ACCOUNTING FINANCIAL STATEMENTS - Part 5 - Cash Flow Statement

ACCOUNTING FINANCIAL STATEMENTS - Part 5 - Cash Flow Statement - Get more knowledge from; Fund Flow Statement and Income Statement, Cost and Management Accounting, 
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In our four previous articles on this topic, we have defined financial statement to include Balance Sheet, Income Statement, Statement of Changes in Equity and Cash Flow Statement, and have discussed Balance Sheet, Purpose of financial statements, the users of financial statements. and income statement.  Complete Full MarksConsultants Limited (CFMC Ltd), presents these articles as part of its roles in educating her numerous clients, other business proprietors, and the public . CFMC Ltd welcomes enquiries for further information and especially on what it can do to help her client's businesses grow. It also has in mind of enriching the knowledge of various students who will read these articles.



What is the General Purpose of Financial Statement?

As a matter of fact,the general purpose of the financial statements is to provide information about the results of operations, financial position, and cash flows of an organisation. This information is used by the readers of financial statements to make economic decisions regarding the allocation and reallocation of resources.

In our previous article we presented the four basic elements of financial statements as follows:

1. A balance sheet, also known as a statement of financial position, displaying reports on a company's assets, liabilities, and owners equity at a given point in time.

2. An income statement, also called statement of comprehensive income, statement of revenue and expense, or profit and loss account, for a period of time. A profit and loss statement provides information on the operations of the enterprise. These include sales (revenue) and the various ( direct cost of production and administrative or operational) expenses incurred during the stated period.

3. A Statement of changes in equity, also known as equity statement or statement of retained earnings, which gives detailed reports on the changes in equity of the company during the stated period.

4. A cash flow statement is a report on a company's cash flow activities, especially its operating, investing and financing activities

We have dealt with Balance Sheet , Income statement,  at this time we shall be dealing with
another element of financial statement called statement of cash flow.



 A statement of cash flows is a financial statement which summarises cash transactions of a business during a given accounting period and classifies them under three heads, namely, cash flows from operating, investing and financing activities. It shows how cash moved during the period by indicating whether a particular line item is a cash in-flow or a cash out-flow. The term cash as used in the statement of cash flows refers to both cash and cash equivalents. Cash flow statement provides relevant information in assessing a company's liquidity, quality of earnings and solvency.

A statement of cash flows comprises of three sections which are :
  • Cash Flows from Operating Activities
This section includes cash flows from the principal revenue generation activities such as sale and purchase of goods and services. Cash flows from operating activities can be computed using two methods. One is the Direct Method and the other Indirect Method.
  • .       Cash Flows from Investing Activities
Cash flows from investing activities are cash in-flows and out-flows related to activities that are intended to generate income and cash flows in future. This includes cash in-flows and out-flows from sale and purchase of long-term assets.
  • .       Cash Flows from Financing Activities
Cash flows from financing activities are the cash flows related to transactions with stockholders and creditors such as issuance of share capital, purchase of treasury stock, dividend payments etc.

The indirect method computes the operating cash flows by adjusting the current year's net income for changes in balance sheet accounts. This is the only difference between the direct and indirect methods. The investing and financing activities are reported exactly the same on both reports.


How do I go about calculating this?

Here are the steps for calculating the cash flow from operations using the indirect method:
Start with net income.
Add back non-cash expenses. ...
Adjust for gains and losses on sales on assets. ...
Account for changes in all non-cash current assets.
Other adjustments….

Cash Flow Statement Indirect Method
The statement of cash flows is one of the components of a company's set of financial statements, and is used to reveal the sources and uses of cash by a business. It presents information about cash generated from operations and the effects of various changes in the balance sheet on a company's cash position.

Under the indirect method of presenting the statement of cash flows, the presentation of this statement begins with net income or loss, with subsequent additions to or deductions from that amount for non-cash revenue and expense items, resulting in net income provided by operating activities.

How is the presentation?

AS indicated above, in the presentation format, cash flows are divided into the following general classifications:

Cash flows from operating activities
Cash flows from investing activities
Cash flows from financing activities

The indirect method of presentation is very popular, because the information required for it is relatively easily assembled from the accounts that a business normally maintains in its chart of accounts. The indirect method is less favoured by the standard-setting bodies, since it does not give a clear view of how cash flows through a business (as is shown under the direct method of presentation).


Statement of Cash Flows Indirect Method Example using assumed figures.

Cash flows from operating activities                        N                      N                                    
Net income                                                                                                                         3,000,000
Adjustments for:                             
Depreciation and amortization                             125,000
Provision for losses on accounts receivable          20,000  
Gain on sale of facility                                       (65,000)     
Increase in trade receivables                                 (250,000) 
Decrease in inventories                                         325,000   
Decrease in trade payables                                    (50,000)    
Cash generated from operations                                                                                                                                                                                                   3,105,000
Cash flows from investing activities                         
Purchase of property, plant, and equipment       (500,000)            
Proceeds from sale of equipment                         35,000     
Net cash used in investing activities                                                                                                                                                                                                 (465,000)
Cash flows from financing activities                         
Proceeds from issue of common stock                     150,000              
Proceeds from issuance of long-term debt                175,000          
Dividends paid                                                     (45,000) 
Net cash used in financing activities                                                                                                                                                                                                 280,000
Net increase in cash and cash equivalents                                      2,920,000
Cash and cash equivalents at beginning of period                                 xx                          
Cash and cash equivalents at end of period                                          xx

Cash Flow Statement Direct Method
The direct method of presenting the statement of cash flows presents the specific cash flows associated with items that affect cash flow. Items that typically do so include:

Cash collected from customers
Interest and dividends received
Cash paid to employees
Cash paid to suppliers
Interest paid
Income taxes paid

The Direct and Indirect method compared:

The advantage of the direct method over the indirect method is that it reveals operating cash receipts and payments and I preferred by the accounting standard setting bodies, but it is not commonly used because the information required for its preparation are not always available due to the fact that the accounting information system in place do not generate such information.


Statement of Cash Flows Direct Method Example:

Since the only difference with the indirect method is the preparation of the operating activities, it is only the operating activities that are highlighted here.

Cash flows from operating activities                                        N                                   N
Cash receipts from customers                                                   xx
Cash paid to suppliers                                                            (xx)           
Cash paid to employees                                                            xx                              
Interest paid                                                                           (xx)
Income taxes paid                                                                    (xx)
Net cash from operating activities                                                                                 xx   


Statement of Cash flow therefore reveals the following:

- the nature of cash receipts

- and disbursements, by a variety of categories.

- shows how changes in balance sheet accounts and income affect cash and cash equivalents,

- it breaks the analysis down to operating, investing and financing activities.

- The statement captures both the current operating Results and the accompanying changes in the balance sheet.

- As an analytical tool, it is useful in determining the short-term viability of a company, particularly its ability to pay bills.

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