Cash Flow Statements Revision Notes for Grade 12 NSC Matric Accounting

Cash Flow Statements

What is the purpose of a cash flow statement?

The cash flow statement serves a unique and vital purpose in understanding a company's financial health. While the income statement shows us the business's profit or loss, and the balance sheet tells us what the company owns and owes on a specific date, neither of these statements shows us where the business gets its cash from or how it spends its money.

The cash flow statement fills this crucial gap. It tracks the actual movement of cash into and out of the business during a specific period. This is essential because a company can be profitable on paper but still struggle with cash flow problems, or conversely, a company might show losses but still have strong cash generation from its operations.

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The cash flow statement is the missing piece that bridges the gap between profitability and liquidity. It answers the critical question: "Where did our cash actually come from and where did it go?"

Basic concepts and terminology

Understanding cash flow statements requires mastering some key concepts:

Cash inflow refers to money coming into the business. In the cash flow statement, cash inflows are shown without brackets. Examples include cash from sales, proceeds from selling assets, or money received from issuing shares.

Cash outflow represents money going out of the business. These amounts are shown with brackets in the statement. Examples include purchasing fixed assets, paying dividends, or repaying loans.

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"Cash is King" - cash flow statements focus entirely on the cash aspects of business operations, not on accounting profits or book values. This fundamental principle drives all cash flow analysis.

The three main sections of cash flow statements

Operating activities

Operating activities represent the most common source of cash for a healthy company. This section includes all cash flows related to the main business operations - not just buying and selling stock, but also paying creditors, receiving money from debtors, and covering operating expenses.

The operating activities section starts with cash generated from operations (calculated in Note 1), then subtracts cash outflows for interest paid, dividends paid, and income tax paid to arrive at the net cash flow from operating activities.

Investing activities

Investing activities focus on the buying and selling of fixed assets and the increasing or decreasing of investments. This includes purchasing equipment or buildings (cash outflow), selling old machinery (cash inflow), or investing in fixed deposits (cash outflow when the deposit increases).

These activities are typically less frequent than operating activities but often involve larger amounts of money. A growing company will usually show net cash outflows in this section as it invests in new assets.

Financing activities

Financing activities show how a company is funded through loans and capital. This section includes:

Issuing new shares (cash inflow)
Repurchasing shares (cash outflow)
Obtaining loans (cash inflow)
Repaying loans (cash outflow)

Preparing a cash flow statement

Sources of information

All the information needed to prepare a cash flow statement can be found in three places:

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Essential Sources for Cash Flow Preparation:

The income statement - provides profit figures and expense details
The balance sheet - provides opening and closing balances for various accounts
The notes - provide additional transaction details

The key is calculating the difference between this year's and last year's figures to determine the flow of cash.

Working with the format

Cash flow statements follow a standard format with specific requirements:

Cash inflows appear without brackets
Cash outflows appear in brackets
Each main section totals to show the net cash flow
Notes provide detailed calculations for major items

Notes to the cash flow statement

Note 1: Reconciliation between profit before tax and cash generated from operations

This note is crucial because it explains why the profit figure differs from the actual cash generated. The reconciliation follows this process:

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Worked Example: Converting Profit to Cash Generated

Step 1: Start with profit before tax from the income statement.

Step 2: Add back non-cash expenses:

Depreciation - This reduces profit but doesn't involve cash leaving the business
Interest expense - Added back because interest paid is shown separately in the statement

Step 3: Adjust for working capital changes:

Increase in inventory - Cash outflow (more stock purchased)
Decrease in debtors - Cash inflow (debtors paid more)
Increase in creditors - Cash inflow (paid creditors less)

These adjustments convert the accounting profit into the actual cash generated from day-to-day operations.

Note 2: Cash and cash equivalents

This note tracks the movement in the company's cash position. It simply compares the cash and bank balances at the beginning and end of the year, taking the figures directly from the balance sheet.

The net change calculated here should match the total net change shown at the bottom of the main cash flow statement - this serves as an important verification check.

Note 3: Dividends paid

Calculating dividends paid requires understanding the difference between dividends declared and dividends actually paid:

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Worked Example: Calculating Dividends Paid

Formula: Dividends paid = Total dividends for the year - Amount owed at the beginning + Amount owed at the end

Last year's dividend liability (shown in brackets) was paid during this year
This year's dividend liability is declared but not yet paid, so it doesn't affect cash flow

Note 4: Taxation paid

Similar to dividends, tax paid differs from tax expense:

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Worked Example: Calculating Tax Paid

Formula: Tax paid = Total tax for the year - Balance owed at the beginning + Balance owed at the end

The SARS balance can appear in different places on the balance sheet:

Under trade and other payables (if the company owes SARS)
Under trade and other receivables (if SARS owes the company)

Worked example breakdown

Let's examine how each section works using a practical example:

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Worked Example: Complete Cash Flow Statement Calculation

Operating activities calculation: Starting with cash generated from operations (R56 200 from Note 1), we subtract:

Interest paid: R8 840 (cash outflow)
Dividends paid: R8 500 (cash outflow from Note 3)
Income tax paid: R13 900 (cash outflow from Note 4)
Net cash from operating activities: R24 960

Investing activities calculation:

Purchase of fixed assets: R48 500 (outflow)
Proceeds from sale of fixed assets: R4 800 (inflow)
Increase of investment: R5 000 (outflow)
Net cash from investing activities: (R48 700)

Financing activities calculation:

Proceeds from shares issued: R79 600 (inflow)
Repurchase of shares: R24 600 (outflow)
Payment of long-term loans: R6 000 (outflow)
Net cash from financing activities: R49 000

Final verification: Total net change: R24 960 + (R48 700) + R49 000 = R25 260

This matches the increase in cash and cash equivalents from R12 040 to R37 300.

Key exam tips

Watch your dates! Make sure you're using figures from the correct year when calculating differences.
Understand brackets: Cash inflows have no brackets, cash outflows are in brackets. An overdraft is shown in brackets because it represents negative cash.
Check your work: The net change in cash must equal the difference between opening and closing cash balances.
Know your sources: Income statement figures are added to profit, balance sheet figures require calculating differences between years.
Master the notes: Each note has a specific calculation method - learn the formulas for dividends paid and tax paid.

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Always double-check that your final net change in cash matches the difference between the opening and closing cash balances from the balance sheet. This is your primary verification that all calculations are correct.

Remember!

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Key Points to Remember:

Cash flow statements show where money comes from and where it goes - they complement the income statement and balance sheet by focusing purely on cash movements
The three main sections are operating, investing, and financing activities - operating activities should typically be the largest source of cash for a healthy company
Cash inflows appear without brackets, cash outflows appear in brackets - this visual system makes it easy to identify the direction of cash movement
The notes provide essential calculations - particularly for converting accounting profits to cash generated from operations and determining actual cash payments for dividends and tax
Always verify your answer - by ensuring the net change in cash equals the difference between opening and closing cash balances on the balance sheet

Cash Flow Statements (Grade 12 NSC Matric Accounting): Revision Notes