = 1,640). Deducted because the reduction in payables must reduce cash.

• Interest paid: (270)



These are the amounts actually paid in the year.

• Income taxes paid: (720)



These are the amounts actually paid in the year.

• Purchases of property, plant and equipment: 1,000



Cash paid for property, plant and equipment and other non-current assets.

• Proceeds of sale of equipment: 20




Cash received on the sale of property, plant and equipment and other non-current assets.

• Interest reveived: 200
• Dividends received: 200



Additional information: $200 of interest was received during the period. Received on investments.

• Proceeds from issue of shares: 250

You can calculate it from the account “Share capital” (1,500 – 1,250 = 250). It’s an inflow of cash.

• Proceeds from long-term borrowings: 450



It’s an inflow of cash.

• Payment of finance lease liabilities: (90)

$90 of capital repayment was paid under the finance leases. It’s an outflow of cash.

• Dividends paid: (1,200)



It’s an outflow of cash.

Opening cash flow: direct method.

Workings:

• Cash receipts from customers



• Cash paid to suppliers and emplyees

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If there appears to be a cash shortfall, the company may have to take one or more of the following steps:

• increase its overdraft (if it’s not already at the limit)
• increase its longer-term borrowings
• rasing money through a share issue (the company must have a good record of profitability and of dividend growth, and the share price must be high)
• tightening credit and inventory control, paying suppliers later
• limiting capital expenditure
• entering into sale and leaseback arrangments (it will need some assets which are not already charged)
• selling some assets
• purchasing a cash-rich company by issuing shares in consideration.

The company should consider most measures in preference to:

• reducing dividends
• reducing its level of activity.

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The two methods which can be used to prepare the cash flow statement are the direct and indirect methods.

Advantages of the direct method:

• Information is shown which is not shown elsewhere in the financial statments.
• It shows the ture cash flows involved in the trading operations of the entity.

The main drawback is the cost of preparing the information.

Advantages of the indirect method:

• The user can easily relate trading profits to cash flow.
• The cost of preparing the information is low.

The main drawback is the lack of information on the significant elements of trading cash flows.

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Cash flow statements should normally be used in conjunction with income statements and balance sheets when making an assessment of future cash flows.

• Cash flow statements are based on historical information and therefore do not provide complete information for assessing future cash flows.
• There is some scope for manipulation of cash flows. For example, a business may delay paying suppliers until after the year-end, or it may structure transactions so that the cash balance is favourably affected. It can be argued that cash management is an important aspect of stewardship and therefore desirable. However, more deliberate manipulation is possible.
• Cash flow is necessary for survival in the short term, but in order to survive in the long term a business must be profitable. It is often necessary to sacrifice cash flow in the short term in order to generate profits in the long term. A huge cash balance is not a sign of good management if the cash could be invested elsewhere to generate profit.

Neither cash flow nor profit provide a complete picture of a company’s performance when looked at in isolation.

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The cash flow statement provides information which is not available from balance sheets and income statements.

• It may assist users of financial statements in making judgements on the amount, timing and degree of certainty of future cash flows.
• It gives an indication of the relationship between profitability and cash-generating ability, and thus of the quality of the profit earned.
• Analysts and othe users of financial information often, formally or informally, develop models to assess and compare the present value of the future cash flow of entities. Historical cash flow information could be useful to check the accuracy of past assessments.
• A cash flow statement in conjunction with a balance sheet provides information on liquidity, viability and adaptability, but the information is incomplete for this purpose as the balance sheet is drawn up a particular point in time.
• Cash flow cannot easily be manipulated and is not affected by judgement or by accounting policies.

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The items about cash flow financing activities are the proceeds of issue of shares and long-term borrowings made or repaid.

Financing cash flows comprise receipts orrepayment of pricipal from or to external providers of finance.

Financing cash inflows include:

• receipts from issuing shares or other equity instruments
• receipts from issuing debentures, loans, notes and bonds and from other long term and short term borrowing (other than overdrafts, which are normally included in cash and cash equivalents).

Financing cash outflows include:

• repayments of amounts borrowed (other than overdrafts)
• the capital element of finance lease rental payments
• payments to reacquire or redeem the enterprise’s shares.

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The items about cash flow investing activities are cash spent on non-current assets, proceeds of sale of non-current assets and income from investments.

The items about cash flow investing activities including:

• cash paid for property, plant and equipment and other non-current assets
• cash received on the sale of property, plant and equipment and other non-current assets
• cash paid for investments in or loans to other enterprise (excluding movements on loans from financial institutions, which are shown under financing)
• cash received for the sale of investments or the repayment of loans to other enterprises (excluding loans from financial institutions)
• interest received on investments of loss
• dividends received on investments.

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Preparing cash flow from operating activities is one parts of preparing the cash flow statement. Here introduce the detailed calculation and the meaning of specific items about cash flow from operating activities.

The section of the statement begins with the profit before tax as shown in the income statement. The remaining figures are the adjustments necessary to convert the profit figure to the cash flow for the period.

• Depreciation: Added back to profit because it’s a non-cash expense
• Interest expense: Added back because it’s not part of cash generated from operations (the interest actually paid is not belong to operating activities)
• Increase in trade receivables: Deducted because this is part of the profit not yet realised into cash but tied up in receivables
• Decrease in inventories: Added on because the decrease in inventories liberates extra cash
• Decrease in trade payables: Deducted because the reduction in payables must reduce cash
• Interest paid, dividends paid, income taxes paid: These are the amounts actually paid in the year.