Lecture 12

Cash-Flow Statement / Notes

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Contents

Cash-Flow Statement
Notes
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The big Picture

The cash-flow statement is one of the four basic elements

of financial statements:
Statement of Income
Statement of Financial Position
Statement of Cash-Flow
Statement of Changes in Equity
7. Cash-Flow Statements
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7.1. Overview

A cash-flow statement delivers information about the

ability of a company (or a group) to generate cash flows.
It also delivers information about movements of cash
regarding
the origin of cash,
the usage of cash,
the amount of cash raised and
The amount of cash used
The cash-flow statement is mandatory and one of the four
basic statements of a financial report.
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7.2. Theory of Cash-Flow Statements

A cash-flow statement is just a reconciliation.

It analyses the movement of the balance of the bank
accounts between the beginning and the end of a fiscal
year.
It considers only cash transactions and not accounting
transactions (so transactions that do not belong to any
underlying cash movements).
Example: Depreciation of fixed assets.
Cash movements are classified into defined categories.
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7.2.1. Accounting Environment

To prepare cash-flow statements, detailed information are

required that exceed balances of accounts.
To example cash flows to suppliers and from customers:
These information have to be taken from the sub ledger
accounts.
Customer Account Supplier Account
Dr Cr Dr Cr

Beginning Balance Cash from customer Cash to supplier Beginning Balance

Invoice to customer Ending balance Ending balance Invoice from supplier

In other words: information of the underlying business

transaction are required.
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7.2.2. Legal Background

Cash flow statements are required by almost all

accounting standards:
IFRS: A mandatory statement
US-GAAP: A mandatory statement
German-GAAP: Mandatory for large companys and
groups only. Small and mediumsized companies are
exempt in preparing cash-flow statements
UK-GAAP: Mandatory but different format (more
categories). Small companies are exempt in preparing
cash-flow statements
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7.3. Presentation
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7.3.1. Overview

The cash-flow statement is divided into three categories:

Operating activities
Investing activities
Financing activities
All business transactions have to be allocated to one of
these categories.
Some business transactions need to be allocated to more
than one category. In this case, the business transaction
needs to be break down into allocatable elements.
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7.3.2. Operating Activities

Cash flows from operating activities measure the cash

performance of the current period.
It is an indicator on how a corporation is able to achieve
cash flows out of their business model.
The category covers all business related transactions that
result in either recording P&L items or current balance
sheet items.
Elements:
Inflows from sales of goods, rendering services and
other earnings.
Outflows to staff and suppliers.
Changes in working capital (inventory, AR, debt, AP)
Tax payments.
In- and outflows of securities trading.
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7.3.3. Investing Activities

Cash flows from investing activities measure the ability of

a corporation to perform in future periods.
It is an indicator about the investment into the future.
Elements:
Outflows from the purchase of immaterial and fixed
assets.
Outflows from the acquisition of investments in other
companies.
Inflows from the sales of fixed assets.
In- and outflows from financial instruments.
In- and outflows from loans granted.
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7.3.4. Financing Activities

Cash flows from financing activities measure the (future)

level of debts and other forms of liabilities.
It is an indicator about the ability to raise external cash.
Elements:
Outflows from dividend payments.
In- and outflows from loans and borrowings.
In- and outflows from the issuing of bonds and other
equity- / financial instruments.
Outflows from leasing obligations.
Outflows from the repayment of debt.
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Exercise

Allocate the following transactions to the correct category.

Transaction Category
Payment of AP
Receipt of an invoice
Purchase of inventory
Payment of license fees
Purchase of a computer
Payment of a dividend
Lease of a server
Capitalization of software
Rental of office space
Preliminary usage of a bank overdraft
Reimbursement of taxes from the tax office
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7.3.5. Special items

The presentation of interests depend on the nature of the

underlying transaction.
If loans and borrowings relate to the financing of the
business, interests are presented as operating.
If loans and borrowings relate to investments outside the
ordinary business, interests are presented as investing.
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Presentation Rules (1)

A netting of inflows and outflows is prohibited unless there

are defined rules to do so.
Exceptions:
Transactions with a large customer
Transactions with high turnover rates und short cycles
Foreign currency transactions have to be presented using
the exchange rate at the day of payment.
Extraordinary items have to be presented separately.
Interests have do be divided into received and paid
interests.
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Presentation Rules (2)

Dividends have to be divided into received and paid

dividends.
Taxes have to be divided into received and paid taxes.
Acquisitions and divestments of subsidiaries are part of
investing activities.
Non-cash transactions have to be eliminated.
Restricted (blocked) cash have to be shown separately.
7.4. Reporting Format
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7.4.1. Direct Method

The direct method is the preferred reporting format as it

provides the best information about cash flows.
But: the current practice is a rare use of this reporting
method because the required information to prepare a direct
method cash flow statement can not be delivered by todays
IT systems.
The method is based on absolute, cash-based transactions.
Identical transactions are pooled and reported as one
element.
The balance sheet and the P&L are reported together. No
differentiation.
Du to the system, non-cash transactions are excluded.
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Direct Method - Format

Cash flow from operating activities

Receipt 1 20 Discrete transactions
Receipt 2 65
Receipt n 58
Disbursement 1 -23
Disbursement 2 -12
Disbursement n -5
Sum 103 Sum of balance sheet
Cash flow from investing activities
Receipt 1 4
and P&L transactions
Receipt 2 1
Receipt n 0
Disbursement 1 -7
Disbursement 2 -13
Disbursement n -3
Sum -18

Cash flow from financing activities

Receipt 1 5
Receipt 2 3
Receipt n 7
Disbursement 1 -2
Disbursement 2 -3
Disbursement n -5
Sum 5

Net increase in cash and cash equivalents 90

Cash at the beginning of the period 10

Cash at the end of the period 100
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7.4.2. Indirect Method

Alternative form.
This form has the highest acceptance in practice.
The method uses a different procedure to present cash
flows.
It starts with the profit of the period and eliminates all non-
cash transactions to get an adjusted profit.
The adjusted profit of the period together with all balance
sheet movements are sorted in the three categories.
No differentiation between receipts and disbursements, we
stick to balance sheet movements only!
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Indirect Method Format

Profit 80
Taken from the
Adjustments
P&L Statement
Depreciation 10
Interests 5 Non-cash Adjustments
Foreign exchange effects 0
others 5
Sum 20

Cash flow from operating activities Reclassification

Changes in item 1 20
Changes in item 2 -15
Changes in item n -2
Sum 103
CF from operating activities:
Cash flow from investing activities
Changes in item 1 -20 80 + 20 + 3 = 103
Changes in item 2 5
Changes in item n -3 The result is identical to the
Sum -18
direct method!
Cash flow from financing activities
Changes in item 1 15
Changes in item 2 -5
Changes in item n -5
Sum 5

Net increase in cash and cash equivalents 90

Cash at the beginning of the period 10

Cash at the end of the period 100
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Example
Consolidated Statement of Cash Flows
xxx GmbH
in EUR
Note # 2009 2008/09

Profit of the Period after Taxes 3.704.451 4.719.352

Depreciation / Write-Up's of Fixed Assets 932.750 3.196.678

Interest Expenses & Earnings 133.029 656.776
Tax Expenses 503.447 1.473.038
Other non-cash related Expenses and Earnings -594.274 -1.276.299

Cash-Earnings 4.679.403 8.769.544

Inflows / Outflows of the sales of fixed assets 31.692 966.218

Increases / Decreases of inventory, accounts receivable and other assets -859.367 115.421
Increases / Decreases due to extraordinary items -2.091.509 -2.932.756
Inflows of interests received 3.270 66.824
Outflows of interests paid -131.710 -723.600
Outflows of taxes paid -137.944 -854.936

Net Cash from Operating Activities 1.493.836 5.406.716

Outflows of the purchase of immaterial and fixed assets -478.497 -1.478.057

Outflow of the acquisition of subsidiaries -1.167

Net Cash from Investing Activities -478.497 -1.479.224

Outflow of the payment of dividends to shareholders -2.500.000

Inflows of the issueing of bonds and the borrowing of loans 2.500.000
Outflow of the repayment of loans -797.956 -2.222.328

Net Cash from Financing Activities 1.702.044 -4.722.328

Effects of exchange rate changes on cash and cash equivalents

Net increase in Cash and Cash Equivalents 2.717.383 -794.836

Cash and Cash Equivalents at the Beginning of the Period 1.881.591 2.676.427

Cash and Cash Equivalents at the End of the Period 4.598.974 1.881.591
7.5. Cash Funds
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Cash Funds

Cash funds are defined as cash and cash equivalents.

This includes:
Petty cash
Cash at banks
Short-term investments, maturity period < 90 days
Investments in monetary market instruments.
Long-term investments are not part of cash funds.
Presented as investing activities!
7.6. Cash Flow Preparation

This section is based on the indirect format!

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7.6.1. Non-cash Transactions

Non-cash transactions are those transactions where just

accounting entries are booked.
Typical examples are:
Depreciation
Foreign currency effects
Fair value changes of financial instruments
The elimination of non-cash transaction is done in a way
that the P&L effects are added / deducted to the profit of
the period:
Non-cash expenses recorded are added
Non-cash revenues recorded are deducted
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Example Rules for non-cash transactions under

IFRS
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Capital Expenditures

Immaterial and fixed assets require specific attention:

Investments (capital expenditures) have a cash outflow
at the date of purchase
Depreciation is a non-cash transaction in subsequent
periods.
To obtain information about capital expenditures, the
following steps are required:
Calculate the differences between the NBV of previous
and current year.
Adjust the difference by depreciation expenses.
Adjust the difference by the sale of fixed assets.
The BASE formula will help!
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Repetition: BASE formula

Memorize the following method!

Account
Beginning Usage
Balance (Substract)
Ending
Additions
Balance

B Beginning Balance
A + Additions
S ./. Subtractions
E = Ending Balance
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7.6.2. Balance Sheet Movements

In addition to the adjusted P&L, all movements of the

balance sheet need to be considered.
The movements can be calculated based on account level.
All movements have to be grouped into increases and
decreases:
Assets Liabilities
Increase

Outflow Inflow
Decrease

Inflow Outflow
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Example
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Exercise

Decide whether the following transactions result in an

inflow or outflow of cash.
Transaction In / Out
A customer pays his invoice
An invoice of a supplier is paid
Purchase of a computer on account
Set-up of an accrual for non-taken holidays
Payment of a dividend to shareholders
Lease of a server
Capitalization of software
Rental of office space
Preliminary usage of a bank overdraft
Reimbursement of taxes from the tax office
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7.6.3. Category Allocation / Reclassification

All movements (by account) have to be allocated to one of

the three categories by considering the criteria for each
category.
If some items belong to more than one category, the have
to be split-up in its components.
Example: Interests can relate to operating activities (to
finance the business) and to investing activities
(proceeds from the investment)
7.7. Special Issues
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7.7.1. Acquisition of Subsidiaries

If subsidiaries are acquired, the acquisitions are shown as

a separate item of investing activities.
If cash-flow statements are prepared on group level, the
investment in subsidiaries is already converted into assets
and liabilities. Therefore, these effects have to be
reversed.
For each item in each category
The acquisition cash flow has to be shown
If a subsidiary acquired hast cash in its balance sheet,
this cash reduces the cash outflow to acquire the
subsidiary
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Example
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7.7.2. Foreign Currency Effects

Foreign currency transactions have to be converted using

the FX-rate at the day of the business transaction.
Adjustments are usually shown as non-cash transactions.
The reference is the functional currency.
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Description

The following information is given:

Exercise Balance Sheet

Current Year Previous Year
Assets
Cash & Cash Equivalents 37 25
Inventories 25 18
Accounts Receivable 110 115
Property, Plant & Equipment 450 420
Intangible Assets 28 30
Other Assets 290 282
Total Assets 940 890

Liabilities
Accounts Payable 88 97
Provisions 70 58
Deferred Taxes 5 5
Other current Liabilities 210 220
Loans & Notes 160 120
Financial Instruments 82 80
Other non-current Liabilities 10 10
Total Liabilities 625 590

Equity
Preferred Shares 20 20
Ordinary Shares 100 100
Retained Earnings 195 180
Total Equity 315 300

P&L
Current Year
Sales 722
Cost of Sales 555
Gross Profit 167

Selling & Marketing 82

Administration 51
Depreciation 7
Interests paid 12
Net Profit 15

Depreciation consists of 5 for PPE and 2 for intangible assets.

Your task

Prepare the cash-flow statement using the indirect method.

8. Notes
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8.1. Purpose

The purpose of notes is to give the user of financial

statements information about financial statements.
Notes are an integral part of financial statements and have
the same prominence that the four basic statements.
Mandatory items of notes are:
Accounting and valuation principles
Disclosures required by accounting standards
Voluntary details on selected business transactions
Usually there are cross references required between the
notes and the statements.
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Example on cross references

Balance sheet:

Notes:
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8.2. Format

There is no defined format or structure of notes.

Nevertheless, the is a recommended structure that most
notes follow:
General information
Accordance of financial statements with accounting
rules
Extent of preparation of financial statements, the
group, consolidation
Accounting and valuation policies
Mandatory disclosures of selected balance sheet and
P&L items.
Other mandatory disclosures.
Other voluntary information.
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Format (2)

If necessary, information can be given on three levels for

each disclosure:
Level 1: Mandatory information
Level 2: Accounting options available or chosen
Level 3: Discretionary decisions taken
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8.3. Accounting Policies

Accounting policies should inform about the underlying

assumptions a company uses to prepare financial
statements.
A company is required to disclose these underlying
assumptions so that the user of financial statements can
obtain information about
the reliability of,
the relevance of and
the risks inherent to
financial statements.
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8.4. Disclosures

The application of accounting standards is complex and

sometimes requires complex disclosures.
An important aspect of financial statement is the
completeness of the notes. This is an important topic in
each financial audit of an auditor.
As the disclosures are complex, checklists are provided by
auditing firm to ensure proper notes.
Example IFRS: Actual checklists are around 120 to 130
parges! (see additional material)