WHY PREPARE A CASH FLOW

STATEMENT?
  
Balance sheets, an income statement and statement of
changes in equity are based on accrual accounting and
provide only piecemeal information about flows of funds
and cash
  
  Cash flow statement identifies cash inflows and outflows
from activities over the period
  
• Statement helps answer questions such as:
– Why is the company in a liquidity crisis when it has been
profitable over the past few years?
 
 
 

1
 ANALYSING THE CASH FLOW STATEMENT

• Statements of cash flows help users:

– evaluate a company’s ability to:
• generate positive cash flows
• meet its obligations to shareholders, creditors and
governments
– assess a company’s solvency and need for external financing
– explain variances between reported accrual profit and cash
flows from operating activities

• Single statements are of limited use, a useful analysis requires

statements covering five or more years.

2
PREPARING THE CASH FLOW STATEMENT

• There are two methods:

– 1. Analyse cash and other accounting records
Or
– 2. Analyse the financial statements

Both methods should produce the same cash

inflows and cash outflows

3
Define the Three Classifications of Cash Flows

1. Operations –
cash flows related to selling goods and services;
that is, the principle business of the firm.
2. Investing –
cash flows related to the acquisition or sale of
noncurrent assets.
3. Financing –
long term and short term cash flows related to
liabilities and owners’ equity; dividends are a
financing cash outflow.
 Components of the Statement of Cash Flows
Cash
Cashreceived
receivedfrom
from Cash
Cashpaid
paidfor
for cash
cashflow
flow
Operations sale
saleof
ofgoods
goods - operating
operatinggoods
goods = from
fromoperations
operations
and
andservices
services and
andservices
services
+-
Cash
Cashreceived
receivedfrom
from Cash
Cashpaid
paidfor
forac-
ac- cash
cashflow
flow
Investing sales
salesof investments - quisition
ofinvestments quisitionof
ofinvest-
invest- = from
and frominvesting
investing
andPP&E
PP&E ments
mentsand
andPP&E
PP&E

Cash
+-
Cash Cashpaid
paidfor
for
Cashreceived
receivedfrom
from dividends
dividendsand
and cash
cashflow
flow
Financing issue
issueof
ofdebt
debtoror - reacquisition
reacquisitionofof
= from
fromfinancing
financing
capital
capitalstock
stock debt
debtor
orcapital
capitalstock
stock
=
Figure 4.1 Net
Netchange
changeinincash
cash
for
forthe
theperiod
period
 LIMITATIONS OF THE STATEMENT

• The usefulness of cash flow statements is limited due

to the fact that they are:

– based on historical cash flows

– non-cash transactions are only disclosed in the
notes
– give only some of the information necessary to
assess liquidity and solvency
– may be manipulated by management
– costs involved in its preparation