LESSON 7: Types of cash inflows and outflows

CASH FLOW STATEMENT Operating activities

the statement of cash flows is to provide information Cash inflows:
about cash receipts, cash payments and the net
• From sale of goods or services
change in cash resulting from the operating,
investing and financing activities of an entity during • From returns on loans (interest received) and on
a period for external users of financial information. equity securities (dividends received)

The statement of cashflows provides answers to Cash outflows:

these important questions about an entity. • To suppliers for inventory
Where did the cash come from during the period? • To employees for services
• To governments for taxes
What was the cash used for during the period? • To lenders for interest
What was the change in the cash balance during • To others for expenses
the period? Investing activities
Cash inflows:
Factors of Cash Flow Analysis
• From sale of property, plant and equipment
Operating activities are the entity's principal • From sale of investments (debt or equity
revenue-generating activities such as the provision of instruments of other entities)
goods and services and activities which are not • From collection of principal on loans to other
classified as investing or financing activities. entities
Investing activities are the acquisition and disposal Cash outflows:
of long-term assets, including activities such as
purchasing and selling non-current assets, and • To purchase property, plant and equipment
lending money and collecting the loans. • To purchase investments (debt or equity
instruments of other entities)
Financing activities are those that affect the size and • To make loans to other entities
composition of contributed equity and borrowing,
and include obtaining cash from issuing debt, Financing activities
repaying the amounts borrowed, obtaining cash from Cash inflows:
shareholders, and paying them dividends or buying
back shares. • From issue of the company’s own shares
• From issue of debt (debentures and notes)
Cash outflows:
• To shareholders as dividends
• To redeem (repay) long-term debt
• To buy back the company’s own shares
• To lessor as lease payments (finance lease)
Steps in Cash Flow Analysis Direct cash flow is an accounting method that
creates a detailed cash flows statements showing the
1. Determine the Starting Balance –
cash changes over an accounting period.
This value can be found on the income
Common descriptions under the direct method
statement of the same accounting period.
include:
2. Calculate Cash Flow from Operating Activities
• Cash from customers
This step is crucial because it reveals how • Cash paid to employees
much cash a company generated from its operations, • Cash paid to suppliers
3. Calculate Cash Flow from Investing Activities • Cash paid for interest

Involving free cash, not debt which is it

details the cash flows related to the buying & selling
of long-term assets like property, facilities, and
equipment.
4. Calculate Cash Flow from Financing Activity
Cash flow from both debt and equity
financing cash flows associated with raising cash and
paying back debts to investors and creditors.
When using GAAP, this section also includes
dividends paid, which may be included in the
operating section when using IFRS standards.
Interest paid is included in the operating section
under GAAP, but sometimes in the financing section
under IFRS as well.
5. Determine the Ending Balance
This value shows the total amount of cash a company
gained or lost during the reporting period.
The change in net cash for the period is equal to the
Indirect cash flow method presents a financial
sum of cash flows from operating, investing, and
statement that shows the amount of money a business
financing activities.
spends or makes in a certain period.
Accountants make adjustments for non-operating
expenses to determine the cash flow for operating
expenses. A few of the typical adjustments are:
• Adding back depreciation expense
• Adding the decrease in accounts receivable
• Deducting the increase in inventory
• Deducting the decrease in accounts payable
• Adding the increase in accrued expenses payable
 2. Generally Accepted Accounting Principles
(GAAP)
Lesson 8: Accounting Principles and Policies
- a set of principles that companies in the United
2 accounting standards & principles adhered to by
States must follow when preparing their annual
countries in the world in relation to financial
financial statements.
reporting
- using authoritative approach so there’s no
IFRS GAAP
inconsistency on financial statements
The International Generally Accepted
Financial Reporting Accounting Principles. - enables investors to make cross- comparisons of
Standards. financial statements in order to make an educated
decision regarding investments in SEC.
which encourages created by the Financial
uniformity in preparing Accounting Standards Key Differences between IFRS vs. US GAAP
financial statements. Board to guide public
companies in the United IFRS GAAP
States when compiling Treatment LIFO (Last in First either the LIFO or
their annual financial Inventory out) method of FIFO (First in
statements. calculating First out) method
110 Countries US only inventory is not can be used to
Worldwide allowed. estimate inventory
LIFO Inventory LIFO or FIFO allowed Intagibles Costs in the Generally requires
Prohibited development phase immediate
may be capitalized expensing of both
Specific rules for Intangibles at current
based on certain research &
intangibles recognitions market value
factors. development
expenditures,
1. International Financial Reporting Standards although some
(IFRS) exceptions exist
Rules vs sets forth the accounting
- a set of standards developed by the International Principles principles that process is
Accounting Standards Board (IASB) companies should prescribed highly
follow and specific rules and
- does not dictate exactly how the financial interpret to the best procedures,
statements should be prepared but only provides of their judgment. offering little
guidelines that harmonize the standards and make the Companies enjoy room for
accounting process uniform across the world. some leeway to interpretation. The
make different measures are
- used in the European Union, South America, and
interpretations of devised as a way
some parts of Asia and Africa.
the same situation. of preventing
opportunistic
entities from
creating
exceptions to
maximize their
profits.
Recognition based on the that revenue is not
of revenue principle that recognized until
revenue is the exchange of a
recognized when good or service
the value is has been
delivered. completed
Classification there is no plain Debts that the - disadvantage: complicated to use necessary to
of Liabilities distinction company expects account for items like unearned revenue and prepaid
between liabilities to repay within the expense, it may require added staff.
so short-term and next 12 months
long-term are classified as - An investor might think the company is
liabilities are current liabilities, unprofitable when, in reality, the company is doing
grouped together. while debts whose well.
repayment period
exceeds12months - required for companies that file audited financial
are classified as statements and is required under the (GAAP) issued
long-term by the Financial Accounting Standards Boards
liabilities (FASB)

Accrual Accounting vs Cash Accounting

Cash Basis Method
Lies in the timing of when revenue and
- key advantage is simplicity, accounts paid for cash
expenses are recognized.
paid or received.
- beneficial to sole proprietorship and small
Accrual Accounting businesses because, it won't require added staff.

- revenue is accounted for when it is earned. - might overstate the health of a company that is
cash-rich.
- money is accounted before it received.
- not acceptable under GAAP.
- record revenue when a product/service is delivered
to a customer with a expectation that money will be
paid in the future.
Revenue Recognition
- aspect of accrual accounting that stipulates when
Cash Basis Accounting and how businesses “recognize” or record their
revenue.
- revenue is reported on the income statement only
when cash is received. - when it’s earned (accrual accounting) rather than
when payment is received (cash accounting).
- Expenses are recorded only when cash is paid out.

5 Step Revenue Recognition Model

Key Differences
1. Identify the customer contract
- Verbal agreements and stated terms and conditions
Accrual Method of your service or product can be considered a
- records accounts receivables and payable and, as a contract.
result, can provide a more accurate picture of the - commercial agreement between two parties where
profitability of a company, particularly in the long the payment terms, rights, and obligations are clearly
term. stated.
- doesn't track cash flow. - a formal written agreement, as is often the case with
service-based businesses, or a receipt for a point-of-
sale purchase at a retail store.
2. Identify the contract's specific performance 2 types of matching expense recognition principle
obligations
1. Accrual Basis –expense will be recognized in the
- "performance obligation" refers to distinct goods books as and when it is matched with the revenue.
that the seller has agreed to deliver.
2. Cash Basis – Under this cash basis method, the
- "distinct" product or service is usually its own line expense will be recognized in the books when it is
item on a receipt or an invoice. paid or received.
3. Determine the transaction price
- transaction price is the money you're exchanging Accounting Policies
with a customer for a good or service
- are the specific procedures implemented by a
4. Allocate the transaction price to distinct company's management team that are used to prepare
performance obligations its financial statements.
- straightforward when there's a stand-alone selling - accounting methods, measurement systems, and
price for each product or service. procedures for presenting disclosures.
- Variable considerations, including discounts,
incentives, and rebates, estimate the price based on
How Accounting Policies Are Used
the expected value.
Accounting Policies are:
5. Recognize revenue when you've fulfilled each
performance obligation - a set of standards that govern how a company
prepares its financial statements.
- deferred revenue when customer has paid for
services not yet completed or goods still in your care. - complicated accounting practices such as
depreciation methods, recognition of goodwill,
- revenue you have transfer the control of the goods
preparation of research and development (R&D)
or service to your customer.
costs, inventory valuation, and the consolidation of
- can be measured in other ways external financial accounts.
milestones met, percentage of production completed,
- all accounting policies are required to conform to
costs, or labor hours.
(GAAP) and (IFRS).
- a framework in which a company is expected to
Expense Recognition: matching principle operate and somewhat flexible.
- acts as a guidance in the accounting process, which - can signal whether management is conservative or
identifies how the expense will be reported in the aggressive when reporting earnings.
financial statement of the company.
- This should be taken into account by investors when
- accrual basis – expenses are recognized as and reviewing earnings reports to assess the quality of
when they take place, not when the cash is paid or earnings
received.
- accounting periods are assumed to be annual,
quarterly or monthly, asper the process followed by
the entity.
Lesson 9: Financial Ratio Analysis Solvency analysis is used to analyse a company’s
ability to pay off all the debt it currently holds with
its income, assets and divided by or equity.
Financial Ratio Analysis
- is the technique of comparing the relationship (or
1. Debt to total assets ratio
ratio) between two or more items of financial data
from a company’s financial statements. - measures the percentage of the total assets financed
by creditors.
- way of making fair comparisons across time and
between different companies or industries. - indicates the degree of leveraging; it provides some
indication of the entity’s ability to withstand losses
without impairing the interests of its creditors.
Liquidity
- POV a lower ratio of debt to total assets is usually
- to analyse a company’s abilities to meet its desirable.
immediate debt obligations out of its current assets.
2 Key Financial Ratios used in Liquidity
2. Times interest earned
Current ratio = current assets divided by current
- also called interest coverage
liabilities
- the entity’s ability to meet interest payments as they
Quick ratio = (current assets minus inventory)
come due.
divided by current liabilities
- A general rule of thumb is that earnings should be
approximately 3–4 times the interest expense.
Current Ratio
- expresses the relationship of current assets to
Profitability
current liabilities.
- analysis is used to analyses a company’s ability to
- used for evaluating an entity’s liquidity and short-
make money from its goods and divided by or
term debt-paying ability.
services.
- A higher current ratio is considered more favorable
1. Return on Assets
than a lower current ratio.
- return on ordinary shareholders’ equity is affected
- 1.5:1
by two factors: the return on assets (ROA) and the
degree of leverage.

Quick Ratio or Acid Test - measures the overall profitability of assets in terms
of the profit earned on each dollar invested in assets.
- is a measure of an entity’s immediate short-term
liquidity.
- current assets, cash, marketable securities and net 2. Profit Margin or Rate of return on sales
receivables are considered highly liquid.
- measure of the amount of each dollar of sales that
- 1:1 results in profit.
Efficiency Lesson 10: Interpretation of Financial Statements
- is used to analyze how hard a business is working
its assets on behalf of its owners.
Interpretation of Financial Statements

Inventory Turnover Ratio

1. Horizontal analysis
- technique for evaluating a series of financial
statement data over a period of time.
- purpose is to determine the increase or decrease that
has taken place, expressed as either an amount or a
percentage.

Days Sales Outstanding - relevant information such as general economic

conditions, industry trends or averages, information
from directors’ reports and media releases.

2. Vertical analysis
Fixed Asset Turnover Ratio - technique for evaluating financial statement data
that expresses each item in a financial statement as a
percentage of a base amount.
- more meaningful if it is supplemented with further
information such as general economic conditions,
Total Assets Turnover Ration industry trends or averages, information from web
sites, directors’ reports and media releases.

3. Common size analysis or as vertical analysis

- is a tool that financial managers use to analyze
financial statements by expressing each line item as
a percentage of a base amount for that period.
- helps to understand the impact of each item in the
financial statements and its contribution to the
resulting figure.
Types of Common Size Analysis
it does provide a simple way for financial managers 2. Income Statement Common Size Analysis
to analyze financial statements.
- used to calculate net profit margin, as well as gross
1. Vertical Analysis - refers to the analysis of and operating margins.
specific line items in relation to a base item within
- the ratios tell investors and finance managers how
the same financial period.
the company is doing in terms of revenues, and can
2. Horizontal Analysis - refers to the analysis of be used to make predictions of future revenues and
specific line items and comparing them to a similar expenses.
line item in the previous or subsequent financial
- to analyze competitors to know the proportion of
period.
revenues that goes to advertising, research and
development, and other essential expenses.
1. Balance Sheet Common Size Analysis
- mostly uses the total assets value as the base value.
- investor can use the common size analysis to see
how a firm’s capital structure compares to rivals.
- make important observations by analyzing specific
line items in relation to the total assets.

4.Trend analysis or Traders Fraternity

- is an analytical method that is commonly used to
interpret any pattern in a set of data.
- widely used in the field of economics, finance,
marketing, etc. In this method, analysts the direction
and amount change that takes place in order to take
informed decisions or make predictions.
- used by management to forecast future financial
statements.