CHAPTER 12 – CASH FLOWS

BACKGROUND
For any business it is important to ensure that:
- Sufficient profits are made to finance the business activities; and that
- Sufficient cash funds are available as and when needed.
Many think that if a business is making profit then there should be no shortage of
cash. This is not necessarily so. Examples of such situations are as follows:
a) A sole trader is making 400k a year profit. However, his drawings have been
over 600k a year for some time;
b) A company has been over-generous with credit terms to debtors, and this last
year extended the time in which debtors could pay from 1-3 months. In
addition it has taken on quite a few extra customers who are not creditworthy
and such sales may result in bad debts in the future;
c) A partnership whose products will not be on the market for quite awhile has
invested in some very expensive machinery. A lot of money has been spent
now, but no income will result in the near future.
In all of these cases, each of the businesses could easily run out of cash. Infact many
businesses fail and are wound up because of cash shortages, despite adequate
profits being made. Statements of cash flows can help to signal the development of
such problems.
WHERE FROM: WHERE TO
Cash comes from Cash goes to
1. Sale of goods and services Purchase of goods and services for resale
2. Sale of non-current assets Purchase of non-current assets
3. Decrease in inventory Increase in inventory
4. Decrease in accounts receivable Increase in accounts receivable
5. Capital introduced Drawings/Dividends
6. Loans received Loans repaid
7. Increase in accounts payable Decrease in accounts payable
CONSTRUCTION OF A STATEMENT OF CASH FLOWS (INDIRECT METHOD)
When net profit is included as a source of cash funds, the net profit figure has to be
adjusted to take account of items included which do not involve a movement of cash
in the period covered by the statement of cash flows. The most common items are
depreciation, allowances for doubtful debts, and book profits on the sale or disposal
of non-current assets.

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Format for an IAS 7 Statement of Cash Flows (indirect method)

XXX Ltd.
Statement of Cash Flows for the year ending 31 December 2019
KES '000 KES '000
Cash flows from operating activities
Operating profit before taxation XX
Adjustments for:
Depreciation XX
(Profit)/loss on sale of tangible non-current assets XX
Operating cash flows before movements in working capital XXX
(Increase)/Decrease in inventory XX
(Increase)/Decrease in accounts receivable XX
(Increase)/Decrease in accounts payable XX
XXX
Cash generated by operations XXX
Tax paid XX
Interest paid XX
Net cash from/(used in) operating activities XXX
Cash flows from investing activities
Dividends from joint ventures XX
Dividends from associates XX
Interest received XX
Payments to acquire intangible non-current assets XX
Payments to acquire tangible non-current assets XX
Receipts from sales of tangible non-current assets XX
Purchase of subsidiary undertaking XX
Sale of business XX
Net cash from/(used in) investing activities XXX
Cash flows from financing activities
Ordinary dividends paid XX
Preference dividends paid XX
Issue of ordinary share capital XX
Repurchase of loan note XX
Expenses paid in connection with share issues XX
Net cash from/(used in) financing activities XXX
Net increase/(decrease) in cash and cash equivalents XXX
Cash and cash equivalents at end of year XXX
Cash and cash equivalents at beginning of year XXX

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REVIEW QUESTIONS
1. Amanda is preparing her statement of cash flows for the 12 months to 30 Sep 2020
and you determine the following facts in relation to that financial year:
KES
Net profit for the year 227
Depreciation expenses 58
Increase in inventory 29
Decrease in accounts receivable 45
Decrease in accounts payable 36

Required:
On the basis of the above information, what net cash will have been generated
from operating activities according to the statement of cash flows?

2. You establish the following details in connection with the non-current assets of P.
Sahani for the year ended 31 Dec 2020:
KES
1 Jan 2020, non-current assets at cost less accumulated depreciation 460
Proceeds from the sale of non-current assets during the year 59
Depreciation expense for the year 68
Profit on the disposal of non-current assets during the year 12
31 Dec 2020, non-current assets at cost less accumulated depreciation 417

Required:
What figure for acquisition of non-current assets will appear in investing activities
section of statement of cash flows for Sahani’s business for yr. ended 31 Dec 2020?

3. D. Mudany
Income Statement for the year ending 31 Dec 2020
KES KES
Gross profit 44,700
Add: Discounts received 410
Profit on sale of van 620 1,030
45,730
Less Expenses
Motor expenses 1,940
Wages 17,200
General expenses 830
Bad debts 520
Increase in allowance for doubtful debts 200
Depreciation: Van 1,800 22,490
23,240

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 Balance Sheet as at 31 Dec
2019 2020
KES KES KES KES
Non-current assets
Vans at cost 15,400 8,200
Less Depreciation to date (5,300) (3,100)
10,100 5,100
Current assets
Inventory 18,600 24,000
Accounts receivable less allowance 8,200 6,900
Bank 410 720
27,210 31,620
Total assets 37,310 36,720
Current liabilities
Accounts payable 5,900 7,200
Non-current liability
Loan from J. Fry 10,000 7,500
Total liabilities (15,900) (14,700)
Net assets 21,410 22,020
Capital
Opening balance b/d 17,210 21,410
Add Net Profit 21,200 23,240
38,410 44,650
Less Drawings (17,000) (22,630)
Total Capital 21,410 22,020

* Accounts receivable 2019 KES 8,800 – allowance KES 600

* Accounts receivable 2020 KES 7,700 – allowance KES 800
Note: A van sold for KES 3,820 during 2020. No new vans purchased during the year
Required:
Draft a statement of cash flows for D. Mudany for the year ending 31 Dec 2020,
using the IAS 7 layout.