Transcript Cash is king

Cash Flow Statements
Chapter 15
© Luby & O’Donoghue (2005)
Cash is king
“profits can be manufactured by creative
accounting but creating cash is impossible”.
Terry Smith, Accounting for Growth
Typical cash flows
CASH
FLOWS
IN
OUT
1. Customer payments

X
X

1. Suppliers payments
2. Capital grants

X
X

2. Staff payments
3. Owners buy shares

X
X

3. Dividends
4. Sale of fixed assets

X
X

4. Purchase of fixed assets
5. Bank Loans

X
X

5. Repayment of loans
6. Tax refunds

X
X

6. Tax
7. Interest received

X
X

7. Interest paid
8. Sale of Business

X
X

8. Business acquisitions
9. Dividends received

X
X

9. Overheads/expenses
Cash
Cash in hand and deposits repayable on
demand with any qualifying financial institution
less overdrafts from any qualifying financial
institution repayable on demand. Cash includes
cash in hand and deposits denominated in
foreign currencies. (FRS 1)
Deposits are repayable on demand if they can
be withdrawn at any time without penalty, and
notice of not more than 24 hours.
Financial Reporting Standard 1
(FRS 1)
Financial Reporting Standard 1 (FRS 1) is an
attempt to ensure that all companies report a
summary of their cash flows.
FRS 1 applies to all medium and large
companies as defined by the Companies Act
1986 and relates to accounting periods ending
on or after 23 March 1997.
Purpose of FRS 1
To show the cash inflows and outflows for the financial
year and the consequent increase or decrease in cash.
The cash flows are reported in various categories to
enable the reader to identify key developments.
To convert the operating profit or loss into the
equivalent amount of cash released or consumed in
the day to day running of the business.
To show how the increase or decrease in cash for the
reporting period links the net funds (where cash and
bank balances are greater than loans/debt) or net
debt (where loans/ debt are greater than bank cash
balances) at the start and end of the reporting period.
Categories of cash flow
1.
2.
3.
4.
5.
6.
7.
8.
Operating activities
Return on investment/serving of debt
Taxation
Capital expenditure
Acquisitions and disposals
Equity dividends paid
Management of liquid resources
Financing
Cash flow statement – 2 steps
Step One Calculate overall cash flow
Total cash movement
€(000)
Total movement in cash in the reporting period
Cash at 1 Jan
300
Cash at 31 Dec
470
Cash Movement
+170
Cash increased by €170,000 over the year.
Step Two Prepare Cash Flow Statement
Categories of cash
1.
2.
3.
4.
5.
6.
7.
8.
Operating activities
Return on investment/serving of debt
Taxation
Capital expenditure
Acquisitions and disposals
Equity dividends paid
Management of liquid resources
Financing
€ (‘000)
500
(10)
(20)
(200)
(100)
(50)
(50)
100
+170
Category 1: Net cash flow from
operating activities
Cash flows from operating activities are in general the
cash effects of transactions relating to the operating or
trading activities of the business (the normal trading
activities of the business, not capital activities).
Operating cash flows will be concerned with:
cash
cash
cash
cash
collected from customers
paid to trade creditors for purchases
paid to staff /PAYE/PRSI
paid for services (overheads)
In calculating the net cash flow from operating activities
two formats are permitted by FRS 1 called
The Direct Method
The Indirect Method
Category 2: Returns on
investments and servicing of debt
Interest received: from loans given to other
businesses.
Interest paid: on loans from financial
institutions, debentures, interest element on
finance lease repayments, dividends paid to
non
equity
shareholders
(preference
shareholders).
Dividends received:
from investment in
subsidiaries, related companies and fixed
asset investments.
Category 3: Taxation
Only corporation tax payments and refunds
during the year are reported in this section.
Category 4: Capital expenditure
and financial investment
This category of activity includes divesting
activities such as cash flow from the sale of
tangible, intangible and financial fixed assets as
well purchases of tangible, intangible and
financial fixed assets.
Category 5: Acquisitions and
disposals
This category includes receipts and payments in
respect of disposals or acquisitions of interests
in subsidiaries, associated or joint venture
companies. The cost of buying a business is
reported net of any cash included in the
purchase price.
Category 6: Equity dividends
paid
Part of the cash generated by a successful
business is paid to the owners as a dividend.
This important outflow is reported as a separate
item in the cash flow statement.
Category 7: Management of
liquid resources
This section deals with receipts and payments in
respect of current asset investments, which are
considered to be liquid (readily marketable).
Under the definitions section in FRS 1, liquid
resources are those that can be realised (turned
into cash) without disruption to the business of
the entity or which can be traded in an active
market. Examples include commercial paper
and short-term investments readily convertible
into cash at their carrying value or close to it.
Category 8: Financing
This category covers the receipts and payments,
which arise from issues or repayments of
finance, from or to, the providers of external
finance. Cash inflows from this category would
include the issue of shares, debentures/bonds
or just simply getting a bank loan. The
repayments of the capital elements of
loans/debentures would be considered a cash
outflow.
Reconciliation of net cash flow to
net debt
The first two objectives or purposes of FRS 1 are achieved by
preparing the cash flow statement. The third objective of FRS1
is to show how the increase or decrease in cash for the
reporting period links the net funds or net debt at the start and
end of the reporting period.
Net debt is as per the definitions in FRS 1 “the borrowings of the
entity less cash and liquid resources”.
If cash and liquid resources exceed debt then the term used
becomes Net Funds.
The revised FRS 1 requires an additional statement
‘Reconciliation of net cash flow to movements in net debt’ to be
shown in the notes to the accounts.
A further note is required to further analyse the changes in net
debt/funds breaking debt into periods of less than one year and
greater than one year.
Reconciliation of net cash flow to
net debt
Comprehensive example
Trading P&L a/c for the year ended
2004
2003
(€,000)
(€,000)
Turnover
4,210
3,694
Cost of goods sold
1,053
924
Gross profit
3,157
2,771
Balance sheet as at
Fixed Assets At N.B.V.
2004
2003
€000
€000
13,120
10,456
Current Assets
Administration expenses
Selling and distribution
1,200
921
Operating profit
2,121
1,012
856
903
Interest
360
230
Net profit before tax
676
673
Corporation tax
200
180
Net Profit after tax
476
493
250
560
Dividends - interim
Dividends - final
200
200
200
200
Retained profits for the year
650
140
120
Debtors
400
300
12
25
8
0
10
130
Short-term investments
1,868
1,036
Transfer to reserve
Stock
Prepayments and accrued Income
Bank
560
585
Creditors < 12 months
Trade creditors
480
260
Taxation
200
180
Dividends
Bank overdraft
200
110
990
200
10
650
4,000
600
4,600
3,500
500
4,000
Creditors >12 months
960
(174)
(467)
Retained profits b/f
218
685
Retained profits c/f
44
218
Debentures
Bank loans
8,090
Capital and Reserves
Called up Share Capital
Ordinary shares nominal value 0.50 per share
Additional information
1. Authorised share capital is 20,000,000 50 cent ordinary shares
2. Administration expenses for the year ended 31/3/04 are the
following:
Depreciation on assets in existence at the year-end €560,000.
Loss on the sale of fixed assets for €80,000.
The assets had a net book value of €150,000 when sold
6,391
6,000
5,000
Reserves
Share premium
623
General reserve
1,423
1,173
Retained profits
44
218
8,090
6,391
Calculate the overall cash
flow
Prepare the cash flow
statement
Prepare the reconciliation of
net debt to net cash flow
Interpreting cash flow statements
Is the overall cash movement positive or negative, and is the cash
movement significant?
Is the company heavily in overdraft?
What is the net debt/funds situation and is it getting better or
worse?
Compare the operating net profit to operating cash flow. Is the
company generating sufficient cash from its operating activities? If
the company is not generating sufficient cash from its operating
activities is this due to large increases in stocks and debtors which
can signal poor control over working capital.
Identify the main cash inflows to the business. The biggest cash
inflow for a business should be its operating activities but other
major ones would be issues of shares/debentures.
Identify the major cash outflows of a business. These in general
would be in the whole area of capital expenditure (investing in new
fixed assets or investments). Try and assess how this capital
expenditure was financed. Was it through a new issue of shares,
debentures or from the cash flows generated from operating
activities.
Come to an overall conclusion about the cash position of the
business in terms of the business’s ability to generate cash and how
it spends it. Also link this to the profitability performance of the
business.
Sample – Arnotts Group
2003
€’000
2002
€’000
30,420
23,719
64
124
(1,042)
(1,442)
(23)
(23)
-
(3)
(6)
(6)
(1,007)
(1,350)
(4,315)
(3,129)
(6,253)
(9,136)
-
64
Net Cash Outflow from Capital Expenditure and Financial Investment
(6,253)
(9,072)
Equity Dividends Paid
(5,955)
(5,107)
Cash Inflow Before Financing
12,890
5,061
(11,840)
(8,961)
1,050
(3,900)
Cash Flow from Operating Activities
Returns on Investments and Servicing of Finance
Interest received
Interest paid
Interest element of finance lease rental payments
Premium paid on redemption of debenture stock
Preference dividends paid
Net Cash Outflow from Returns on Investments and Servicing of Finance
Taxation
Corporation tax paid
Capital Expenditure and Financial Investment
Purchase of tangible fixed assets
Repayment of loan by associated undertaking
Financing
Increase/(Decrease) in Cash in the Year
Commentary