Statement of cash flows

What the statement of cash flows shows

Profit is not the same as cash. The statement of cash flows explains how cash and cash equivalents changed during the year, under three headings:

• Operating activities: cash from the company's main trading.
• Investing activities: buying and selling non-current assets and investments.
• Financing activities: issuing or repaying shares and loans, and paying dividends.

The indirect method

Start with profit before tax, then:

1. add back non-cash expenses, such as depreciation, amortisation and impairment;
2. remove non-operating items, such as the profit or loss on disposal of assets and finance costs;
3. adjust for changes in working capital: an increase in inventory or receivables uses cash, and an increase in payables saves cash;
4. deduct interest paid and tax paid.

Worked example

Profit before tax is $500,000 and depreciation is $120,000. During the year inventory rose by $40,000, receivables rose by $30,000 and payables rose by $25,000.

• Cash generated from operations = $500,000 + $120,000 − $40,000 − $30,000 + $25,000 = $575,000.

Finding missing figures

FR questions rarely give you the cash figures directly. Use T-account style workings for property, plant and equipment, tax and loans: opening balance, add the items that increase it, take off the items that reduce it, and the balancing figure is the cash flow. For example, the cash paid for new assets is the balancing figure in the PPE working, after depreciation, disposals and revaluations.

Common mistakes

• Getting the working capital signs the wrong way round.
• Including the profit on disposal as cash, instead of the sale proceeds in investing activities.
• Forgetting deferred tax when working out the tax paid.

Interpretation

Section C may ask you to comment on a statement of cash flows. Look at whether operating cash covers interest, tax, dividends and investment, and whether the company is relying on new borrowing.