Pall Accounting Semon of Cosh Flow 5.1 Introduction Under intemmational sccounting standards the requirement to produce a statement of cash flow was not introduced until 1992 when IAS 7 Statement of Cash Flow was published. Prior to the 1990s in Ireland, the UK and internationally the main elements of the financial statements were the ‘Statement of Comprehensive Income and the Statement of Financial Postion, Investors and the users of financial statements had an in-built assumption that, if a company was proftable then it would automatically have enough cash to discharge it's abilities as they fll duo. In the late 1980s this assumption was proven incorrect with the falure of several high profile companies, Thesa companies were inberenty profitable, but felled due to cash flow problems. It was realised that more companies go ‘out of business by running out of cash rather than being unprofitable, IAS 7 Statement of Cash Flow addresses this concern by requiring companies (with limited exceptions) to prepare a statement of cash flow annually and include it Wwithia the financial statements, The statement of cash flow is to be given equal prominence to the Statement of Comprehensive Income and the ‘Statement of Financial Position and is considered of equal importance as a primary statement tothe users of fnancial statements 5.2 Importance of Cash to a Business Entity With the exception of @ selection of organisations (eg, non profit E organisations) most business entities are set up with the prime focus of k ‘making a prof In the long term a business entity must make @ profit in order k {0 continue in operation. However in the short term businesses can survive ‘making a loss for a several years. This is especially tue of ausinesses when they are frst set up. Most businesses wil make a loss in the frst few yoars of trading until the business name has been established. Establshed businesses ‘can also go through periods where they make a loss, e.g. in an economic recession. Thus @ loss making business can survive in the short term, however the situation wil need to be tuned around if the business is to ‘emain viable in the medium to long term. Businesses can not continue to sete 161 eeStrano of Cah Flow Phone decnangy ‘make losses indefinitely ‘The siuation with respect o cash i vary ferent. Cash i often retereg toas | “he ite blood &f a business", Businesses require cash on « dally basis 1g Gscherge expenses and continue in operation, Hf business wins shoe of Gash Shor lem measures can be taken, 9. payment to supplirs eon tn Gotves, However supprs are unitely to canine to supply goods Companies who are ot paying ther is fr longer than a priod ofa fn montis. Further, employees wil not continue to wark fora business that ens of cash is much shorter than for a company making losses. This is Particularly ‘rue as the main sources of hance (cash), shareholders and banks, may not being wiingable to advance further cash in ime to seve the business Raising fonds through investors can take time, ime the company may not have. Furher, investors may be reluctant to pump more money into a falling company because of the high level of risk, Bank loanloverdraftrepaymenis ae made out of cash, Thus banks may ba reluctant land toa compen that 's experioncing cash flow probiems. ash, cash flow. the sources of cash and the user of cash within @ business are Metefore of paramunt importance f0 all businesses and increasingly businesses are becoming more and more aware of the need to properly ‘manage their cash flow. From an accounting perspective, each wos acionaly Vewed 25 not belng as important as prott and very few Fusnesses prior tothe 1990s prepared statements of cash fow in any form IAS 7 however introduced the requirement that al companies (with some Iminor exceptions) @ aquired to produce a statement of cash flow and Incorporate within the financial statements in an attempt to.addiress tne situationoot wae cAnuo ojqnop 2uy 81 yey Bulpina # eseyaund o exo Auedwod & code ‘ewoou) ansuayascwog Jo WEWAEIS OWN Ul pepnioU 10u axe Aout “01 ‘awoou) onysusyesdlU09 Jo 1EUIEIS eM Ut PasUBooe! 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PUE YSeO Jo yUNOWE UMOL 1 0} ojqquenuco Aypeat exe yey) USUASENLY piMby AYBY WSLHOUS « “sysodep puewep pue puey uo yseD ‘Se squojenynba yseo PUe YSED SeLUEp “MOY YEO Jo SMOWIES J SY J sviued se yseojo suonmuyea 6's sot 499 fo noms i Senmossy poneGe srement of 2 lo Final Accnig IT ‘The company would: ‘+ Debit buildings in the Statement of Financial Position ‘+ Credit bank jn the Statement of Financial Postion ‘the wansection does not affect the Statement of Comprehensive Income, “Therefore 25 capital items of expenditure are not included in the Statement of CCompretensive Income they have no impact on the proft or loss figure that a company reports. However, i a company purchaset a building for €100,000 it ‘yi nave @ negative Impact on cash, as cash will leave the business to pay for the buléing. “The treatment of capital items is therefore one reascn wy proft and cash are diferent. Tis is due to the fact that purchaselsale of capital items effect cash put do nol affect prof 5.42 Non Cash toms ‘The Statement of Comprehensive Income will usually contain transactions which have no cash affect. These items are sometimes referred to as non cash items. What is meant by this Is that even thcugh the expense item Is recognised 88 an expense in the Statement of Comprehensive Income and reduces profits accordingly, no cash actually leaves the business. There are ‘many examples of such expense items. The most comman one is deprecation. ‘he éscussed above, when a non current asset is purchased there is @ cash impact bu 00 affect on the Statement of Comprehensive Income. In each financial year depreciation is charged on the non current asset in order to ‘assign the cost of the asset to profit over its useful economic fife, The «Debit depreciation in the Statement of Comprenensive Income, + Credit accumulated depreciation in the Statement of Financial Position{o00'0s) (o00'0s) ypayo (eI, ort oxoz (o00'01) bxoz (o00'01) - oxoz (o00'01) - x02, (o00'01) {000'0s) exoz > > yog Wo 190N3, seg uo 390H3, uognies: ‘owes aig 8 seo PUB Yo1d yjOg UO ay eAOA0 oun AOREWTIN nq seoueseyp Suuuy o} onp sie siaays waIEYP eu Moy ereAsnI) AqaL0W pue Jeaf yoee uy uopoesueN a\y Jo YseO HUE WK UO yaYe Uy eIENSNI 10} paxindes 838 no, ‘Quy ies wnuue sod %02 18 Y98 SeMyonA ela UO YoNE!Da:COG '8XOZ J2aK ye‘UEUY UI qoO'DSS 401 YON e pasewINd pom OBY folduexe payuom e aouaiayip Bunun ay Jo uoRDeH09 “aus ou aq jou pinom faut 220K evo Aue uy poveduion alam yseo puE yoWd 4! 12\y S| Wod ywELOdLI| eL 22n9Mo}t js 1991400 Kvenquans ja YeLR 2oUB.OWP Gulu 81 YoNdsO2 SIN UE \yseo pue youd usanten couszeyip aug eUs Be; 511 "2wWES Jo uOHe;saidep OLN ue jesse queue uou e Jo eseyound ou) ‘enoge SaICLWEKD My ey} BUILIQWWOD uaJeyp aie yseo pue Wold "Yse tuo yoeye ov easy ya Ing swosd aseo199p jm aBiEyO UOTeKa:dep jeNLUe ‘yy suojovoys, “spuey seBueyD YseD OU Inq ‘aBLeYo voHeReldep enue ‘yy Jo qunowe ey Kq paonpas s} suloou; ansusyelduiog Jo waweREIS eu 0d se euny youd 04g esse yusiun9 UoU e seyeweidep AuedulcO € JeeK YOeS oy 9 J omg In Sonmesoy ovensSeat of Cash Flow Finacial counting 5.4.3 The Application of the Accruals Concept |AS 1 states that with the exception ofthe statement of cash flow the financial Statements are to be prepared using the accruals concept. The accruals ‘concept therefore is fundamental to the preparation of the Statement of Comprehensive Income and the Statement of Financial Position. To recap, the accruals concept states that, the non-cash effecs of tansoctions relating to @ certain accounting period must be recorded in tat period's Statement of ‘Comprehensive income and the Statement of Finandlal Postion regartless of when the cash was actually paid or recelved. The application of the accrual ‘concept leads to a timing difference between when the profifloss from an ‘activity is recorded and when the cash is receivedlpeid from the activity. Effect of accruals on profit and cash—a worked example, ‘ABC Limited with a year end of 31 December 20X9 enters into an agreement {to pay rent bimonthly in arrears on 1 January 20X9, The rent due dates fall as follows: rent for January and February 20X9 is due on 1 March 20XS etc, The annual rent charge 's €120,000.tustrate the affect en profit and cash of the transaction, Solution Under accrual the charge for rent in the Statement of Comprehensive Income isthe rent liabilty for the financial year regardless of whether it has actually been paid at the year end, From a cash perspective only ten months rent was paid as at 31 December 20X9 and therefore as illustrated before the effect on profit and the effect on cash are different. Effect on Cash Effect on Profit, € € Financial year 20x9 (100,000) (120,000) 166 seis