PREPARATION OF CASH FLOW STATEMENTS (IAS 7)

Contents of the topic

i). To explain the purpose and objectives of IAS 7

ii). Clear difference between CASH FLOW statements, funds flow statement, cash budget.

A). cash flow statement.

Is actual it tells you how the condition is moved from day one to the end of the year.

B). funds flow statement

This is about movement of working K

C). cash budget

This is a plan.

iii) Methods used to prepare Cash flow statements

– Direct

- Indirect

iv) To cover and explain the various components that makeup a cash flow statement, as per IAS
7. It requires cash flow statements under 3 headings

 Operating activities
 Investing activities
 Financial activities

v) Construction of a cash flow

Cash flow statement

Definition

Cash flow statement is a statement that indicates the movement of cash from opening balance to
the closing balance.

The cash flow statement has two main objectives and one minor objective

Main objectives

 To indicate how cash was received both the source and amount.
 How cash was spent both the destination and the amount.

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 Minor objective
 To determine or explain the increase or decrease of the cash flow statements.

Definition: cash

IAS 7 defines cash as cash in hand and bank balances which are payable on demand. Cash also
includes cash equivalents.

A cash equivalent is a short term and lightly liquid investment.

 The maturity of a cash equivalent should not exceed 3 months.

 It should in reality be convertible into cash on maturity.

Preparation of cash flow statements

Basically cash flow statements indicate where the cash funds come from and where they have
gone too.

Cash funds come from commonly the following.

Sources;

i). profits

ii). Sell of fixed assets

iii). Decrease in debtors

iv). Decrease in stock so / any as the stock is not stolen.

v). Capital introduced

vi). loans received

vii). Increases in payables

Cash commonly goes to the following.

Destinations;

i). Losses

ii). Purchase of fixed assets

iii). Increase in stock

iv). Increase in debtors

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 v). drawings or payment of dividends.

vi). Decrease in creditors

Methods of presenting cash flow from operating activities.

IAS 7 permits either the direct or indirect method of presentation to be used.

A). Direct method

This method reports cash flow and out flows starting with major categories of gross cash receipts
and payments.

Cash flows such as receipts from customers and payments to supplies are stated separately with
in the operating activities. This method provides more information about the sources and
methods of presenting cash flow statements.

B). Indirect method

This method starts with profit before tax and is adjusted for non cash items such as changes in
current assets and depreciation. It highlights the differences between operating profit and net
cash flow from operating activities.

Headings under which cash flow statement is prepared

1. Operating activities.

These are generally the cash efforts of transactions and often meet relating to operating and
trading activities that the organization changes in the net cash flow on operating activities
represent the net increase or decrease of cash and cash equivalent resulting from operations
indicated in income statement when calculating profits.

2. Investing activities.

This includes cash flows in disposal or acquisition of any asset which are fixed or current asset.
Under this heading, we find cash flows relating to purchase of fixed assets, disposal of assets or
sale of investments in subsidiary companies, purchase and sell of growth bonds etc.

3. Financing activities.

They refer to receipts and repayment of principal amounts to external providers of finance.
Under this heading the following are included also; sell of shares, sell of debentures, redemption
of preference shares and debentures, receiving loans from financial institutions, loan repayment
etc.

NB

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When constructing a cash flow statement, a bracket figure decreases the cash flows and a
non-bracket figure increases the cash flows.

Illustration of the direct method

The following summary transactions trial occurred during 2005 for Ken ltd.

Cash received from:

Customers 660,000

Interest on note receivable 12,000

Sale of investment 20,000

Proceeds from note receivable 100,000

Sale of equipment 40,000

Issue of common shares 200,000

Cash paid for:

Purchase of investment 100,000

Interest note payable 18,000

Purchase of equipment 120,000

Operating expenses 440,000

Payment of note payable 150,000

Payment of dividends

(to share holders) 30,000

Additional information:

The balance of cash and cash equivalent is 130,000 at the beginning of 2005 and 304,000 at the
end of 2005.

Required

Prepare a statement of cash flow statement for Ken ltd for the period 2005 using the Direct
method for reporting operating activities.

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KEN LTD
Cash flow statement
For period ended 31-12-2005
Cash flows from operating activities

Collection from customers 660,000

Interest on note payable 6,000

Payment of operating expenses 440,000

Net cash increase from operating activities 214,000

Investing activities

Purchase of investments 100,000

Sale of investment 20,000

Purchase of equipment 120,000

Sale of equipment 40,000

Net cash decrease from investing activities (160,000)

Financing activities

Proceeds from note receivable 100,000

Payment of note payable 150,000

Issue of common share 200,000

Payments of Dividends 30,000

Net cash increase from finance Activities 120,000

Net increase in cash 174,000

Also:

Opening Balance of cash and cash equivalent 130,000

Closing Balance of cash and cash equivalent 304,000

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Indirect Balance
The balance sheet of Ken Ltd for two years where as follows:
Ken Ltd
Balance Sheet
31st/12/2004 31st/12/2005
Fixed Assets:
Equipments at debt 28,500 26,100
Less: Depreciation on Equity (11,450) (13,010)
Current Assets:
Stock 18,570 16,250
Debtors 8,470 14,190
Provision for bad Debts (420) 8,050 (800) 13,390
Cash for bank 4,060 3,700
Balances 30,680 33,340
Less: Current Liabilities
Creditors 4,140 5,730
Loan 26,540 27,610
Net Assets 30,680 33,340
Financed by
Capital 35,760 33,590
Profits 10,240 11,070
46,000 44,660
Cash Introduced ___ 600
46,000 45,260
Less:
Drawings (12,410) (8,560)
33,590 36,700
Loan a/c 10,000 4,000

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 43,590 40,700
Additional Information

 Equipment with B/K value of 1,350 was sold for 900

 Depreciation written off against equipment during the year was 2,610

Required

Prepare a C/F statement for the year ended 31st/12/2005

Steps

Determine the Net C/F from opening Activities. This is Net cash flow from ordinary operations
of trade. This is done by reconciling the Net profit to the Net C/F
KEN LTD
CASH FLOWS FOR PERIOD ENED 31st/12/2005
Cash inflows from operating Activities
Net profit 11,070
Depreciation 2,610
Loss on sale of equipment 450
Increase in provision for Bad debts 380
Movements in CAs and CLs
Decrease in Stock 2,320
Increase in Debtors (5,720)
Increase in creditors 1,590 1,630
Net C/F’s from Operation Activities 12,700

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Ken Ltd
Cash Flows for Period Ended 31st/12/2005
Net cash flow operating Activities (Note) 12,700
Cash flow from investing Activities
Sale of equipments 900
Net cash flow before financing Activities 13,600
Cash Flow Financing Activities
Cash introduced 600
Drawing (8,560)
Loan A/C (6,000) (13,960)
Net decrease in Cash (360)
Add:
Opening cash Balance 4,060
Closing Cash Balance 3,700
Reconciliation of Opening and closing Cash Balances
Opening Cash Balance 4060
Less: Decrease in Cash (360)
Closing Cash Balance 3700

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Question

The Balance sheet statement of Okello for 2 years were as follows

2005 2006

Fixed Assets:

Increases at cost 25,000 28,800

Current Assets:

Stock 12,500 12,850

Debtors 21,650 32,140

Cash and Cash Equipments 4,300 5,620

Less: C.L’s

Creditors 11,350 11,120

Net cash/ working 27,100 30,490

Total Net Assets 52,100 59,290

Financed by:

Capital 52,660 52,100

Net profit 16,550 25,440

69,210 77,540

Less: Drawings (17,110) (18,250)

52,100 59,290

Required

Prepare a cash flow statement for Okello for the year ended 31st /Dec /2006.

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Note 1

Okello

Cash flow statement for period ended 31 Dec 2006

Cash flows from operating Activities:

Net profit 25,440

Measurement in C.A and CL

Increase in stock (350)

Increase in debtors (1490)

Decrease in creditors (230) (2,070)

Net cash flows from operating activities 23,370

Okello

Cash flows for period ended 31/12/2006

Net cash flows from operating activities (note 1) 23,370

Cash flows from investing activities

Purchase of premises (3,800)

Net cash flows before financing activities 19,570

Financing activities

Drawings (18,250)

Net increase in cash and equivalent 1,320

Reconciliation of Opening and Closing Balances

Opening Balance 4,300

Add; increase in cash 1,320

Closing Balance 5,620

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Uses of Cash flow statements.
 The Cash Flow statements informs the enterprise clearly where the cash funds came
from and where they went
 The Cash Flows explains how well or badly the Cash Funds where managed
 It explains whether there is sufficient profits being released to finance the biz
 Cash Flows help the biz to determine whether they have sufficient Cash Funds as and when
they are needed. This helps in liquidating management of the biz.
 It helps in managing lending and borrowing (Debtors and Creditors)
 It also facilitates debiting management.
In summary, IAS 7, defines more briefly the format of individual items with in the Cash Flow
statement. This heads to uniformity and greater comparability between Co’s
However there is still some criticism of the current IAS 7;
 They are options with in IAS 7 for presentation since either the direct or indirect
method can be used.
 The definition of cash and cash equivalency can cause problem. In that companies may
interpret which investments are cash equivalent differently heading to a lack of
comparability. Cash flows could be improved by removing cash equivalents and
concentrate on the movement of cash.

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