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Cash Flow Statement Print E-mail

The cash flow statement tells us how much cash the business has gained or lost in the year and why. The format of the cash flow statement is defined in IAS 7.  

Cash flows are separated from accounting flows in the statement, to determine the true 'cash profit or loss' of the business. The cash flows contributing to the movement in cash balances are divided into operating, financing and investing activities in the cash flow statement.

To prepare the cash flow statement, begin with net accounting profit before tax. Deduct all non cash items (such as depreciation) from the net accounting profit before tax. Add the inflow/outflow of working capital (stock/accounts payable/accounts receivable).

The sum of operating, financing and investing inflows and outflows should equal the net movement in cash which represents net cash profit.

Each line item in the cash flow statement should reconcile to other movements in the primary financial statements. For example, additions to fixed assets should be the cash amount paid for new assets and unless assets have been purchased on credit, the reconciliation as follows should tie back to balance sheet and P&L movements:

opening assets  (bs) + additions (notes & cfs) - disposals (notes & cfs) - depreciation - impairment (p&l) = closing assets

Now look at the balance sheet and calculate the difference between last year and this year's closing balances.

Decide if there has been a cash outflow or a cash inflow for each difference between opening and closing assets and liabilities. Outflows are increases in assets and decreases in liabilities. Inflows are decreases in assets (fixed assets, stock and debtors) and increases in liabilities (long term loans). Remember, you have already deducted depreciation from your net profit, so you need to exclude it from your increases or decreases in fixed assets to get to the cash element of the increase or decrease. Allocate each inflow or outflow to the line items in the example cashflow at the end of IAS 7. 

The statement reconciles net accounting profit to net cash and cash equivalents. Calculate last year's cashbook balances (bank balance plus petty cash and savings), add all the inflows including cash profit and deduct all the outflows including cash losses, the total should give you this year's cashbook balances. Operating profit, interest flows, tax flows and depreciation should equal the movement between the current years' opening and closing profit and loss reserve in the balance sheet. 

This is useful information to ensure you have enough cash coming into your business to pay all the money owed by your business on time. Profits don't always turn into cash, as we have all experienced bad debt in business. By making sure you can pay the money you owe, you'll avoid the main reason for business failure, cash shortages. You can also plan to take on additional finance you may need to top up your cash, but make sure your business is generating enough to make the repayments.

Foreign exchange difference arise when cash or other balances are held in foreign currencies.  Loans and cash balances (and perhaps foreign investments) held in foreign currencies different from the reporting currency are revalued at the average rate for the year to estimate the transaction rate.  These exchange differences need to be stripped out from cash flows and shown separately in a single line in the cash flow statement to clearly identify 'pure' cash flows from unrealised foreign exchange gains or losses.

Realised foreign exchange gains or losses occur when transactions are invoiced at one rate and settled at another rate. These types of gains or losses represent 'pure' cash flows.  

Cash flows identified in this way are also useful for producing forecasts and business plans, or net present value calculations.  When producing a business plan for an investor or a bank, the profit or loss presented should be the cash equivalent, and not accounting profits or losses.  Cash flows are useful for planning working capital requirements, by calculating the cash conversion cycle between outlay for inventory and inventory holding periods, payments to creditors and receipts from debtors. If there is not enough liquid cash available to cover the time lag between these three events, the business could suffer from cash shortages leading to default payments or inability to restock or meet demand. Overtrading could badly damage profits.  

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