(IV) Statement of Cash-Flows

BE3205 Financial Management
(iv) Statement of Cash-flows
Dr. Sachie Gunatilake
Department of Building Economics, University of Moratuwa

Learning Outcomes of this Module
• The students should be able to:
- Interpret financial statements
- Prepare cash flow statements
- Apply capital budgeting techniques for financial decision making
Areas covered in this module…
• Financial Reporting
• Analysis of Financial Statements
• Ratio Analysis
• Cash Flow Forecasting and Cash Flow Statement
• Working Capital Management
• Project Financing – Availability and sources of finance
and borrowing, Financial structure of organisations
Main Components of Financial
Statements: Recap
• Statement of financial position (a.k.a. Balance sheet)
• Statement of profit and loss (a.k.a. Income statement)
• Statement of changes in equity
• Statement of cash flows
• Notes comprising a summary of significant accounting
policies and other explanatory notes
Importance of cash flows for
businesses
• Fundamental objective of a business – to generate
profits to increase owners’ wealth
- A long term objective
• In the short-term, business viability determined by its

ability to generate cash
• Even profitable businesses will collapse if sufficient
cash is not available to settle bills
Why a statement of cash flows?
• Even though, the balance sheet provides ‘bank
balance’
- However, difficult to identify the major causes of changes in the
balance
• Information about cash flows is useful to users of

financial statements to assess the ability of the
enterprise to generate and utilise cash and cash
equivalents
Cash and cash equivalents
• Cash: comprises cash on hand and demand deposits
- E.g. Coins, Currency, Cash in checking/ savings accounts, Bank drafts,
Money orders, Petty cash
• Cash equivalents: short-term, highly liquid investments
that are readily convertible to known amounts of cash and
which are subject to an insignificant risk of changes in value
- E.g. Commercial paper, Marketable securities, Money market funds,
Short-term government bonds, Treasury bills
Need for a statement of cash flows
• Profit made during the period = Increase in cash and
bank balances
Why???
03 Main Reasons
Reasons profit earned does not equal
the change in cash/bank balances
1) Profit is calculated on an accruals basis
- i.e. revenue is taken when earned, not when received. Expenses
deducted on same basis to match with revenue.
- But bank/ cash balances change when money is received and paid
out
- Hence, bank balance may be different from profit due to items
such as inventories balance, receivables, payables, accruals,
prepayments.
the change in cash/bank balances Contd…
2) Profit calculation includes items that do not affect cash
or affect it differently
- E.g. 1: profit is after deducting depreciation, which involves no
cash movements
- E.g. 2: profit/ loss on disposal of a non-current asset considered in
calculating profit, but proceeds of the sale affects cash
- E.g. 3: tax may be paid after the year end
the change in cash/bank balances Contd…
3) Bank/ cash balance affected by items that do not
affect profit
- E.g. purchase of non-current assets, raising additional capital,
repayment of loans
What is a statement of cash flows?
• Statement of cash flows:
- Reports the effect of the transactions of the business during the
period on the bank, cash and other liquid assets
- Recognises the importance of liquidity to a business
- Simply, it is a summary of receipts and payments during the
period
Statement of cash flows:
Cash flows from operating activities
03 Main Sections
Cash flows from investing activities
Cash flows from financing activities

03 Main Sections

(A) Cash flows from operating activities
• This is the cash flow from operating the business
- Operations: the normal everyday activities activity of a business
that earn it profit and result in cash flow
• Mainly relates to the income statement

• Intended to give an indication of the cash generated
from operating profit
Calculating the cash generated from
operations
• Begin with profit before taxation in the income statement
• Add back interest received/paid (i.e. finance costs)
• Make adjustments for non-cash items included in arriving
at the operating profit figure:
i. Depreciation charge
ii. Profit/ loss on disposal of non-current assets
iii. Increase/ decrease in inventories
iv. Increase/ decrease in receivables Working capital
v. Increase/ decrease in payables changes
vi. Increase/ decrease in accruals/ prepayments
And add back interest
expense
Can start with profit before

taxation
Calculating
the cash
generated
from
operations
Activity 1:
A company had the following items on its balance sheet at the end of year 2017 and 2018:
2017 (Rs.) 2018 (Rs.)
Inventories 35,000 25,000
Receivables 24,000 28,000
Payables 31,000 33,000
Income statement for 2018 included the following items:

Rs. Rs.
Gross profit 90,000
Less:
General expenses 17,000
Depreciation on plant 10,000
Loss on disposal of plant 4,000
(31,000)
Operating profit 59,000
Less: Interest payable (3,000)
Profit before tax 56,000
Calculate the cash generated from operations for 2018.

Activity 2:
Webster Ltd. has the following financial information for the year ended 31 December 2018:
Income statement for the year ended 31 December 2018
$ 000
Revenue 222
Operating expenses (156)
Operating profit 66
Finance costs (9)
Profit before tax 57
Income tax expense (21)
Profit 36
The following information is also available:
31.12.2018 31.12.2017
$ 000 $ 000
Inventories 21 12
Trade receivables 24 21
Trade payables (15) (9)
Depreciation charge for the year 2018 is $42,000. A machinery with a net book value of $20,000 was sold for
$50,000 during the year.
Calculate the cash generated from operations for 2018.
Reasons for adjusting for non-cash
items
• Depreciation:
- This is a book adjustment – reflect the wearing out of an asset
- Reduces the net income (or profit) but does not require cash
- The cash impact of non-current assets is the cash spent on buying
the asset – included in the investing section of cash-flow statement
• Profit/ loss on disposal of non-current assets:

- The cash impact is the total proceeds from the disposal – not just
the profit/ loss
Reasons for adjusting for non-cash
items Contd…
• Changes in inventories:
- Operating profit is calculated after charging cost of sales
- Cost of sales has been adjusted for opening and closing inventory
– i.e. the cost of goods used in the year
- Need the total cash spent on materials in the year
- E.g. If inventory increased during the year, then cash spent on
purchases has exceeded the cost of goods sold and vice versa
Reasons for adjusting for non-cash items
Contd…
• Change in receivables:
- The income statement includes the sales revenue
- Need to consider the total cash received from customers – can be
calculated from the change in accounts receivable for the year
- E.g. if receivables ; then, revenue on accrual basis is higher than cash
receipts from customers – i.e. more money has been lent out to
customers – i.e. a cash outflow
E.g. cash received from customers
• Blue Plc. reported revenues of Rs. 50 mn, total
expenses of Rs. 35 mn, and net income of Rs. 15 mn
in the most recent year. If accounts receivable
decreased by $ 12 mn, how much cash did the
company receive from customers?
Reasons for adjusting for non-cash items
Contd…
• Change in payables:
- Similar to receivable above
- Need to consider the total cash paid to suppliers
- E.g. if payables ; the company is in effect ‘borrowing’ from suppliers –
i.e. a cash inflow
Net cash from operating activities
• Once the ‘cash generated from operations’ are
calculated ‘cash from operating activities’ is calculated
as follows:
Cash generated from operations xxx Only include

(-) Interest paid (xx) sums
(-) Income tax paid (xx) actually paid
during the
Cash from operating activities xxx
period
03 Main Sections

(B) Cash flows from investing activities
• Includes transactions to buy non-current fixed assets
and investments in long-term fixed income and equity
instruments of other companies (e.g. bonds)
(B) Cash flows from investing activities
Contd….
• Includes items such as;
- Cash payments to purchase property, plant and equipment (i.e.
non-current fixed assets) - (if purchased on a previous period will
have no impact on the cash in the current period)
- Receipts from the sale of property, plant and equipment (i.e. non-
current fixed assets)
- Cash payments to acquire equity of other companies
- Interest received from investing activities
- Dividends received
03 Main Sections

(C) Cash flows from financing activities
• In general, transactions including debt or equity of the
company are included in this section
• Includes;
- Proceeds from issuing shares
- Proceeds from issuing loan notes or debentures or cash paid for
their redemption
- Dividends paid (may also be included in the operating cash flows)
Format of the statement of cash flows
• Should report cash flows during the period classified by
operating, investing and financing activities.
• IAS 7 Cash-flow statements provides a standard format
Linkage between the statement of cash
flows and balance sheet
Cash flow
Beginning balance Ending balance
statement for the
sheet as at 31 sheet as at 31
year ended 31
December 20x1 December 20x2
December 20X2
Beginning Cash and Plus: Cash receipts Less: Cash Ending Cash and Cash
Cash Equivalents (from operating, payments (for Equivalents
investing, financing operating,
activities) investing, financing
activities)
Analysis of the statement of cash flows
• Can provide useful information about the company’s
business and earnings and for predicting its future cash
flows
• Can be useful for;
- Evaluating where the major sources and uses of cash flows are
between operating, investing and financing activities
- Evaluating the primary determinants of operating/ investing/
financing cash flows
Activity 1:
Prepare the cash flow statement for David Plc. for the year ended 31 March 2019 from following:
David Plc. – Income statement for the year ended 31 March 2019
$ 000
Revenue 1,700
Cost of sales (900)
Gross profit 800
Distribution costs (50)
Administrative expenses (120)
Operating profit 630
Interest received 80
Interest paid (65)
Profit before tax 645
Income tax expense (28)
Profit for the financial year 617
Dividends (55)
Retained profit for the year 562
David Plc. – Balance sheet as at 31 March 2019
2019 2018
$ 000 $ 000 $ 000 $ 000
Non-current assets
Tangible assets 1,580 1,000
Current assets
Inventory 250 130
Receivables 450 360
Prepaid distribution costs 4 2
Cash at bank and in hand 220 144
2,504 1,636
Equity
Issued share capital 120 100
Share premium account 88 49
Revaluation reserve 203 130
Accumulated profits 877 315
1,288 594
Non-current liabilities
Loans 800 700
Deferred tax 10 7
810 707
Current liabilities
Trade payables 344 290
Accrued administrative expenses 6 3
Income tax 26 22
Proposed dividends 30 20
406 335
2,504 1,636
The following additional information is also available:
a) The enterprise sold some tangible non-current assets, which had a net book value of $200 mn. The
cost of sales figure includes a loss of $10 mn on this disposal.
b) Cost of sales is arrived at after charging depreciation on the tangible non-current assets of $42 mn.
c) A proposed dividend (declared before the balance sheet date) is included.
Thank you

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BE3205 Financial Management

(iv) Statement of Cash-flows

Dr. Sachie Gunatilake

Department of Building Economics, University of Moratuwa

• In the short-term, business viability determined by its

• Information about cash flows is useful to users of

Cash flows from financing activities

Cash flows from financing activities

• Mainly relates to the income statement

Can start with profit before

Income statement for 2018 included the following items:

Calculate the cash generated from operations for 2018.

• Profit/ loss on disposal of non-current assets:

Cash generated from operations xxx Only include

Cash flows from financing activities

Cash flows from financing activities

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