Printer Friendly

Paper F1 finance operations: the secret to answering questions requiring you to produce cash flow statements is to take a methodical approach to taking out the non-cash items.

All that a cash flow question actually asks you to do is to take the statement of comprehensive income and the statement of financial position (the balance sheet to you and me) and turn this into cash. That entails getting rid of the non-cash stuff- depreciation and receivables and so on. Here's a step-by-step guide to doing it.

Step one: take your operating profit figure and add back all non-cash items.

The first task is to add back all non-cash expenses to the operating profit (PBIT) and take off all noncash receipts. Magically, you'll be left with cash. There are seven non-cash items to consider: depreciation; amortisation; impairment; profit/loss on sale of non-current assets; increase/decrease in inventory; increase/decrease in receivables; and increase/decrease in payables. For the last three of these, if it's an increase in receivables or inventory, you take off from operating profit; if it's a decrease, you add back. The opposite applies to payables. All of this goes into the "Cash flow from operating activities" section of the cash flow statement.

Step two: continue down the income statement after PBIT: calculate the cash and put it into the cash flow statement.

Let's assume that the next item in the income statement is interest and that it says interest expense ($200). The question to consider is whether this $200 is all cash or not. Before we look at that, let me give you a scenario: at the start of year you owed me [pounds sterling]100. During the year you bought more things from me (on credit) worth [pounds sterling]40. At the end of the year you should owe me [pounds sterling]140, obviously. But, if I were to tell you that you owed me only [pounds sterling]120, what must have happened? You must have paid me [pounds sterling]20 in cash--and it's this cash that goes into the cash flow statement.

Let's use the principles of this scenario in a cash flow question. You need three figures:

* What you owe or are owed at the start of the year (opening receivable/payable): [pounds sterling]100.

* What was bought or sold in the year (income statement figure): [pounds sterling]40.

* What you owe or are owed at the end of the year (closing receivable/payable): [pounds sterling]120.

Using our scenario, we therefore have a cash paid of: [pounds sterling]100 + [pounds sterling]40--[pounds sterling]120 = [pounds sterling]20.

Let's get back to the question where I said that the interest figure in the income statement was $200. Now let me tell you that the interest payable at the start of the year was $1,000 and the payable at the end of the year was $900. How much interest cash has been paid out during the year? $1,000 + $200--$900 = $300. This figure goes into the "Cash flow from operating activities" section of the cash flow statement.

Let's assume that the income statement next shows a taxation expense of $400. There is an opening payable of $90 and a closing payable of $120. What is the tax cash paid that goes into the "Cash flow from operating activities" section of the cash flow statement? $90 + $400--$120 = $370.

Lastly, let's assume there are dividends in the statement of changes in equity of $300 and no dividends payable. As there's nothing payable, this is all cash and goes into the cash flow statement in the "Cash flow from financing activities" section.

You simply follow this procedure for all items in the income statement after operating profit, putting the cash amounts into the cash flow statement as you go along.

Step three: go down the statement of financial position (SFP), find the cash and put it into the cash flow statement.

The first item you will encounter is non-current assets. These can be tricky, so let's leave them until the end. Many of the SFP items we have already sorted out--payables, receivables etc--so let's look at four items we haven't yet dealt with:
* Shares. Consider the following illustration:

SFP X2 X1

Share capital ($) 200 140

Share premium ($) 150 80

Opening ($) 140 + 80

Cash received ($) 130 (balancing figure)

Closing payable ($) 200 + 150

STATEMENT OF COMPREHENSIVE INCOME

Sales ($) 1,000

Cost of sales ($) (400)

Admin ($) (100)

Distribution ($) (100)

Finance costs ($) (80)

Tax($) (50)

Profit after tax ($) 270

OTHER COMPREHENSIVE INCOME

Revaluation gain ($) 1,000


The proceeds from share issue--ie, the $130--go to the "Financing activities" section of the statement of cash flows.
* Loans. Consider the following illustration:

SFP X2 X1

10% loan ($) 100 140

Opening ($) 140

Cash paid ($) (40) (balancing figure)

Closing payable ($) 100


Loan repayments go to the "Financing activities" section of the statement of cash flows.
* Bank. Consider the following illustration:

SFP X2 X1

Cash at bank ($) 200 140


Here you simply take the increase in cash of $60 and put it at the bottom of the cash flow statement in the "Increase in cash and cash equivalents" section. Note that this is the total of your statement of cash flows, so you should check the addition of your statement results in this figure also.

* Property, plant and equipment. This needs to be handled slightly differently: first you write down the property, plant and equipment (PPE) figures per the accounts and then you work out the cash element of each item (if any). Consider the following illustration:
SFP X2 X1

PPE ($) 200 140

Notes to the exam question: depreciation in year = $50; revaluation =
$100; disposal = asset sold for $100, making $20 profit.


The key here is to try to find the balancing figure, which will be additions in the year. Note that we are dealing with net book values (NBV).
STATEMENT OF FINANCIAL POSITION

 X1 X2

Non-current assets ($) ($)

Property, plant and equipment 10,000 12,000

Current assets

Cash 400 600

Receivables 1,000 2,000

Inventory 1,000 900

Total assets 12,400 15,500

Equity and liabilities

Equity shares of $1 each 5,000 6,630

Share premium 500 800

Retained earnings 4,000 4,270

Revaluation reserve 1,000 2,000

Equity 10,500 13.700

Non-current liabilities

Loan 1,000 800

Current liabilities

Trade payables 700 810

Interest payable 100 80

Tax payable 100 110

Total equity and liabilities 12,400 15,500

Notes: the depreciation charged to cost of sales in the year was $200
and there was a disposal of PPE for $600, making a profit of $100.


First, we write down the PPE figures per the accounts as follows:
Opening ($) 140

Depreciation ($) (50)

Revaluation ($) 100

Disposal ($) (80) (NBV = $100--$20)

Closing ($) 200


The balancing figure is $90, therefore, and this is additions. Next, we work out the cash element of each item (if any) as follows:
 Cash

Opening ($) 140

Depreciation ($) (50) Add back to operating activities

Revaluation ($) 100

Disposal ($) (80) 100

Additions ($) 90 (90)

Closing ($) 200


All PPE items go the investing activities section of the statement of cash flows.

Now, let's put this all together in a worked example using the statements in the two panels at the top of the page. We start with PBIT and add back or take away all non-cash items as follows:
Profit before interest and tax ($) 400

Depreciation ($) 200

Profit on sale of asset ($) (100)

Decrease in inventory ($) 100

Increase in receivables ($) (1,000)

Increase in payables ($) 110


All of this goes to the Cash flow from operating activities" section of the statement of cash flows.

Next we continue with the rest of the statement of comprehensive income, calculating the cash and putting it into the statement of cash flows as follows.

* Finance costs. The opening payable is $100, the figure on the income statement is [pounds sterling]80 and the closing payable is [pounds sterling]80, meaning that $100 + $80--$80 = $100 in cash must have been paid. This figure goes to the "Cash flow from operating activities" section of the statement of cash flows.

* Taxation. The opening payable is $100, the figure on the income statement is $50 and the closing payable is $110, meaning that $100 + $50--$110 = $40 in cash must have been paid. This figure also goes to the "Cash flow from operating activities" section of the statement of cash flows.

Now we go through the SFP to deal with all remaining items, find the cash and put it into the statement of cash flows.

* PPE. First we write down the relevant figures per the accounts as follows:
Opening ($) 10,000

Depreciation ($) (200)

Revaluation ($) 1,000 (the increase in the revaluation reserve)

Disposal ($) (500)(NBV = 600-100)

Closing ($) 12,000


The balancing figure is $1,700 and this is additions. This goes to the "Cash flow from investing activities" section of the statement of cash flows. The disposal cash of $600 goes there as well.

* Cash at bank. Looking at the SFP, we can see that the cash at bank has increased by $600--$400 = $200. This figure goes into the "Net increase in cash and cash equivalents" section of the statement of cash flows.

* Loans. Again, looking at the SFP, we can see that the cash paid on the loan in the year is $1,000--$800 = $200. This figure goes to the "Cash flow from financing activities" section of the statement of cash flows.

* Shares. Looking at the SFP, we can see the following picture:
 X1 X2

Share capital ($) 5,000 6,630

Share premium ($) 500 800

Opening ($) 5,000 + 500

Cash received ($) 1,930 (balancing figure)

Closing payable ($) 6,630 + 800


The share proceeds of $1,930 go to the "Cash flow from financing activities" section.

So now we can compile the statement of cash flows for the year 20X2 (see panel below).
STATEMENT OF CASH FLOWS FOR THE YEAR ENDED 20X2

 $ $

CASH FLOW FROM OPERATING ACTIVITIES

Profit before interest and tax 400

Adjustments for:

Depreciation 200

Profit on sale of asset (100) 100

Working capital adjustments:

Decrease in inventory 100

Increase in trade receivables (1,000)

Increase in payables 110 (790)

Cash generated from operations (290)

Interest paid (100)

Tax paid (40) (140)

Net cash used in operating activities (430)

CASH FLOW FROM INVESTING ACTIVITIES

Purchase of PPE (1,700)

Sale of PPE 600

Net cash from investing activities (1,100)

CASH FLOW FROM FINANCING ACTIVITIES

Loan repayment (200)

Share issue 1,930

Net cash from financing activities 1,730

Net increase in cash and cash equivalents 200

Cash and cash equivalents at beginning of period 400

Cash and cash equivalents at end of period 600


Further reading J Watkins, CIMA Official Learning System--Finance Operations, CIMA Publishing 2009.

By Richard Clarke

CIMA training provider in Belfast, Edinburgh and Aberdeen (www.richardclarkeacademy.com)
COPYRIGHT 2011 Chartered Institute of Management Accountants (CIMA)
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 2011 Gale, Cengage Learning. All rights reserved.

Article Details
Printer friendly Cite/link Email Feedback
Title Annotation:Study notes
Author:Clarke, Richard
Publication:Financial Management (UK)
Date:Jan 1, 2011
Words:1772
Previous Article:Paper P3 performance strategy: the UK's corporate governance code has been revised--and it features a number of significant changes of emphasis that...
Next Article:Complex harmonic motion: this will be a crucial year in the convergence process for international financial reporting standards. The initiative has...
Topics:

Terms of use | Privacy policy | Copyright © 2019 Farlex, Inc. | Feedback | For webmasters