FAC1601

Financial Accounting
Reporting
 STUDY UNIT 9

STATEMENT OF CASH FLOWS

 STATEMENT OF CASH FLOWS

A statement of cash flows is a financial statement that shows a business

entity’s flow of cash and cash equivalents.

The presentation of a statement of cash flows is dealt with in IAS 7.

The main objective is to disclose how cash and cash equivalents of a

business entity were generated and managed.
 ACCRUAL vs CASH BASIS OF ACCOUNTING

The statement of comprehensive income and statement of financial position is

prepared on the accrual basis of accounting.

In terms of the accrual accounting:

“income, the sale of non-current assets etc., is reported when earned, and expenses,
the purchase of non-current assets etc., when incurred”

In terms of the cash basis of accounting:

“income, the sale of non-current assets etc., is reported when received, and
expenses, the purchase of non-current assets etc., when paid”

The period when earned or incurred is irrelevant

 BUSINESS IS BASED ON THREE GROUPS OF ACTIVITIES

Operating activities - Principal revenue-producing activities,

primarily disclosed in the statement of comprehensive income.

Investing activities - Mainly the acquisition and disposal of non-

current assets, primarily disclosed in the non-current asset sections
of the statements of financial position.

Financing activities - Activities that result in changes of the equity

and borrowings, primarily disclosed in the equity and liabilities
sections of the statements of financial position.
 CASH FLOWS FROM OPERATING ACTIVITIES

Two methods for reporting cash flows from operating activities:

– Direct Method - The direct method for creating a statement of cash

flows reports major classes of gross cash receipts and payments.

– Indirect Method - involves reconciling comprehensive income to a

cash basis. It shows how non-cash flows affect comprehensive
income. The indirect method uses net-income as a starting point,
makes adjustments for all transactions for non-cash items, then adjusts
for all cash-based transactions.

Remember that outflows of cash are always

indicated in brackets, whereas cash inflows are
indicated without brackets.
DIRECT METHOD
 CASH FLOWS FROM OPERATING ACTIVITIES
(DIRECT METHOD)

R
CASH FLOW FROM OPERATING ACTIVITIES
Cash receipts from customers 0000
Cash paid to suppliers and employees (0000)
Cash generated from operations 0000
Interest received 000
Interest paid (000)
Income tax paid (000)
Distribution to members paid (000)
Net cash from operating activities 0000
 CASH FLOWS FROM OPERATING ACTIVITIES
(DIRECT METHOD
METHOD))
1. Determination of cash receipts from customers:

• Where goods are sold for CASH use the REVENUE figure.

• Where goods are sold on CREDIT, the following calculation is necessary:

• Opening receivable balance

• Plus revenue
• Less closing balance receivable
• Example 8.5
 CASH FLOWS FROM OPERATING ACTIVITIES
(DIRECT METHOD
METHOD))
2. Determination of cash paid to suppliers and employees:

Where goods are purchased for CASH, use the PURCHASES amount.
PLUS
All expenses incurred by the entity paid for in CASH

• Opening payable balance

• Add purchases
• Less closing balance payable
• Example 8.5
ITEMS REQUIRING SEPARATE
DISCLOSURE
DIRECT METHOD
 ITEMS REQUIRING SEPARATE DISCLOSURE
(DIRECT & INDIRECT METHOD)

• Dividends received
• Interest received
• Interest paid
• Income tax paid
• Drawings (sole proprietor / partnership)
• Distribution to members paid (cc)
• Proceeds from sale of listed investments
• Acquisition of listed investments
INDIRECT METHOD
 INDIRECT METHOD
CASH FLOWS FROM OPERATING ACTIVITIES

Indirect Method - involves reconciling comprehensive income to a cash

basis. It shows how non-cash flows affect comprehensive income. The
indirect method uses net-income as a starting point, makes adjustments
for all transactions for non-cash items, then adjusts for all cash-based
transactions.

Profit (or loss) before tax

Adjusted for
• any non-cash entries; and

• any items that must be disclosed on the face of the statement of cash flows.

Adjust for working capital

 INDIRECT METHOD
CASH FLOWS FROM OPERATING ACTIVITIES

R
Profit before tax 000
Non-cash items
+/-
Items disclosed after cash generated from/(used) in operations
+/-
=
Changes in current assets and liabilities:
Decrease in current assets +
Increase in current assets -
Decrease in current liabilities -
Increase in current liabilities +
Cash generated from operations =
Items disclosed after cash generated from/(used) in operations
+/-

Net cash flow from operating activities =

 INDIRECT METHOD
CASH FLOWS FROM OPERATING ACTIVITIES

• Profit (or loss)

before tax

• Adjust for :
• Non-cash
items
• Items
separately
disclosed
• Working capital
movement
 INDIRECT METHOD
CASH FLOWS FROM OPERATING ACTIVITIES

• Profit (or loss)

before tax

• Adjust for :
• Non-cash
items
• Items
separately
disclosed
• Working capital
movement
INVESTING ACTIVITIES
 Cash Flows from Investing Activities

This section of the cash flow is based on cash received or paid based on changes in the Non-current assets of an entity

• Discloses money used to purchase assets (resources that will generate future economic benefits)

• Discloses money received from the selling of assets

• Also, the cash used for purchasing of non-current financial assets like investments or fixed deposits

• Cash received for sale/ maturity of non-current financial assets or investment

 OF CASH INFLOW OR OUTFLOW

Calculation of Cash inflows and Outflows

NFLOW O

Ascertain the following:

- was there a change?

- if yes, was it for cash or credit?

Cost is given
- deduct current year and prior years from each other
- difference is due to cash or not, refer to additional information
Carrying amount is given
- deduct the prior year and current year from each other, take into account the depreciation for the current year
- difference cash or not, refer to additional information
Property, plant and equipment (PPE) note is given

- refer to additions and disposal line

- cash or not, refer to additional information

Selling price or Proceeds on sale = Carrying amount + profit (– loss)

Workings to determine proceeds on the CASH sale of
Workings
equipment Proceeds from the maturity of fixed deposit

Balance at 2015 50 000,00

Cost of Equipment 2014 220 500,00
Less balance at 2014 -35 000,00
Cost of Equipment 2015 177 000,00
43 500,00 15 000,00

Accumulated depreciation relating to the asset that was sold

Balance at 2014 49 000,00
Current year depreciaton 19 000,00
Less 2015 - 43 000,00
25 000,00

Carrying value of Equiment

Cost 43 500,00
less accumulted deprecaition - 25 000,00
18 500,00

Proceeds on sale
Carrying value 18 500,00

less Loss on sale - 500,00

18 000,00
INVESTIGATING ACTIVITIES
 CASH FLOWS FROM FINANCING ACTIVITIES

Determination of cash spent or received from changes in Equity

and Long-term borrowings

• Shows the sources of money used to finance the entity’s activities

• Indicates future claims on the entity

• Equity – retained earnings is non-cash

• Shows money repaid on borrowings or capital/membership

contributions
EXAMPLE 23: CASH FLOWS FROM FINANCING ACTIVITIES

The following information is extracted from the accounting records of UnicornCC, at

31 December, the end of the financial year:
2009 2008
R R
Member contributions 300 900 275 900
Mortgage 500 000 -
Long term-borrowings - 207 500
Current portion of long-term borrowings 207 500
Bank (Dr) 265 530 36 500

Additional information:

1. A member of the CC contributed specialised equipment, valued at R25 000, to the

CC. This contribution was regarded as capital contribution and was recorded as
such. All the other additions was were paid for in cash.

Required: Prepare the cash flow from financing activities section.

EXAMPLE 23: CASH FLOWS FROM FINANCING ACTIVITIES

The following information is extracted from the accounting records of UnicornCC, at

31 December, the end of the financial year:
2009 2008
R R
Member contributions 300 900 275 900
Mortgage 500 000 -
Long term-borrowings - 207 500
Current portion of long-term borrowings 207 500
Bank (Dr) 265 530 36 500

Additional information:

1. A member of the CC contributed specialised equipment, valued at R25 000, to the

CC. This contribution was regarded as capital contribution and was recorded as
such. All the other additions was were paid for in cash.

Required: Prepare the cash flow from financing activities section.

CASH FLOWS FROM FINANCING ACTIVITIES R

Proceeds from mortgage R(500 000 – 0) 500 000
Net cash from financing activities 500 000
UNICORN CC
STATEMENT OF CASH FLOWS FOR THE YEAR ENDED 31 DEC 2009

CASH FLOWS FROM OPERATING ACTIVITIES R R

......................................................................................... ......
......................................................................................... ......
Net cash from operating activities 58 530
CASH FLOWS FROM INVESTING ACTIVITIES
......................................................................................... ......
......................................................................................... ......
Net cash from investing activities (329 500)
CASH FLOWS FROM FINANCING ACTIVITIES
......................................................................................... ......
......................................................................................... ......
Net cash from financing activities 500 000
Net increase in cash and cash equivalents 229 030
Cash and cash equivalents at beginning of the year 36 500
Cash and cash equivalents at end of the year 265 530
FAC1601
Financial Accounting
Reporting
 FAC1601
eTUTORS

Dr S Moolman
Mr. L Nkoana
E-mail: fac1601@unisa.ac.za
 STUDY UNIT 9

ANALYSIS AND INTERPRETATION OF

FINANCIAL STATEMENTS
 PRESENTATION CONTENTS

1. THEORY

2. THE ANALYSIS AND

INTERPRETATION OF FINANCIAL
STATEMENTS
 THE PURPOSE OF FINANCIAL STATEMENTS ANALYSIS

• Serves as a tool used to assess the entity’s performance

and financial position in relation to its risk exposure.

- The results of the financial statements analysis can be used to

highlight areas that require attention for further investigation in an
entity

- Ratios are used for the purpose of financial statements analysis

- The following are categories of key ratios used.

a) Profitability ratios
b) Liquidity ratios
c) Solvency ratios
 PROFITABILITY RATIOS

• Measure the success of an entity in generating comprehensive

income.
• The following ratios are used in this regard.
- The return on equity (ROE): measures how profitable the owners’ investment
to the entity is = Profit before tax x100
Total Equity
- The return on assets (ROA): measures how effectively the entity’s assets are
being used in generating comprehensive income
=Profit before interest and tax X100
Total assets.
- The gross profit %: measures gross profit on sales, (before deducting selling
costs) = Gross profit x100
Sales .
- The profit margin: measures the comprehensive income the entity made for
every R and amount generated in revenue = Profit before tax x100
Sales.
- The financial leverage ratio and financial leverage effect: measure the
extent to which the entity benefits from using debt instead of equity in
expanding the business.
- Financial leverage= Return on equity
Return on assets
 PROFITABILITY RATIOS

• Note: financial leverage effect is about the effect of debt on the return on
equity.

• An example: If the entity pays 3% interest on debt and its members receive
5% return, this yields a positive. Therefore, it is worth increasing the level of
debt as long the return on equity remains higher.

• Therefore, the leverage effect is the difference between Return on Equity and
Return on Assets.

- Leverage effect = Return on equity less Return on Assets

 LIQUIDITY RATIOS

Used to measure the ability of an entity to meet its short-term financial

obligations (current liabilities)as they become due with its current
assets. Ratios are.

- Current ratio: measures the extent to which current liabilities are covered by
current assets = Current asset
Current liabilities.
- Asset test ratio: Same as in the current ratio but deduct the inventory from
current assets. = Current assets-inventory
Current liabilities
– Trade receivables collection period: measures time (in days) it takes to
collect accounts receivables = Average trade debtors x 365 days
Credit debtors
– Trade payables settlement period: measures time it takes for an entity to pay
its trade creditors/accounts receivables = Average trade payables x 365 days
credit purchases.
 LIQUIDITY RATIOS

– Inventory turnover rate: measures the number of times the entity has sold
and replenished its inventory over a specific time
= Cost of sales.
Average inventory

– Inventory holding period: measures period it takes the entity to have its
inventory on hand = Average inventory x 365 days
Cost of sales
 SOLVENCY RATIOS

• Measures the entity’s ability to meet its long-term debts and obligations

– Debt-Equity ratio: compares the level of total liabilities in relation to total equity
= Total debt
Total Equity
– Times interest earned ratio: measures the number of times interest payment
is covered by profits = Profit before interest
Interest expense
 SOLVENCY RATIOS

• Measures the entity’s ability to meet its long-term debts and obligations

– Debt-Equity ratio: compares the level of total liabilities in relation to total equity
= Total debt
Total Equity
– Times interest earned ratio: measures the number of times interest payment
is covered by profits = Profit before interest
Interest expense
 SOLVENCY RATIOS

• Measures the entity’s ability to meet its long-term debts and obligations

– Debt-Equity ratio: compares the level of total liabilities in relation to total equity
= Total debt
Total Equity
– Times interest earned ratio: measures the number of times interest payment
is covered by profits = Profit before interest
Interest expense
 SOLVENCY RATIOS

• Measures the entity’s ability to meet its long-term debts and obligations

– Debt-Equity ratio: compares the level of total liabilities in relation to total equity
= Total debt
Total Equity
– Times interest earned ratio: measures the number of times interest payment
is covered by profits = Profit before interest
Interest expense
 THE ANALYSIS OF FINANCIAL STATEMENTS
(PROFITABILITY RATIOS)
USUTHU CC
STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR THE
YEAR ENDED 28 FEBRUARY 20.15
20.15 20.14
R R
Revenue 360,000 307,500
Cost of sales (270,000) (225,000)
Inventory (1 March 20.14) 66,000 58,000
Purchases 273,000 233,000
339,000 291,000
Inventory (28 February 20.15) (69,000) (66,000)
Gross profit 90,000 82,500
Other income 1,000 1,000
Interest income 1,000 1,000
91,000 83,500
Distribution, administrative and other expenses (69,000) (61,000)
Administration expenses 45,000 43,000
Depreciation 9,000 8,000
Remuneration: Accounting officer 15,000 10,000
Finance costs (15,000) (10,000)
Interest on long-term loan (15,000) (10,000)
Profit before tax 7,000 12,500
Income tax expense (2,000) (3,600)
Profit for the year 5,000 8,900
Other comprehensive income for the year - -
Total comprehensive income for the year 5,000 8,900

ROE = Profit before tax X 100

Total equity
ROA = profit before interest & tax X100 = (R7000+R15000) = R22 000 Gross profit %
Total Assets = Gross Profit x 100
Profit margin = Profit before tax X 100 Sales
Sales
 THE ANALYSIS OF FINANCIAL STATEMENTS
(PROFITABILITY) Cont…
USUTHU CC
STATEMENT OF CHANGES IN NET INVESTMENT OF MEMBERS FOR THE YEAR
ENDED 28 FEBRUARY 20.15

Retained
Members' Contributions Earnings Total
R R R
Balances at 1 March 20.14 100,000 19,000 119,000
Members' contributions 23,000 - 23,000
Total comprehensive income for the year 5,000 5,000
123,000 24,000 147,000

USUTHU CC
STATEMENT OF FINANCIAL POSITION AS AT 28 FEBRUARY 20.15
20.15 20.14
R R
ASSETS
Non-current assets 115,000 100,000
Property, plant and equipment 107,000 92,000
Fixed deposit 8,000 8,000

Current assets 137,000 123,000

Inventories 69,000 66,000
Trade receivables 68,000 57,000
Total assets 252,000 223,000

EQUITY AND LIABILITIES

Total equity 147,000 119,000
Members' contributions 123,000 100,000
Retained earnings 24,000 19,000

Total liabilities 105,000 104,000

Non-current liabilities 50,000 50,000
Long-term borrowings 50,000 50,000

Current liabilities 55,000 54,000

Trade payables 41,000 36,000
Bank overdraft 14,000 18,000
Total equity and liabilities 252,000 223,000
 THE ANALYSIS OF FINANCIAL STATEMENTS
(PROFITABILITY) Cont…
USUTHU CC
STATEMENT OF CHANGES IN NET INVESTMENT OF MEMBERS FOR THE YEAR
ENDED 28 FEBRUARY 20.15

Retained
Members' Contributions Earnings Total
R R R
Balances at 1 March 20.14 100,000 19,000 119,000
Members' contributions 23,000 - 23,000
Total comprehensive income for the year 5,000 5,000
123,000 24,000 147,000

USUTHU CC
STATEMENT OF FINANCIAL POSITION AS AT 28 FEBRUARY 20.15
20.15 20.14
R R
ASSETS
Non-current assets 115,000 100,000
Property, plant and equipment 107,000 92,000
Fixed deposit 8,000 8,000

Current assets 137,000 123,000

Inventories 69,000 66,000
Trade receivables 68,000 57,000
Total assets 252,000 223,000

EQUITY AND LIABILITIES

Total equity 147,000 119,000
Members' contributions 123,000 100,000
Retained earnings 24,000 19,000

Total liabilities 105,000 104,000

Non-current liabilities 50,000 50,000
Long-term borrowings 50,000 50,000

Current liabilities 55,000 54,000

Trade payables 41,000 36,000
Bank overdraft 14,000 18,000
Total equity and liabilities 252,000 223,000
 INTERPRETATION OF PROFITALITY RATIOS
20.15 2014

ROE R7 000 X100 R12 500 x100

R147 000 R119 000
4.76% 10.50%
Huge decrease in ROE from 20.14 to 20.15

ROA R22 000 x100 R22 500 x100

R252 000 R223 000
8.75% 10.09%
Slight decrease in ROA from 20.14 to 20.15

Gross profit % R90 000 x100 R82 500 x100

R360 000 R307 500
25% 26.83%
Decrease in Gross profit %. Which affected the overall profitability of the entity
 INTERPRETATION OF PROFITABILITY RATIOS Cont…
20.15 2014

Net Profit margin R7 000 x100 R12 500 x100

R360 000 R307 500
1.94% 4.07%
Decrease in net profit margin

Financial leverage = ROE 4.76% 10.50%

ROA 8.73% 10.09%
0.55 1.04
There is a decline in financial leverage

Leverage effect = ROE 4.76% 10.50%

Less ROA (8.73%) (10.09%)
(3.97) 0.41%
 FINANCIAL ANALYSIS

LIQUIDITY RATIOS
• Current Ratio

• Acid Test Ratio

• Trade Receivables Collection Period

• Trade Payables Settlement Period

• Inventory Turnover Rate

• Inventory Holding Period

 FINANCIAL ANALYSIS
FINANCIAL INFORMATIONAND INTERPRETATION OF FINANCIAL STATEMENTS
 FINANCIAL ANALYSIS

CURRENT RATIO
• ANALYSIS AND INTERPRETATION OF FINANCIAL STATEMENTS
2021 2020
Current Assets R221 000 R171 000
= :
Current liabilities R111 000 R101 000

= 1,99 : 1 : 1,69 : 1

COMMENT:
The company’s current ratio increased by 17,75% over the year, which is an
ideal result for the company. This means that each R1 of the current liabilities
is covered by R1,99 of current assets or a margin of 99%.
 FINANCIAL ANALYSIS

ACID TEST RATIO

• ANALYSIS AND INTERPRETATION OF FINANCIAL STATEMENTS
2021 2020
Current Assets less Inventory R(221 000 – R100 000) R(171 000 – R80 000)
= :
Current liabilities R111 000 R101 000

= 1,09 : 1 : 0,9 : 1

COMMENT:
The company’s acid test ratio improved by more than 100% which is a good coverage
of current liabilities. It means that each R1 of current liabilities is covered by R1,09 of
“quick” assets. This also indicates that the cash flow position of the company is
favourable.
 FINANCIAL ANALYSIS

TRADE RECEIVABLES COLLECTION PERIODANALYSIS AND INTERPRETATION

OF FINANCIAL STATEMENTS
2021 2020
Average trade receivables R77 200 R66 000
X 365 X 365 X 365
Credit Sales R400 000 R360 000

= 69 days = 66 days

(R88 000 + R66 400)/2 = R77 000

COMMENT:
The company’s credit control weakened as debtors’ amounts were outstanding for a
longer period in 2021 that in 2020. The company decreased its collection period by
4,92% which was accompanied by a 11,11% increase in sales. This means that the
company extended credit terms to boost sales.
 FINANCIAL ANALYSIS

TRADE PAYABLE SETTLEMENT PERIODANALYSIS AND INTERPRETATION OF

FINANCIAL STATEMENTS
2021 2020
Average trade payables R104 500 X 365 R99 000
X 365 X 365
Credit purchases R320 000 R290 000

= 117 days = 124 days

(R110 000 + R99 000)/2 = R104 500

COMMENT:
The company paid its creditors sooner in 2021 than in 2020. When compared with
trade receivables collection period, the trade payables settlement period is still
favourable to the company’s cash flow. The company will receive payments from its
debtors sooner that it would be required to settle it creditors accounts.
 FINANCIAL ANALYSIS

INVENTORY TURNOVER RATEANALYSIS AND INTERPRETATION OF

FINANCIAL STATEMENTS
 FINANCIAL ANALYSIS
INVENTORY TURNOVER RATEANALYSIS AND INTERPRETATION OF
FINANCIAL STATEMENTS
 FINANCIAL ANALYSIS

SOLVENCY RATIOS

• Debt-to-Equity Ratio

• Times Interest Earned Ratio

 FINANCIAL ANALYSIS
DEBT-TO-EQUITY RATIOAND INTERPRETATION OF FINANCIAL STATEMENTS
 FINANCIAL ANALYSIS
DEBT-EQUITY RATIOANALYSIS AND INTERPRETATION OF FINANCIAL
STATEMENTS

the company
 FINANCIAL ANALYSIS
TIME INTEREST EARNED RATIOANALYSIS AND INTERPRETATION OF
FINANCIAL STATEMENTS