Semester 2 - Lecture 1 Flashcards
Why do firms need cash?
- users need cash
- liquidity - ‘where the money comes from and how it is used’
- Frequency
- Company success depends upon having the liquidity to service obligations as and when they fall due
- the accruals concept disguises cash flow
Why might a company may report healthy profits whilst suffering liquidity problems?
- profits may not convert to cash for a number of reasons e.g. bad debts, build up of inventory
- purchase of non-current assets had immediate cash impact but filters through to the income statement gradually in form of depreciation
- repayment of loan takes cash out of the but has no direct effect in profit
When did firms need to provide cash flow statement?
In 1992, the IASB issued ISA 7 cash flow statements which became effective in 1994.
What does the survival of a company depend on?
Not so much it’s profit but it’s liquidity/solvency and therefore it’s ability to generate cash flows
Difference between cash and profit (matching concept)
matching concept
- depreciation
- accruals/prepayments (expenses)
- realisation convention (sales)
- excluding unsold inventory from expenses
- profits basis deals only with on period (1 year)
Differences between cash and profit?
- cash basis measures only cash movements during the period (a sort of summarised bank statement)
- cash basis is not subject to estimation or assumptions - thus more objective.
- cash flow statements cover expenditure on long-term assets and movements in funding as well as operating activity, so us with additional information
- cash basis is to useful ‘control’ on profit basis
Why have a statement of cash flows?
- cash is king. It’s necessary for survival
- users of FS may be misled by reported profit
- profits can be manipulated
- provides additional information on business activities
- allowing users to see the major types of cash flows(in and out) and to estimate future cash flows
- distinguishing between cash flows generated from trading transactions and other cash flows
- enhances comparability
- easier for users to understand
What is a ISA 7 cash flow statement?
Primary statement
What does cash flows help us identify?
- why bank/cash has decreased despite healthy profit
- whether the trading activities generate cash as well as profit?
- how the new bank loan spent
- how businesses generate utilises cash
- liquidity
What is the form of a cash flow statement?
Cash flows from operating activities | | Cash flows from investing activities | | Cash flows from financing activities | | Net increase (or decrease) in cash and cash equivalents over the period
ISA7 and cash equivalents
- cash companies cash at bank and on demand deposits less overdrafts repayable on demand
- cash equivalents are short-term, highly liquid investments that are readily convertible to known amounts of cash (generally three months) and which are subjects to insignificant risk of change in value e.g. money market funds, marketable securities, treasury bills
- ISA7 cash = cash + bank - over draft
What are the 3 sections of the cash flow statement?
Operating activities, investing activities, financing activities
What is financing activities section in the cash flow statement?
- activities that result in changes in the size and composition of the equity and borrowings of entity
- I.e. cash proceeds from share issue, repayment of loan capital
What is the operation activity in the cash flow forecast?
- principle revenues-producing activities of the entity and other activities that are not investing or financing activities
- I.e. trading receipts and payments, interest and tax paid and dividend
What is investing activities in the cash flow forecast?
- the acquisition and disposal of long-term assets and other investments not included in cash equivalents
- I.e. cash paid for new assets, cash received for selling an old asset
(If you purchase a non-current asset it’s outflow (negative), if you sell the non-current asset it’s an inflow (positive)
