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Acct2101
Lecture 10
Statement of cash flows

Chapter 11
 Revision – internal control and accounting information
systems
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Accounting information systems

Phases of accounting information systems
Principles of accounting information systems
Developing an accounting information system
Internal control
Corporate governance
Special journals
Subsidiary ledgers and control accounts
 Learning objectives

After this lecture, you should be able to:

1. Indicate the main purpose of the statement
of cash flows.
2. Distinguish among operating, investing and
financing activities.
3. Prepare a statement of cash flows.
4. Explain the impact of the product life cycle
on an entity’s cash flows.
5. Use the statement of cash flows to evaluate
an entity.
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 The statement of cash flows:
purpose and format

To provide information about:

 cash receipts

 cash payments
 net change in cash resulting from operating,

investing and financing activities.

To reconcile the beginning and ending cash
balances.

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 The statement of cash flows:
purpose and format

The statement of cash flows provides answers

as to:
 Where did the cash come from during the period?
 What was the cash used for during the period?
 What was the change in the cash balance during the
period?
 Is the entity generating sufficient cash flows from
operations to meet cash requirements?

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 Classification of cash flows

Operating activities:
 Entity’s principal revenue-generating activities,

and activities not regarded as investing or

financing activities.
Investing activities:
 Acquisition and disposal of long-term assets.
Financing activities:
 Affect the size and composition of contributed

equity and borrowing.

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 Significant non-cash activities

Significant financing and investing

activities that do not affect cash are not
reported in the body of the statement of
cash flows, but are reported in the
notes.
These include:
 Issue of shares to purchase assets.
 Conversion of debt into ordinary shares.
 Issue of debt to purchase assets.
 Exchanges of property, plant & equipment.

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Format of the statement of cash flows

Operating activities are reported using

two methods: direct and indirect.
These methods differ in the way that net
cash provided (used) by operating
activities is calculated.
AASB 107 encourage companies to use
the direct method for published financial
statements.
AASB 107 requires the indirect method
by way of a note as a reconciliation.

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Format of the statement of cash flows

The direct method presents cash

payments as deductions from cash receipts
to determine net cash provided (used) by
operating activities.
The indirect method starts from net profit
after tax and adjusts this by changes in
non-cash items affecting net profit to
determine net cash provided (used) by
operating activities.

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Format of the statement of cash flows
 Usefulness of the statement of
cash flows

Helps investors, creditors and other

interested parties to evaluate the
following about the entity:
 Ability to generate future cash flows.
 Ability to pay dividends and meet obligations.
 Reasons for difference between profit and net
cash provided (used) by operating activities.
 Cash investing and financing transactions for the
period.

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 Preparing the statement of
cash flows

There are 3 sources of information to

prepare the statement of cash flows:
 Statement of financial position:
 Comparative this year’s and last year’s.
 Current period’s Statement of profit or loss.
 Additional information (about transactions that
occurred during the period).
Internal reports are used to prepare the
statement of cash flows.

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 Preparing the statement of
cash flows

There are 4 steps in the preparation:

Step 1: determining the net increase (decrease) in cash

The difference between the beginning

and ending cash balances can be easily
calculated from comparative statement of
financial position data.
Reports opening cash balance compared
to closing balance.
Calculate movement in balances over the
year.
Pacific Ltd.'s cash increased by $32 000:
 this is entered on the bottom of the statement of
cash flows.
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Step 1: determining the net increase (decrease) in cash

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 Step 2: determining net cash provided
(used) by operating activities

This step involves analysing not only the

current year’s statement of profit or loss
but also comparative statement of financial
position information and selected additional
data.
Aims to adjust activities reported in the
statement of profit or loss from accrual to
cash basis.
Remember some activities are non-cash and
are not included (e.g. depreciation, loss or
gain on sale of assets).
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Step 2: determining net cash provided
(used) by operating activities
 Step 2: determining net cash provided
(used) by operating activities

Hint as information is used tick each amount

and then review for any unticked information
ensure no cash flows omitted.
 Step 2: determining net cash provided
(used) by operating activities

Cash receipts from customers:

 Use sales and comparative accounts receivable

account balances.
 Assume all sales made on credit.
 Formula to calculate cash receipts from customers:
 Step 2: determining net cash provided
(used) by operating activities

• Pacific Ltd calculation of cash received from

customers:
 Step 2: determining net cash provided
(used) by operating activities

Or reconstruct the Accounts Receivable

account:
 Step 2: determining net cash provided
(used) by operating activities

Cash paid to suppliers:

 Use cost of sales and comparative accounts payable

and inventory.
 Assume all purchases made on credit.

 Two steps: calculate amount of purchases made

during period, then the amount of cash paid to

suppliers for purchases.

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 Step 2: determining net cash provided
(used) by operating activities

Cash paid to suppliers:

 How?
 use the formula
 reconstruct accounts.
 Step 2: determining net cash provided
(used) by operating activities

• Formula to calculate cash payments to suppliers:

 Step 2: determining net cash provided
(used) by operating activities

• Pacific Ltd calculation of cash paid to suppliers:

 Step 2: determining net cash provided
(used) by operating activities

Reconstruct Accounts Payable:

 Step 2: determining net cash provided
(used) by operating activities

Continue step 2 until all major classes of

operating receipts and payments are
completed e.g.
 Cash receipts from interest or dividends.
 Cash paid for operating expenses.
 Cash paid for income tax.
 Cash payments for interest.

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 Step 2: determining net cash provided
(used) by operating activities

• Formula to calculate payments for operating

expenses:
 Step 2: determining net cash provided
(used) by operating activities

• Pacific Ltd calculation of cash paid for operating

expenses:
 Step 2: determining net cash provided
(used) by operating activities

Cash payments for income tax:

 Use income tax expense and comparative tax payable

balances.
 Statement presentation of calculation of cash

payments for income tax:

 Step 2: determining net cash provided
(used) by operating activities

• Pacific Ltd calculation of cash paid for income tax:

 Step 3: determining net cash provided
(used) by investing activities

This step involves analysing statement of

financial position data and statement of
profit or loss data and selected additional
information for the effects of cash on.
Transactions relating to non-current
assets:
 property, plant and equipment
 Investments
 loans to other entities.
Non-cash transactions are not included.

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 Step 3: determining net cash provided
(used) by investing activities

New equipment may be completely or partly

funded through debt.
This does not represent cash out flow, so
does not appear in the statement.
Cash outflow for purchase of equipment or
investments is listed separately from cash
inflow from sale of equipment or
investments.
Calculate inflows and outflows either by:
 formula
 reconstructing accounts.
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Step 3: determining net cash provided
(used) by investing activities
 Step 4: determining net cash provided
(used) by financing activities

This step involves analysing comparative

statement of financial position data and
selected additional information for the
effects of cash.
Relates to debt and equity of company.
Use net profit and notes payable, issued
shares and retained earnings accounts:
 Cash inflows: issue shares, issue notes.
 Cash outflows: dividends, repay notes.

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 Step 4: determining net cash provided
(used) by financing activities

Notes payable:
 Cash inflow = cash received from issue of notes.

 Cash outflow = cash paid upon redemption of

notes.
 Check additional information for details (e.g. non-

cash transactions that are not included in

statement).

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 Step 4: determining net cash provided
(used) by financing activities

Increase in ordinary shares:

 Check additional information for details.

 If none, assume increase/decrease represents cash

received/paid.
 If non-cash transaction, check that details account

for changes to issued share balances.

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 Significant non-cash items

 If non-cash transaction in relation to shares, check

the additional information to account for changes to
issued share balances.
 e.g. issue shares for land.
 Convert notes payable into shares.
 Report significant non cash transactions in a NOTE
at the end of the Statement of Cash Flows.
 e.g. Non-cash investing and financing activities.
 Conversion of notes payable to ordinary shares.

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Completing the statement of cash
flows
 Indirect method of determining cash
flows from operating activities

If the direct method is used to calculate

the operating cash flows, the
reconciliation of net profit to cash
provided (used) by operating activities
must be disclosed as a note.
Indirect method is used for this:
 Net profit is adjusted for accrual accounts.
 Result should equal net cash provided and/or
used by operations.

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 Re-cap

Direct Method:
 Reports cash inflows and outflows for:
 operating
 investing
 financing.
Indirect Method (Reconciliation):
 Starts with profit and converts/reconciles to net

cash provided (used) by operating activities.

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 Indirect method of determining cash
flows from operating activities

Adjustments required:
 Items affecting profit but not cash (e.g.,

depreciation).
 Timing differences (e.g., changes to accounts

receivable, accounts payable).

 Items affecting profit but are not operating

activities (e.g., revenue received from sale of land

or plant).

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Indirect method of determining cash
flows from operating activities
 Indirect method of determining cash
flows from operating activities

Operating section Statement of Cash Flows

using the indirect method:
 Summary of indirect method of determining cash flows
from operating activities

Adjustments for current assets and

current liabilities:
 Summary of indirect method of determining cash flows
from operating activities

Adjustments for non-cash items and cash

flow items not classified as operating
activities:
 Free cash flow

Free cash flow describes cash from

operations available for expansion or
payment of dividends.
Free cash flow is estimated by the formula:
 Capital expenditure ratio

Capital expenditure ratio indicates an

entity’s ability to generate sufficient cash to
finance the purchase of new property, plant
and equipment.

Example for Nick Scali 2013:

 Assessing liquidity, solvency and
profitability using cash flows

Liquidity:
 The ability of an entity to meet its immediate
obligations.

 Example for Nick Scali 2013:

 Assessing liquidity, solvency and
profitability using cash flows

Solvency:
 The ability of an entity to survive over the long term.

 Example for Nick Scali 2013:

 Assessing liquidity, solvency and
profitability using cash flows

Profitability:
 The ability of an entity to generate a reasonable
return.

 Example for Nick Scali 2013:

 Next week
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Final lecture on examinable material –

financial statement analysis.
Week 13 – Revision!