ACCT1101 Chap.6 Preparing the Statement of Cash Flows
Preparing the Statement of Cash Flows
One asset is tracked here and nothing else: the money that came in and the money that went out over a period. The basis is cash rather than accrual, and the statement exists because the other two can both look healthy while a business runs out of money.
The course notes that a large majority of new entities fail through poor cash flow management rather than through lack of profit.
Every cash movement falls into one of three activity classifications. Operating activities are the day to day trading flows: receipts from customers, payments to suppliers, wages, tax and interest.
Read together they say whether trading produces money, whether the near term bills can be met, whether the business can keep going, and whether it can grow. Investing activities cover buying and selling the long lived assets, so a business that is expanding normally shows money leaving here.
Financing activities relate to how the business is funded: owner contributions, share issues, borrowings, loan repayments and dividends paid. Financing can be positive or negative without either being a problem in itself.
There is a neat mapping worth memorising.
Operating flows connect to revenue and expenses and to current assets and liabilities; investing flows connect to non current assets; financing flows connect to non current liabilities and equity. If you can place an account on the statement of financial position, you can classify its cash effect.
Two conventions govern the presentation. Inflows are shown as positive numbers and outflows in brackets.
And if an item is non cash, it does not appear at all, which is why depreciation is absent from a statement prepared this way even though it sits in the profit statement. The encouragement in Australia runs towards the direct method, which shows gross receipts and gross payments, and the approach taken in this course is to sort receipts and payments directly rather than working back from profit.
What this chapter covers
- 01
What the statement reports and why the cash basis is used here
- 02
Operating activities and the four abilities they measure
- 03
Investing activities and what a growing business looks like
- 04
Financing activities and why a negative total can be good news
- 05
The mapping from statement of financial position sections to the three classifications
- 06
Direct against indirect presentation, and which one is encouraged
- 07
Brackets for outflows and the exclusion of non cash items
- 08
The three nets, the opening balance and the closing balance
- 09
Working capital and why cash timing is managed separately from profit
Classifying a month of movements and proving the closing cash balance
- +1Operating inflows and outflows first. Receipts from customers $94,200 in; payments to suppliers $51,800 out, wages $22,400 out and interest $3,100 out. These are all day to day trading flows.
- +1Net the operating section. $94,200 less $77,300 of payments gives a net operating inflow of $16,900. Showing this as one net figure, with the gross receipts and payments above it, is the direct presentation.
- +1Investing next, and only non current assets belong here. The edge bander is a $26,000 outflow and the table saw sale is a $4,500 inflow, giving a net investing outflow of $21,500. A negative investing total in a month of buying equipment is exactly what you would expect.
- +1Financing is the funding section. The $30,000 loan drawdown is an inflow and the $2,900 repayment is an outflow, a net financing inflow of $27,100. Interest stays in operating; only the principal movements are financing here.
- +1Add the three nets and reconcile. $16,900 less $21,500 plus $27,100 gives a net increase in cash of $22,500. Opening $18,600 plus $22,500 gives closing cash of $41,100.
Key terms
- Operating activities
- Cash flows from the day to day operations of the entity, such as receipts from customers and payments of expenses, wages, interest and tax.
- Investing activities
- Money moving because a long lived asset was bought or sold, such as a new machine or a block of land.
- Financing activities
- Cash flows relating to how the entity is funded, including owner contributions, share issues, borrowings, repayments and dividends paid.
- Direct method
- A presentation of operating cash flows as gross cash receipts and gross cash payments, which Australian entities are encouraged to use.
- Working capital
- Current assets less current liabilities, representing the funding a business needs to carry inventory and receivables while it waits for cash.
- Non cash item
- An amount recognised in the profit statement without any movement of cash, such as depreciation, which therefore never appears on this statement.
Preparing the Statement of Cash Flows FAQ
Why does depreciation not appear on the statement of cash flows?
Because no cash moves when it is recognised. Depreciation allocates the cost of an asset across the periods that use it, and the cash left the business earlier, when the asset was bought. That earlier payment appears once, as an investing outflow. Showing the depreciation as well would count the same money twice.
Is a negative net cash flow always bad?
No, and the course is explicit about this. A business in a growth phase will show negative investing flows because it is buying assets, and a business repaying borrowings will show negative financing flows, which reduces liabilities and is good news for shareholders. The one to be careful about is a persistently negative operating figure, because that means trading itself is consuming cash.
Where do owner drawings go?
In financing. Drawings and dividends are both distributions to the owners, which is how the business is funded rather than how it trades, so they sit with contributions, borrowings and repayments. Putting them in operating would make the trading section depend on how generous the owner felt this month.
How do I check a completed statement?
Add the three net figures and confirm the total equals the movement in the cash balance, opening to closing. That single arithmetic check catches a misclassified item only if it also changed the total, so follow it with a second pass asking of each line whether cash actually moved, since a non cash item slipped into any section will not break the reconciliation.
Exam move
Learn the classification by the balance sheet map rather than by memorising lists. Current assets and current liabilities, plus anything in the profit statement, means operating. Non current assets means investing. Non current liabilities and equity means financing.
With that map you can classify an item you have never seen before, which is what an unfamiliar exam scenario is testing.
Then always finish with the reconciliation. Practise writing the last four lines of the statement, the three nets, the net movement, the opening balance and the closing balance, from any set of figures. Students who leave those lines off lose marks that are the easiest in the whole topic to secure.
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