Cash Flow

Cash Flow Statements

Introduction

There is always a requirement of financial support from external parties like investors and creditors to grow and expand a business. Thus, the company needs to highlight their strength, image, financial position, growth and projections to attract and develop the interest of these external parties in their company.

In this, the clear presentation of the cash flow statement helps the users to identify the current liquid performance of the company (Chen et al., 2011). This is because these external parties need to review the company’s financial statements and are relying on this statement to make a decision whether or not to credit, investor continues the investment in the concerned company.

The main aim of this report is to improve the knowledge and understanding of the cash flow statements and its various activities and elements. For this, the selected firm is Woolworths and considers the annual report of the year 2018.

The report also discusses details the purposes of the statement of cash flow and concept of cash used in the preparation of the statement of cash flows – Cash and Cash equivalent.

Moreover, it also highlights why cash flows from operating activities are important to users and why cash in cash flow statement does not concur with current assets in the balance sheet. It also provides distinguish between the cash flows from operating activities, investing activities and financing activities.

Question 1

Discuss in details the purposes of the statement of cash flows?

The main financial statements prepared by Woolworths are income statement, balance sheet statement, cash flow statement, retained earnings statement and changes in equity statement. The purpose of the statement of cash flows to present in the income (McLean et al., 2012).

This financial statement provides the required information on the financial health, position, and activities of the business to the investors and the creditors.

However, it can be stated that the cash flow is impacted by the use of an accounting approach either historical cost or fair value which will also affect the investment decision making process considering company assets and liabilities.

The main purpose of a cash flow statement is to highlight the gross payment and receipt in the current financial year. It enables the user of the financial statement to identify what are elements from which cash is generated and what are elements on which cash has spent by the company.

As the name indicates cash flow, it is aimed to concern on the cash activities and transaction in the business in the particular time period (Chea, 2011). The management and company also have the aimed to identify the amount of the cash that is reserved in the cash flow statement.

Question 2

Describe the concept of cash used in the preparation of the statement of cash flows – Cash and Cash equivalent?

The accountants consider only Cash and Cash equivalent when they are preparing the cash flow statement for the company. According to Cohen et al. (2011), cash flow gives an understanding of the company’s cash income and expenses for a particular time period which provides an insight into the cash transactions.

From this financial statement, the user of cash flow statement can gain an understanding of the performance of the company in the reference of the liquid assets (cash) (De Franco et al., 2011).  This will help the potential and existing suppliers in the decision making process in evaluating the company performance for the required period to take decisions to supply the material and equipment.

From the cash flow statement Woolworths, it can understand that there is a significant difference between the Cash and Cash equivalent. In this, the cash refers to the amount of money that is showing in the cash balance and bank.

It is because it is pure cash that can be used any time in a quicker manner. Beside of this, it is also identified that Cash equivalent indicates some short term investments those can convert into the cash any time. It is also part of the current liabilities.

The figure presents the cash flow statement of Woolworths. In this, it can be seen that cash can be recognized in the two manners. One is cash that is associated with the operating activities. It is pure cash that is presented in the cash accounts and bank account of the company.

The second form of the cash is Cash equivalent that can be seen in the investing activities and financing activities. The short term investment is not pure cash but by the sale of the short term investment, Woolworths can generate cash. Due to this, these investments are known as the Cash equivalent (Cohen et al., 2011).

Question 3

Explain why cash flows from operating activities are important to users of a statement of Cash Flow?

In the cash flow statement, the cash from the operating activities presents the summary of the cash transactions that are happened in the business. The operating activities include the cash received from the customers after the sales of the product and services.

The cash flow from the operating activities also includes the payment to the suppliers and employees in the business (Brigham and Houston, 2012). It also includes the net financial cost paid in the context of the interest and income tax paid in the context of the cash.

It is vital for the users of the cash flow statement to have the proper knowledge of the cash transactions of the company. In this, it can be seen that cash flows from operating activities are important to users of a statement of cash Flow because it helps the users to determine how well companies are working.

Moreover, it also helps to know whether the company is profitable or not. It detects and determines if the company can pay its short term liabilities or not because a company needs to enough cash to pay its short term liabilities. The cash flows from operating activities are important to users to determine the efficiency of the company to conduct its core activities (De Franco et al., 2011). The following figure shows cash flow from the operating activities of Woolworths.

 It provides the information to the users of the financial statements to an indication of the company performance.

Question 4

Why does the cash on hand balance as at the end of the financial year in the statement of cash flow not concur with the cash balance shown in current assets in the statement of financial position?

It can be said that the amount of cash balance in the statement of cash flow is not equal to the cash balance shown in current assets in the statement of financial position.

The main reason behind this difference is that the cash flow statement only includes the cash transaction that has been done by an organization. In concern to Woolworth, it is identified that the statements of cash flow are useful for the decision making the process as it provides these external parties help in evaluating the financial status of the company.

Generally, it is defined as operating income includes non-cash items like depreciation (Hidayat and Abdulla, 2015). This provides the detail to the investors and creditors that the company requires such amount on daily basis. On the other hand, Woolworth also includes their cash transaction in cash flow statement as per their activities like Operating, Investing, and Financing.

All these activities include the cash transactions for previous year’s activity and next year’s activity. It is because the statement of the financial year includes the transactions that are done in cash during the financial year (Doidge et al., 2018).

On the other hand, it is identified that cash balance shown in current assets in the statement of financial position shows the available can balance to the company. In concern to this, the cash in hand account includes the cash transactions related to the current financial year.

In addition, no one transaction related with previous or next financial year is included in this account. Due to this, it can be seen that the cash balance in the cash flow statement and statement of financial position shows the difference (Enomoto et al., 2015). However, it can be said that the cash flow statement and statement of financial position include the difference in their cash balance.

Question 5

Distinguish between cash flows from operating activities, investing activities and financing activities

The statements of cash flow are useful for the decision making the process as it provides these external parties to help in evaluating the financial status of the company.

The cash flow statement includes three different activities to separate the flow of cash in an understandable manner (Albertazzi et al., 2015). The below points are defining the difference between these activities as per the International Accounting Standard 7 (IAS 7):

Cash Flow from Operating Activities

In concern of cash flow statement, it is determined that cash flow contains the day to day transactions that are done for the operating activities that mean net amount of cash coming in the organization or leave from the routine operations of an organizations.

Generally, it is defined as operating income includes non-cash items like depreciation (Jensen, 2017). This provides the detail to the investors and creditors that the company requires such amount on daily basis (Bonner et al., 2014).

Cash Flow from Investing Activities

Under this, cash flow is included that take place due to investing activities in which mainly included the outflow for the assets that are for long term such as buildings, lands, and equipment etc.

At the same time, in which inflows from the sales of assets, securities and businesses etc. are also included in these activities (Du et al., 2015).  The key objective of these activities is to provide a description of the long term operations and future growth of the organization to the investors as well as creditors.

Cash Flow from Financial Activities

Under the cash flow from the financial activities, cash outflow for the investors of the organization and shareholders and cash inflows due to sales of the bonds or issuance of stock equity are included (Bartov and Mohanram, 2014). With the insight of financial activities, investors and creditors take the advantages while making the decision in concern of the company’s equity.

On the basis of above three activities of cash flow, it can be said that the International Accounting Standard 7 (IAS 7) has separated them to each for identification of ability to change cash flows in a future situation.

In addition to this, it is also identified that this choice of classification is allowed by IAS 7 to provide Woolworth’s liquidity and solvency information as well as it is helpful to evaluate the changes in assets, liabilities, and equity of the company (Daniel and Hirshleifer, 2015). In addition, this is in relation to the company ability to generate cash flow in the future and its ability to pay financial obligations like dividends.

Question 6

The direct method of preparing the cash flows from operating activities in a statement of cash flows

In a statement of cash flows, there are two methods to prepare the cash flows from operating activities like direct method and indirect method. During preparing the cash flow statement through direct method, the actual cash payment for operating activities and actual cash receipts from operating revenue are presented and arranged in the cash flow statement.

In addition to this, under the direct method, the difference between a cash payment and cash receipts is the net cash flow from operating activity. On the other words, it can be said that the profit and loss account (Income Statement) is prepared on the basis of cash in direct method.

At the time, preparing the cash flow statement through direct method different non-cash activities are ignored like Amortisation of Intangible Assets, Depreciation, Debenture discount, Preliminary expenses, etc.  It is because this method includes only cash transactions (Bonner et al., 2014).

On the other hand, it can also be said that this method does not include the adjustment activities ass loss or gain such as loss on sale of fixed assets, investment. However, it can be said that the direct method includes cash receipt from customers, cash paid to supplier and employees, income tax paid and extraordinary items.

Conclusion

It can be summarized that investors and creditors have a high reliance on the income statement, cash flow statement and balance sheet statement for their decision-making process.

These financial statements are used to gain an understanding of the company financial health and status, and allow comparison of past performance to predict their investment returns. It can be concluded that the main purpose of the cash flow statement is to determine the cash income and expense during the financial year.

Cash flow statement includes cash and cash equivalent in which cash refers to pure cash and cash equivalent refers to short term investments that can convert in cash.

Moreover, the cash flow from the operating activities is important for the users of the financial statement to know the actual business performance of the company and its efficiency in operation. It can also be summarized that cash flow from the operating activities includes cash transaction in the business operation activities.

Cash from the investing activities includes the cash from the investment such as sales and purchase of the assets. Beside of this, cash from the financial activities includes the cash transaction related to the transfer of share and debentures.

References

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Bartov, E. and Mohanram, P.S., 2014. Does income statement placement matter to investors? The case of gains/losses from early debt extinguishment. The Accounting Review89(6), pp.2021-2055.

Bonner, S.E., Clor-Proell, S.M. and Koonce, L., 2014. Mental accounting and disaggregation based on the sign and relative magnitude of income statement items. The Accounting Review89(6), pp.2087-2114.

Brigham, E.F. and Houston, J.F., 2012. Fundamentals of financial management. Mason: Cengage Learning.

Chea, A.C., 2011. Fair value accounting: its impacts on financial reporting and how it can be enhanced to provide more clarity and reliability of information for users of financial statements. International journal of business and social science, 2(20).

Chen, F., Hope, O.K., Li, Q. and Wang, X., 2011. Financial reporting quality and investment efficiency of private firms in emerging markets. The accounting review, 86(4), pp.1255-1288.

Cohen, J., Holder-Webb, L., Nath, L. and Wood, D., 2011. Retail investors’ perceptions of the decision-usefulness of economic performance, governance, and corporate social responsibility disclosures. Behavioral Research in Accounting, 23(1), pp.109-129.

Daniel, K. and Hirshleifer, D., 2015. Overconfident investors, predictable returns, and excessive trading. Journal of Economic Perspectives29(4), pp.61-88.

De Franco, G., Kothari, S.P. and Verdi, R.S., 2011. The benefits of financial statement comparability. Journal of Accounting Research, 49(4), pp.895-931.

Doidge, C., Kahle, K.M., Karolyi, G.A. and Stulz, R.M., 2018. Eclipse of the public corporation or eclipse of the public markets?. Journal of Applied Corporate Finance30(1), pp.8-16.

Du, N., Stevens, K. and McEnroe, J., 2015. The effects of comprehensive income on investors’ judgments: An investigation of one-statement vs. two-statement presentation formats. Accounting Research Journal28(3), pp.284-299.

Enomoto, M., Kimura, F., and Yamaguchi, T., 2015. Accrual-based and real earnings management: An international comparison for investor protection. Journal of Contemporary Accounting & Economics11(3), pp.183-198.

Goldstein, I. and Yang, L., 2015. Information diversity and complementarities in trading and information acquisition. The Journal of Finance70(4), pp.1723-1765.

Hidayat, S.E. and Abdulla, A.M., 2015. A comparative analysis on the Financial performance between takaful and conventional insurance companies in Bahrain during 2006-2011. Journal of Islamic Economics: Bank and Finance11(2), pp.149-162.

Jensen, M.C., 2017. Value maximisation, stakeholder theory and the corporate objective function. In Unfolding stakeholder thinking (pp. 65-84). UK: Routledge.

McLean, R.D., Zhang, T. and Zhao, M., 2012. Why does the law matter? Investor protection and its effects on investment, finance, and growth. The Journal of Finance, 67(1), pp.313-350.

Woolworths (2018) Annual Financial Report: [Online] Available at: https://www.woolworthsgroup.com.au/icms_docs/195396_annual-report-2018.pdf (Assessed: 18 Jan 2019)

 

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