IAS 7: STATEMENT OF CASH FLOWS

Learning Outcomes
By the end of this lecture, learners must be able to:

1) Appreciate the importance of statement of Cash flows to a company.

2) Analyse the importance of statement of Cash flows to different
stakeholders.
3) Prepare a Statement of cash flows from given financial information.
4) Comment on the Cash and Cash Equivalents of the company.
 Objective (IAS7)

The objective of IAS 7 is to allow presentation of financial

information about historical changes in Cash and cash
equivalents during an accounting period.
Fundamental Principles
The CFSs analyses the cash and cash (c&c) equivalents
during a given accounting period, the c&c equivalents
comprise of cash and demand deposits as well as short term
highly liquid investments (readily convertible into cash). An
investment meets the definition of c&c equivalents when its
maturity is less or equal to 3months, (Guidance notes).
 Why Statement of cash flows?

The Statement of Cash Flows is one of the three key financial

statements that summarizes the amount of
cash and cash equivalents entering and leaving a company
(inflows & outflows).
 It’s a report of the cash generated and spent during a
specific period of time (e.g., a month, quarter, or year).
The statement of cash flows acts as a bridge between the P&L
and SoFP by showing how money moved in and out of the
business.
The cash flow statement (CFS) measures how well a company
manages its cash position, meaning how well the company
generates cash to pay its debt obligations and fund
 Why Statement of cash flows?, cont…

However, it is worth noting that Cash flow statements (CFS)

are different from SOCI and SoFP because (CFS) does not
include the amount of future incoming and outgoing cash that
has been recorded on credit, as the SOCI & SoFP do.
In this regard, cash is not the same as net income, which on
the income statement and balance sheet include both cash
sales and credit sales.
Three Sections of the Statement of Cash Flows:

Operating Activities: The principal revenue-generating

activities of an organization and other activities that are not
investing or financing;

Investing Activities: Any cash flows from the acquisition

and disposal of long-term assets and other investments not
included in cash equivalents.

Financing Activities: Any cash flows that result in changes

in the size and composition of the contributed equity capital
or borrowings of the entity (i.e., bonds, stock, dividends)
 Cash flows From Operating Activities

These include any sources and uses of cash from business

activities. This section reflects how much cash was generated
from the company's products or services. Generally, changes
made in cash, accounts receivable, depreciation, inventory, and
accounts payable are reflected in cash from operations. So,
because not all transactions involve actual cash
items/movement, many items have to be re-evaluated when
calculating cash flows from operations.
 Cash flows From Operating Activities, cont…

These Operating Activities include:

Receipts from sales of goods and services
Interest payments
Income tax payments
Payments made to suppliers of goods and services used in
production
Salary and wage payments to employees
Rent payments
Any other type of operating expenses
 Cash flows From Operating Activities, cont…

Investment Companies
In the case of a trading portfolio or investment companies,
receipts from the sale of loans, debt, or equity instruments
are also included in cash flows from operating activities
(results of primary business).
When preparing a cash flow statement under the indirect
method, depreciation, amortization, deferred tax, gains or
losses associated with a noncurrent asset, and dividends or
revenue received from certain investing activities are also
included. However, purchases or sales of long-term assets are
not included in operating activities.
 Methods of preparing Cash flows

There are two methods of calculating cash flows; the direct

method and the indirect method.
Direct Cash Flow Method
The direct method adds up all the various types of cash
payments and receipts, including cash paid to suppliers, cash
receipts from customers, and cash paid out in salaries. These
figures are calculated by using the beginning and ending
balances of a variety of business accounts and examining the
net decrease or increase in the accounts.
 Methods of preparing Cash flows

Indirect Cash Flow Method

With the indirect method, cash flow from operating activities is
calculated starting from the EBITDA/Profit before Tax, from the income
statement. However, because a company’s income statement is
prepared on an accrual basis, where revenue is recognized when it
is earned and not when it is received, Net income is not an accurate
representation of net cash flow from operating activities, hence the
need to adjust earnings before interest and taxes (EBIT) for items that
affect net income.
So, because not all transactions involve actual cash items, many items
have to be re-evaluated when calculating cash flows from operations.
 Cash flows From Operating Activities, cont…

The indirect method also makes adjustments to add back non-

operating activities that do not affect a company's operating
cash flow. For example, depreciation is not really a cash
expense; it is an amount that is deducted from the total value
of an asset that has previously been accounted for.

NB The only time income from an asset is accounted for in CFS

calculations is when the asset is sold.
 Cash flows From Operating Activities, cont…

Accounts Receivable and Cash Flow

Changes in accounts receivable (AR) on the balance sheet
from one accounting period to the next must also be reflected
in cash flow. If accounts receivables decrease, this implies
that more inflows to the company from customers paying off
their credit accounts—the amount by which AR has decreased
is then added to net sales/ Profit before Tax.

If accounts receivable increases from one accounting period

to the next, the amount of the increase must be deducted
from net sales because, although the amounts represented in
AR are revenue, they are not cash.
 Cash flows From Operating Activities, cont…

Inventory Value and Cash Flow

An increase in inventory, signals cash outflow - the company
has spent more money to purchase more raw materials.
Assuming the inventory was paid in cash cash, the increase in
the value of inventory is deducted from net sales. A decrease
in inventory would be added to net sales.
If inventory was purchased on credit, an increase in accounts
payable would occur on the SoFP, and the amount of the
increase from one year to the other would be added to net
sales.
 Cash From Investing Activities

Investing activities include any sources and uses of cash from

a company's investments. A purchase or sale of an asset,
loans made to vendors or received from customers, or any
payments related to a merger or acquisition is included in this
category. In short, changes in equipment, assets, or
investments relate to cash flows from investing.
 Cash From Financing Activities

Cash from financing activities includes the sources of cash

from investors or banks, as well as the uses of cash paid to
shareholders. Payment of dividends, payments for
stock repurchases, and the repayment of debt principal
(loans) are included in this category.
Changes in cash from financing are "cash in" when capital is
raised, and they're "cash out" when dividends are paid. Thus,
if a company issues a bond to the public, the company
receives cash financing; however, when interest is paid to
bondholders, the company is reducing its cash.
 structure of statement of Cash Flows
Hisense (ltd)

Statement of cash flows for the year ended 31 Dec 20x9 20x9 20x8
Cash flows from operating activities (000) (000)
Profit before tax xxx xxx
Adjustment for:
Depreciation xx
Loss/ (Gain) on sale PPE xx
xx
(Increase)/Decrease in Trade receivable xx
(Increase)/ Decrease in inventory xx
Increase/ (Decrease) in Trade payables xx
Cash generated from operations xxx
Finance cost/ Interest paid (xx)
Income Tax paid (xx)
Net Cash from operating activities xxx
 Hisense (ltd)

Cash flows from investing Activities:

Acquisition of PPE (xx)
Receipt from sale of PPE xx
Net cash flow from Investing Activities xxx

Cash flows from financing activities

Decrease in long term loans (xx)
Proceeds from issue of share xx
Dividends paid (xx)
Net cash flow from financing activities xxx
Net increase in cash and cash Equivalents xxx
Add Cash and cash equivalents at the beginning of the year xx
Cash and cash equivalents at the end of the year xxx
 PRACTICAL EXAMPLE, Dec 2021 main paper, Zindoga (ltd)

How to Use a Cash Flow Statement

The Cash flow statements
helps investors determine whether a company is on
a solid financial footing. From analyzing the Cash
flow statements, Investors can understand:
1. how a company's operations are running,
2. where its money is coming from, and;
3. how that money is being spent.
 How to Use a Cash Flow Statement, cont…

On the other hand, Creditors can use the Cash Flow
Statement to assess the liquidity position of the company,
they can determine how much cash is available for the
company to fund its operating expenses and pay its debts.
 Advantages and Disadvantages of Cash flow statements

Advantages Disadvantages
• Displays liquidity levels/ ability to pay • Fails to present Net Income
debts
• Shows Optimum cash balance, Idle & • Fails to clearly show solvency of firms
excess cash
• Allows cash management plans for • It does not show what SOCI show
recourse allocation

• Helps capital budgeting decisions • Does not conform to Co.s Act.

• Cash basis is more reliable than accrual • Does not assess future cash flows
basis
• Planning & coordination of focusts • Inter industry comparison is not
possible
 Significance of Cash flow statements - Recap

A cash flow statement is a valuable measure of strength, profitability,

and the long-term future outlook for a company. It shows whether a firm
has enough liquidity or cash to pay its expenses.
A company can use a cash flow statement to predict future cash flow to
aid its budgeting processes.
For investors, CFSs reflect a company's financial health. Typically, the
more cash available for business operations, the better. However,
this is not a hard and fast rule. Sometimes, a negative cash flow results
into a company's growth strategy in the form of expansion of operations.
Through studying CFSs, an investor can get a clear picture of how much
cash was generated and expensed, thus gaining a solid understanding of
the financial well being of a company.
 Q&A

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