Topic 4

The Statement of Cash Flows

AFAC02-6
 Introduction
• This topic will cover the following:
̶ The difference between cash and accrual accounting
̶ The importance of cash flows
̶ Components of the statement of cash flows
̶ Preparation of the statement of cash flows
Cash vs Accrual Accounting
• In discussing the statement of cash flows, it is important to distinguish
• between accrual and cash accounting
– Accrual accounting – income and expenses are recognised in the period
to which they relate, which might not necessarily be the period in which
cash is received or paid
– Cash accounting – income and expenses are recognised in the period in
which cash is received or paid, which might not necessarily be the period
in which the transactions occurred
– No assets and liabilities are recognised for accrued expenses, prepaid
• expenses, accrued income, or income received in advance in cash
accounting
• The statement of cash flows is prepared using cash accounting
 Importance of Cash Flows
• Cash is regarded as the lifeblood of a business; without it, businesses
would struggle to:
– Pay for day-to-day operating expenses
– Service their debt (pay suppliers and lenders)
– Make new investments
– Provide a return (dividends) to owners of the business (shareholders)
• The SOCI and SOFP are prepared using accrual accounting, as a result, do
not provide insight into the movement of cash in and out of the business
• Profit does not necessarily mean that the business has cash
• The SOCFs combines information from the SOCI and SOFP to provide
more insight into the movement of cash in and out of the business
 Components of the Statement of Cash Flows
• The SOCFs is divided into three main sections:
– Cash flows from operations
• Represent cash flows resulting from the core activities of the business
• Include cash from operations (receipts from customers and payments to
suppliers and employees) and cash relating to interest, tax and dividends
• Can be reported using the direct or indirect method
– Cash flows from investing activities
• Report on cash received and paid in relation to non-current assets
– Cash flows from financing activities
• Include cash received from and paid to suppliers of funds (shareholders
and lenders)
 Components of the SOCFs cont.
Cash flows from operating activities – Direct method:
R
Cash flows from operating activities
Cash received from customers XXXX
Cash paid to suppliers and employees (XXXX)
Cash generated/(used) from operations XXXX
Interest received XXXX
Interest paid (XXXX)
Dividends received XXXX
Drawings (or dividends paid) (XXXX)
Tax paid (XXXX)
Net cash flow from operating activities XXXX
 Components of the SOCFs cont.
Cash flows from operating activities – Direct method cont.
• It is often necessary to prepare the following ledger accounts:
– Accounts receivable (debtors control) account to determine cash collected
from customers
– Inventory account to determine purchases for the period
– Accounts payable (creditors control) account to determine cash paid to
suppliers
– Shareholders for dividends account to determine dividends paid
– SARS (tax payable) account to determine the tax paid
– Interest payable account to determine the interest paid
 Components of the SOCFs cont.
Cash flows from operating activities – Indirect method:
R
Cash flows from operating activities
Profit before tax XXXX
Add back depreciation XXXX
Add back/(less) loss (profit) on disposal XXXX
Less interest income (as shown in the SOCI, received and accrued) (XXXX)
Add interest expense (as shown in the SOCI, paid and accrued) XXXX
Operating profit before changes in working capital XXXX
Working capital changes:
Add decrease (less increase) in inventory XXXX
Add decrease (less increase) in accounts receivable XXXX
 Components of the SOCFs cont.
Cash flows from operating activities – Indirect method:
R
Add decrease (less increase) in stationery on hand XXXX
Add increase (less decrease) in accounts payable XXXX
Add increase (less decrease) in accrued expenses XXXX
Cash generated/(used) from operations XXXX
Interest received (actual amount received, might not be same as shown in SOCI) XXXX
Interest paid (actual amount paid, might not be same as shown in SOCI) (XXXX)
Dividends received (actual amount received, might not be same as shown in SOCI) XXXX
Drawings (or dividends paid) (XXXX)
Tax paid (actual amount paid, might not be same as shown in SOCI) (XXXX)
Net cash flow from operating activities XXXX
 Components of the SOCFs cont.
Cash flows from investing activities:
R
Cash flows from investing activities
Purchases of PPE (XXXX)
Proceeds on sale of PPE XXXX
Purchases of investments (or other businesses) (XXXX)
Proceeds from sale of investments (or other businesses) XXXX
Net cash flow from investing activities (XXXX)
 Components of the SOCFs cont.
Cash flows from financing activities:
R
Cash flows from financing activities
Proceeds from issue of shares (contributions from the owners) XXXX
Proceeds from new debt (debentures issued and loans obtained) XXXX
Repurchase of shares (XXXX)
Repayment of loans (XXXX)
Net cash flow from financing activities XXXX
 Preparing the Statement of Cash Flows
• To prepare the SOCFs, we combine the net cash flows from operating,
investing and financing activities
• The sum of these net cash flows shows the increase/decrease in cash
during the year
• The increase/decrease in cash is then added to/subtracted from the
cash and cash equivalents at the beginning of the year to arrive at the
cash and cash equivalents at the end of the year
• The cash and cash equivalents at the end of the year should be the
same as the amount shown in the SOFP
 Preparing the Statement of Cash Flows cont.
R
Cash flows from operating activities
Cash received from customers XXXX
Cash paid to suppliers and employees (XXXX)
Cash generated/(used) from operations XXXX
Interest received XXXX
Interest paid (XXXX)
Dividends received XXXX
Drawings (or dividends paid) (XXXX)
Tax paid (XXXX)
Net cash flow from operating activities XXXX
 Preparing the Statement of Cash Flows cont.
Cash flows from investing activities
Purchases of PPE (XXXX)
Proceeds on sale of PPE XXXX
Purchases of investments (or other businesses) (XXXX)
Proceeds from sale of investments (or other businesses) XXXX
Net cash flow from investing activities (XXXX)
Cash flows from financing activities
Proceeds from issue of shares (contributions from the owners) XXXX
Proceeds from new debt (debentures issued and loans obtained) XXXX
Repurchase of shares (XXXX)
Repayment of loans (XXXX)
Net cash flow from financing activities XXXX
 Preparing the Statement of Cash Flows cont.
Net increase/(decrease) in cash and cash equivalents XXXX
Cash and cash equivalents (opening balance) XXXX
Cash and cash equivalents (closing balance) XXXX
Example:
Best Buys (Pty) Ltd issued the following statement of financial performance and financial
position for the year ended 31 December 2017:
Best Buys (Pty) Ltd
Statement of Comprehensive income for the year ended 31 December 2017
Revenue (sales) 800 000
Cost of sales (80 000)
Gross profit 720 000
Depreciation (145 000)
Salaries & wages (110 000)
Operating profit 465 000
Foreign exchange losses (20 000)
Interest payable (20 000)
Profit before tax 425 000
Taxation (140 000)
Profit for the year 285 000
Best Buys (Pty) Ltd
Statement of Financial position as at year ended 31 December 2017
2017 (R) 2016 (R)
Non-current assets
Property, plant and equipment (Carrying value) 1 225 000 1 320 000

Cost 1 625 000 1 575 000

Accumulated depreciation (400 000) (255 000)

Current assets 170 000 130 000

Inventory 30 000 25 000
Accounts Receivables 85 000 55 000
Bank 55 000 50 000
Total assets 1 395 000 1 450 000

Equity and liabilities 1 395 000 1 450 000

Equity 975 000 890 000
Share capital 440 000 400 000
Retained earnings 535 000 490 000

Non-current liabilities
Long-term liabilities 250 000 450 000

Current liabilities 170 000 110 000

Accounts Payable 50 000 10 000
Taxation 120 000 100 000
• Note: Dividends of R240 000 were paid during the year. Dividends and
interest paid are classified as part of operating activities. Interest which
was incurred in 2017 was paid at the year end.
• Foreign exchanges losses relates to the translation of the US$-
denominated bank balance during the year. Salaries were paid all in cash
this year.
• The business adopts the straight-line method depreciation policy.

• Required:
• Prepare a full statement of cash flows for Best buys (Pty) for the year
ended December 2017, using the direct method.
• NB: Use T-accounts to show your workings.
Cash flow statement of Best Buy (Pty) Ltd as at 31 December 2017.

Cash flows from operating activities (R)

Cash receipts from customers 770 000

Cash paid to suppliers and employees (45k+110k) (155 000)

Cash generated from operations 615 000

Interest paid (20 000)

Dividends paid (240 000)

Tax paid (w4) (120 00)

Net cash flows from operating activities 235 000

Cash flows from investing activities

Payments to acquire property, plant and equipment (w5) (50 000)

Net cash flows from investing activities (50 000)

Cash flows from financing activities

Issue of share capital (w6) 40 000

Long-term loans repaid (w7) (200 000)

Net cash flows from financing activities (160 000)

Workings:

Accounts Receivable (w1)

DR CR
Opening balance 55 000 Closing balance 85 000
Revenue 800 000 Bank 770 000

855 000 855 000

• Accounts Payable (w2):

DR CR
Closing balance 50 000 Opening balance 10 000
Bank 45 000 Purchases 85 000

95 000 95 000
 Inventory (w3)
DR CR
Opening balance 25 000 Closing balance 30 000
Purchases 85 000 Cost of sales 80 000

110 000 110 000

Tax Payable (w4):

DR CR
Closing balance 120 000 Opening balance 100 000
Bank 120 000 Tax expense 140 000

240 000 240 000

• Property, Plant and Equipment (W5)

DR CR
Opening balance 1 575 000 Closing balance 1 625 000
Bank (Acquisition) 50 000

1 625 000 1 625 000

• Share Capital (W6)

DR CR
Closing balance 440 000 Opening balance 400 000
Bank 40 000

440 000 440 000

• Long-term loans (W7)

DR CR
Closing balance 250 000 Opening balance 450 000
Bank 200 000

440 000 450 000

Indirect method