The components of the cash flow statement
The 2002 and 2003 cash flow statement of the ABC business group is as follows:
Consolidated cash flow statement:
Net cash inflow/outflow from operating activities
This is the cash flow that results from the daily trading activities of the business. It is shown in the accounts of Miller as a reconciliation between the operating profit and the net cash inflow from the operating activities of the Company.
In summary the components are as follows:
Operating profit
The above details of this reconciliation must be shown in the notes to the cash flow statement within the financial statements. As can be seen from the above it is calculated by taking the operating profit from the P&L and adjusting it to show the underlying cash flow.
The operating profit in the P&L contains numbers that conform with the accruals accounting policy. As mentioned earlier, this is the reason why the P&L does not provide information about the cash flows of the business. The operating profit is adjusted for those numbers that do not involve money changing hands. For example, depreciation is included as an expense in the operating profit but depreciation is an accounting estimate rather than a physical cost. To remove depreciation (which was originally deducted) from the operating profit we must add the number back.
In addition, the operating profit needs to be adjusted for the fact that turnover and costs are accounted for under the accruals concept. These adjustments are taken into account by considering the related movement in stocks, debtors and creditors. If stocks and debtors have increased over the last year this effectively means that money has flowed out of the business to finance these increases. If creditors, on the other hand, have increased over the last year then money will effectively have flowed into the business (more suppliers are owed more money; so the business has not paid the money; the money has not flowed out of the business).
The operating profit is therefore adjusted for the difference between the levels of this year’s and last year’s stocks, debtors and creditors. Details of all the adjustments made to the operating profit are given in the notes to the accounts. This avoids cluttering the face of the cash flow statement.
The significance of the direction of cash from the operating activities of the business should be recognised. If the trading activities of the business are resulting in a net cash outflow this could indicate ‘overtrading’. This is particularly possible if the business is going through periods of expansion or is a newly set up business. Overtrading arises from a gap in the trade cycle which is caused because of a shortage of working capital to support the level of sales.
When a business is new or growing, money may have to be paid out before it is earned. This may occur because the business has to increase production levels to meet growing demand.
To meet growing demand, the business will have to buy more stock. This means an increase in the level of creditors. If the products are not sold (because the goods are not what the consumers want) or the debtors do not pay in a timely manner (because the company has not maintained good credit control) the company will not have the money available to pay the suppliers. The company may also not have the money to pay interest on loans and wages to employees. In the worst case the business could go bankrupt.
Therefore, particularly in times of expansion, the cash flow position of the business is crucial, as it must ensure that it has the money to pay debts as they fall due.
Returns on investment and servicing of finance
This shows the actual interest paid and interest received for the year. It also shows the dividends paid on the preference shares of ABC Business Group.
Taxation
Quite simply taxation refers to all amounts paid to the tax authorities. If the business is making profits then this cash flow should be a cash outflow. Any refunds from the tax authorities would also be included but as a cash inflow.
Capital expenditure and financial investment
This relates to items that the business has paid for long term use. For example, if the business has purchased fixed assets then the cost of the assets will be shown under this heading.
Cash inflows will result from the sale proceeds received from the sale of fixed assets.
Acquisitions and disposals
This deals with the buying and selling of companies as well as any lending between these companies within the group.
Equity dividends paid
This is the cash paid out to ordinary shareholders.
Net cash inflow/outflow before management of liquid resources and financing
This is a subtotal to show the level of money that the business is generating internally. This number gives an indication as to whether the business is self-financing.
Financing
This category provides details of the money that has been generated from external sources. For example, it includes cash inflows from shareholders who have purchased share capital and from the bank if they are lending a medium or long term loan.
Cash outflows would result if the business were to repay a medium or long term loan. Cash outflows also arise as a result of paying the capital element of a finance lease rental.
Increase/(decrease) in cash
This is the grand total of all the above categories, which equates with the movement in cash from last year to this year. The details of the movements in the company’s cash over the last year will be given in the notes to the accounts.