Session 5 objectives
By the end of this session you should:
Understand the importance of cash
Be able to explain the reasons why ‘profit’ does not equal ‘cash generated’
Be able to prepare and interpret a cash flow statement
Be aware of why cash flow reporting was introduced
Understand the key issues regarding cash and working capital management
Melville CHAPTER 16
W&A CHAPTER 10
What are cash and cash equivalents?
Cash is defined as notes and coins in hand and deposits in banks and similar institutions
Cash equivalents are short-term, highly liquid investments that are readily convertible to cash which are subject to an insignificant risk of changes in value.
Cash and cash equivalents normally:
− Exclude equity investments
− Exclude bank borrowings (as they are financing activities)
− Include bank overdrafts (as they are an integral part of an enterprise’s cash management)
The Importance of Cash
Ultimately, it is cash flow and not profit which is the key to financial success Cash is the ‘lifeblood’ of the business:
To pay day to day expenses within the working capital cycle
To pay interest and taxes
To pay dividends
To repay loans
To make investments in non current assets, acquisitions…..
Profitable companies can still have an adverse cash flow
so why is profit not necessarily the same as the cash flow for the period? Stuart Cooper
The Difference Between Profit and Cash Flow
Revenues include sales made on credit not yet received in cash
Cash flows arising from financing activities are not recorded in the income statement
Expenses are recorded when costs are consumed not when paid for
Profit ≠ Cash
Cash spent on inventories is only recorded as an expense when goods are sold Cash spent on capital investment is not recorded in the income statement, and depreciation and amortisation are non cash expenses
Profit versus cash
Profit is judgemental, conceptual and a matter of opinion.
Cash is fact!
◦ In 2010/11 profit for the year was £597m, but cash inflow £62m
◦ In 2011/12 profit for the year of almost £490m, but the net cash flow reported was NEGATIVE £66m.
◦ In 2012/13 profit for the year of £458m, but the net cash flow reported was NEGATIVE £36m
Cash Flow Statements
Necessary to consider both cash flows and profits
Mid 1970s -1990 Funds Flow Statements produced (emphasis on working capital)
1992 IAS7 revised Cash Flow Statement introduced. Stuart Cooper
Objective of cash flow information
The economic decisions that are taken by users require an evaluation of the ability of an enterprise to generate cash and cash equivalents and the timing and certainty of their generation.
A cash flow statement, when used in conjunction with the rest of the financial statements, provides information that enables users to determine the following:
the ability of an enterprise to generate cash from its operations the cash consequences of investing and financing decisions the sustainability of an enterprise’s cash-generating capability how well operating cash flow correlates to net income information about the liquidity and long-term solvency of an enterprise the ability of an enterprise to finance its growth from internally generated funds.
Objective of cash flow statements
McLaney and Atrill (2012, p. 216)
The cash flow statement explains how the level of cash and cash equivalents has changed from one balance sheet (statement of financial position) to the next.
Format and structure of the cash flow statement IAS 7
Cash flows from operating activities
+ Cash flows from investing activities
+ Cash flows from financing activities
Net change in cash during period
+ Beginning cash balance