Cash Flows
Construct a Simple Cash Flow Statement
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Worked Example of How to Construct a Simple Cash Flow
Below is a sample question to construct a Simple Statement of Cash Flows for Reese Refrigerators. Question: Reese Refrigerators is a refrigerator supplier in Perth. On 1st July 2019, it had $45,000 in its bank account.
The following cash receipts came into the business during the year:
Cash Sales: $201,000
Cash collected from Accounts Receivable: $20,000
Dividends received: $3,000
Proceeds from sale of delivery truck: $10,000
Proceeds from additional share issue: $15,000
The business borrowed $30,000 from the bank in a long term loan. The following cash payments were incurred during the year:
Wages: $70,000
Advertising: $20,000
Purchases: $110,000
Electricity: $8,000
Interest paid: $500
Loan repayment: $1,000
Dividends paid: $8000
Purchase of new delivery truck with cash: $35,000
Income tax paid: $45,000
Prepare a statement of cash flows for the year ended 30th June 2020 and comment on the pattern of cashflows for Reese Refrigerators.
Step 1: Classify the financial information
As discussed in the previous page, cash inflows and outflows fall under 3 different classifications: Operating, Investing and Financing activities.
1) The following are classified under Operating activities as they are directly concerned with the daily revenue generating activities of the business. The reasoning has also been provided below.
Cash sales / Cash Collected from Accounts Receivable: Cash collected from cash and credit sale of goods are the main revenue driver of the businesses daily operations.
Wages: Reese Refrigerators would need to regularly pay their employees wages in return for their labor in managing the business.
Advertising: Advertising is an expense used to increase sales of goods. - Purchases: Purchase of Refrigerators is required to be sold at a profit. - Electricity: Electricity is consumed to carry out daily activities.
Interest paid: Accounting Standards permits the interest paid on borrowings to be recorded in either Operating or Financing activities. This example recorded it under an operating activity. - Income tax paid: Income tax is paid on the total revenue generated by the business.
2) The following are classified under Investing activities as they as directly involved with the sale and purchases of non-current assets, and investments external to the business:
Dividends received: Business received dividends from external share investments. Proceeds from the sale of old delivery truck: Sale of old delivery vehicle refers to activity relating to a previous investment in Property, Plant and Equipment.
Cash Purchase of new delivery truck Purchase of new delivery vehicle refers to activity relating to a new investment in Property, Plant and Equipment.
3) The following are classified under Financing activities as they are directly involved with debt and equity financing, the repayment of borrowings and the payment of dividends:
Loan repayment: Related to debt financing.
Dividends paid: Related to equity financing.
Proceeds from additional share issue: Related to equity financing.
Receipt of Bank Borrowings: Related to debt financing.
Step 2: Construct the Cash flows from Operating Activities
When it comes to filling in the 'operating activities' section of a cashflow statement, only the following can be and must always be included: cash receipts from customers (inflow), cash paid to suppliers and employees (outflow), interest paid (outflow) and income tax paid (outflow).
The cash inflows and outflows are added and subtracted, resulting in the Net cash from operating activities. To calculate the cash receipts from customers, add together the cash sales and cash received from accounts receivable (goods sold on credit).
1) Cash receipts from customers: 201,000 (Cash Sales) + 20,000 (Cash Received from Accounts Rec) = $ 221,000 Cash paid to suppliers and employees will include all payments the business made in relation to the daily running of the business (refer to the reasoning for the classification in step 1).
2) Cash paid to suppliers and employees: 110,000 (Purchases) + 70,000 (Wages) + 20,000 (Advertising) + 8,000 (Electricity) =($ 208,000)
3) Include the interest paid ($500) and income tax paid ($45,000). 4) Calculate the net cash from operating activities: 221,000 - 208,000 - 500 - 45,000 = (32,500)
*Figures in brackets indicate an outflow and will be subtracted to find the net cash for this section.
Step 3: Construct the Cash flows from Investing Activities
As previously mentioned, all the cashflows resulting from investing activities are recorded in this section of the cashflow statement. From the question, this includes: interest received- from other investments (inflow), proceeds from sale of truck (inflow), and the purchase of a new truck (outflow).
1) Include these figures individually in this section of the cash flow statement: - Interest received = 3,000 - Proceeds from sale of truck = 10,000 - Purchase of new truck = (35,000)
2) Calculate the net cash from investing activities: 3,000 + 10,000 - 35,000 = (22,000)
Step 4: Construct the Cash flows from Financing Activities
All cashflows pertaining to financing activities are recorded in this section. From the question, this includes: additional share capital- from share issue (inflow), borrowings from loan (inflow), loan repayment (outflow), and dividends paid (outflow).
1) Include these figures individually in this section of the cash flow statement: - Additional share capital = 15,000 - Borrowings from loan = 30,000 - Loan repayment = (1,000) - Dividends paid = (8,000)
2) Calculate the net cash from financing activities: 15,000 + 30,000 - 1,000 - 8,000 = 36,000
Step 5: Construct the Net Change in Cash Flow
In the final section of the cashflow statement only the following can be and must always be included: -
Net increase/ decrease in cash and cash equivalents = Cash and Cash Equivalents at the start of the period - Cash and Cash Equivalents at the end of the period To calculate the net increase/ decrease in cash and cash equivalents, calculate the sum of the net cash from the operating, investing and financing sections of the report.
1) Net increase/ decrease in cash & cash equivalents = - 32,500 (operating activities) - 22,000 (investing activities) + 36,000 (financing activities) = (18,500)
2) Include the figure for the Cash & Cash Equivalents at the Start of the period = $ 45,000
3) Calculate the Cash & Cash Equivalents at the End of the period: = Cash and Cash Equivalents at the Start of the Period +Net Increase/Decrease Cash & Cash Equivalents = 45,000 - 18,500 = 26,500 Reese Refrigerators have a positive cash and cash equivalents balance of $26,500 at the end of the period for the year ending 30th June 2020.
Step 6: Interpretation
Refer to the 'Interpretation of cashflow statements' module. As a guide, ensure you comment on the main changes in the following:
Change in the overall cash balance
The operating activities
The investing activities
The financing activities
The cash position of Reese Refrigerators has decreased by $18,500 during this year, taking the business from having a balance at the start of the year of $45,000 down to $26,500 at the end of the period. A negative net cashflow of - $32,500 was recorded for operating activities. This is not a healthy indicator for the business as it indicates the cash inflows from customers is insufficient to cover the payments for operating the business (cash paid to suppliers and employees). The dividend payout of $8,000 is considered excessive given its comparison to the negative net cashflow made in operations. This means $8,000 would have had to come from the business's cash reserves to meet the dividend payout which is not ideal.
Despite making a negative net cashflow of - $22,000, the business sold its old truck and with the proceeds bought a new truck. This is a positive indicator as the purchase of this non-current asset can be used to generate income in the future and the business may be expanding by replacing old assets. In order to meet payments for the year, the business issued additional shares to raise $15,000 capital, and took a loan of $30,000. This is a negative indicator as it was still insufficient to cover all payments and the shortfall has come from the cash reserves.