How to tackle the statement of cashflow in Financial Statements

Cashflows are like Marmite…. you either love it or hate it.  I hate Marmite, it tastes awful, but I do love a good cashflow question. We quite often get asked how to master financial statements?

The key to these is practice.

Practice, practice, practice.

Financial Statements

How to tackle the statement of cashflow in Financial Statements

Cashflows are like Marmite…. you either love it or hate it.  I hate Marmite, it tastes awful, but I do love a good cashflow question. We quite often get asked how to master financial statements?

The key to these is practice.

Practice, practice, practice.

With financial statements there is an awful lot of information to work through, it is easy to get lost or muddled and before you know it, there are numbers all over the place and you have no idea what is happening anymore.

So, I wanted to share my thought process and what I am looking for when I am tackling these questions.

I thought I would work through Task 1 in the AAT practice assessment 1.

Where to start with your financial statements?

The first thing I do, before looking at the statements, is look at what has been provided for me in the actual task…

This will help me understand what I am going to have to do in this task.

There is a reconciliation to do, there is a statement of cash flow to fill in and they have also provided me with two working boxes.

One for the proceeds on a disposal of PPE and one for purchases of PPE.

So straight away, I know that during the year, I have sold some assets and I have purchased some assets and these working boxes will need filling in.

Note* Never leave any working boxes blank, always fill them in, if you make any errors in the statements, you can gain marks from the working boxes… unless you have left them empty.*

The first thing to do in this task is the reconciliation of profit before tax to net cash from operating activities.

By making the necessary adjustments I can find out how much cash was generated by operating activities.

The adjustments are going to be any non-cash items, any items dealt with elsewhere (things like investment income and dividends), and the working capital (inventory, receivables, and payables).

Note* It is important you understand these adjustments… this will help you work through all this information properly.*

I open my statements and I see that I have a statement of profit and loss (SPL) and a statement of financial position (SFP).

I will look through the SPL… (I will ignore the SFP for now).

I can see all the SPL figures and some additional information underneath.

Additional information

I read all the additional information, so I know what is there. Everything here is important, so I make sure I read it and I do not miss anything out.

  1. The total depreciation charge for the year was £4,992,000
  2. PPE with a carrying amount of £543,000 was sold during the year
  3. Land was revalued upwards during the year by £7,000,000
  4. All sales and purchases were on credit, other expenses were paid for in cash
  5. A dividend of £4,000,000 was paid during the year

Here are my thoughts on this

Depreciation is a non-cash adjustment, so this is going to be part of my reconciliation.

The sold PPE will be dealt with in my working boxes (because I know I have working boxes for this).

The increased land value will increase my PPE so this will likely be part of my PPE working boxes.

All the sales and purchases are on credit. These will be dealt with in my reconciliation when I adjust the working capital for trade receivables and trade payables.

All other expenses are paid in cash so all the other expenses can be ignored as we are only adjusting for non-cash items in the reconciliation.

The dividend paid will be entered in the finance activity section of the cash flow statement, so it is not part of the reconciliation.

Note* Do you see that by understanding the adjustments I need to make, I can comfortably work through all this additional information and sort through it one line at a time, deciding what I need and do not need for my reconciliation. This is where I would like you to be in your knowledge too.*

The reconciliation

I always begin the reconciliation with the profit before tax figure, so this is the first thing I am looking for to start my reconciliation off.

I enter this at the top…

Profit before tax = £16,400

 

I am then going to look for anything in the SPL above the profit before tax figure that needs adjusting for.

I will start with the profit before tax and I work my way upwards to the top of the SPL.

The first thing I get to is the finance costs (normally interest). This has decreased the profit so I will need to add it back in the reconciliation.

Now you may be thinking “Why is the finance costs an adjustment, surely that is a cash expense”.

No. Think of how the SPL works. The SPL entry needs to be exactly 1 year, so this could include accruals and prepayments, so it may not be exactly what was paid in interest, so it is a non-cash item and needs adjusting. This is why it is added back and then I will deduct the exact interest paid at the same time as I deal with any tax paid, right at the very end of this reconciliation.

Finance costs = £3,200

 

The next thing I get to is the admin and the distribution costs.

These are expenses and can be ignored because they are cash expenses.

(Number 4 in the additional information).

The next thing is the profit on disposal of PPE.

This is not a cash profit as this is based on accounting figures including depreciation.

So, this is a non-cash item so needs adjusting for. It has increased the profit, so it needs to be deducted in the reconciliation.

Profit on disposal of PPE = (£139)

 

The final three things in the SPL, are gross profit, cost of sales, and revenue.

Gross profit is made up of revenue less cost of sales.

Cost of sales is made up of the change in inventory and purchases.

These three things can all be ignored, (even though I know purchases and sales are all credit sales so do need adjusting for).

(Number 4 in the additional information).

I will adjust for them when I adjust for the working capital which is inventory, receivables, and payables, so the working capital adjustments will deal with sales, purchases, and inventory.

That is it, I am now at the top of the SPL so that is the SPL dealt with, from revenue to the profit before tax figure.

I now need to include the depreciation from the additional information which is £4,992,000.

(Number 1 in the additional information).

I need to be careful here.

Look at all the top of both statements, and the working boxes, and the reconciliation boxes, and the statement of cash flow.

At the top of all of these is £000.

This means all of this is in thousands, so if I enter £10, that is £10,000.

If I enter £10,000, that is £10,000,000.

But the additional information gives the full figures, so to enter £4,992,000 depreciation, I must enter it as £4,992, If I enter £4,992,000, I will be saying it is £4,992,000,000.

Depreciation has reduced the profit, so I need to add it back in the reconciliation.

Depreciation = £4,992

 

I will now need to go to the SFP to get the information I need, to adjust for the working capital section which is inventory, receivables, and payables.

For these, I need to think of the cash position.

Is it good or bad for our cash if these are increasing or decreasing?

If inventory has increased, it is bad for cash as the business has more cash tied up in inventory so the increase will need deducting to reduce the cash position.

If receivables have increased, it is bad for cash, as the business has more sales on credit, so less cash has been received, so the increase will need deducting to reduce the cash position.

If payables have increased, this is good for cash, as the business has more purchases on credit, so is paying less cash to its suppliers, so the increase will need adding to increase the cash position.

It is the opposite to these explanations if any of them have decreased.

For each of the working capital items, I need to decide if they are increasing or decreasing first.

Note* It is important to pay attention to the years at the top of the SFP so you can properly decide if they are increasing/decreasing. If you do not pay attention it can be very easy to get these mixed up.*

I deal with inventories first

Inventories at the start of the year is £18,608, at the end of the year it is £22,732.

This is an increase of £4,124 so will need deducting in the reconciliation.

Adjustment in respect of inventories = (£4,124)

Next is trade receivables

Trade receivables at the start of the year is £15,162, at the end of the year it is £18,251.

This is an increase of £3,089 so will need deducting in the reconciliation.

Adjustment in respect of trade receivables = (£3,089)

 

Next is trade payables

Trade payables at the start of the year is £12,316, at the end of the year it is £14,712.

This is an increase of £2,396 so will need adding back in the reconciliation.

Adjustment in respect of trade payables = £2,396

 

I now have a “Cash generated by operations” figure in the reconciliation.

It is £19,636 after entering all the adjustments above (highlighted).

The last thing to do is to deduct the exact interest paid and the exact tax paid in the year.

Note* The finance costs and the tax figure in the SPL is the amount for a whole year so could include accruals and prepayments so may not be the exact amounts being paid out in the year.*

 

Interest paid

Have they given me any information about interest?

There is no working box for interest.

There is nothing mentioned in the additional information about interest.

There is no information about any interest liability in the SFP.

There is no information anywhere about interest, so because of this, the actual interest paid must be the £3,200 finance cost.

(There would be some other information if it were different).

This needs deducting as it is a payment so will reduce the cash position.

Interest paid = (£3,200)

 

Tax paid

Have they given me any information about tax?

There is no working box for tax.

There is nothing mentioned in the additional information about tax.

But in the SFP, it does show that there has been a change in the tax liability.

This means I can work out the exact tax paid.

Tax liability at the start of the year = £4,120.

A full year’s tax (from SPL) = £3,546.

If I add these two figures together, it gives me a total amount owed of £7,666, but at the end of the year the tax liability is £3,270.

The difference between these two must be the amount of tax that was paid during the year.

£7,666 – £3,270 = £4,396

This needs deducting as it is a payment so will reduce the cash position.

Tax paid = (£4,396)

 

That is the reconciliation finished

I now have a “Net cash from operating activities” figure from the completed reconciliation.

It is £12,040.

This reconciled figure of £12,040 is entered at the top of the statement of cash flows.

Net cash from operating activities = £12,040

 

Working boxes

Now before I start to fill in any more of the statement of cash flows, I will fill in both of my working boxes that they have given me for the PPE.

The first working box is “Proceeds on disposal of PPE”.

I now need to look through the information I have, to see what I can find about a disposal of PPE.

I can see that the PPE sold, has a carrying amount of £543,000.

(Number 2 in the additional information).

Because it is the carrying amount, I know I do not have to deal with any depreciation for this.

Again, I do have to be careful with the figure from the additional information as it is the full figure, but the working box is in thousands, so to enter £543,000 into the working box, it needs to be entered as £543.

I will enter this into the working.

Carrying amount of PPE sold = £543

 

The only other information I can see is in the SPL, I have made a profit on disposal of PPE for £139.

As this is a profit, it is what I have received for the sale above the carrying amount value, so if I add this to the carrying amount, it will get me to the proceeds received for the sold PPE.

I will enter this into the working as an addition.

Profit on disposal of PPE = £139

 

The working box adds these together for me and I now have a proceeds figure of £682.

Total disposal proceeds = £682

 

This means that I sold the PPE for £682,000, the PPE was worth £543,000 so I made a profit on this disposal of £139,000.

 

The last working box is “Purchases of PPE”

I now need to look through the information I have, to see what I can find about anything that affects the PPE figures.

In the SFP I can see that there is a change in the PPE amounts from the start of the year to the end of the year. I can include these in my working box.

The amount of PPE at the start of the year can be entered first. This is my starting point as it is already entered, I just need to include the figure… Be careful of the years at the top of the SFP so you enter the correct figure.

(It is easy to get mixed up if you rush).

PPE at start of year = £31,962

 

Now the idea here is to include anything that increases/decreases the PPE figure, and I should end up with the PPE figure at the end of the year.

The only thing is, I have an extra addition…. There has been some PPE purchased but I do not know how much for.

That is what I am trying to work out in this working box.

To help me work that out, I will enter the PPE figure at the end of the year, but I will deduct it.

The reason this works is, if I include all the known increases/decreases, then deduct the year-end figure, the remaining figure will be the amount spent on the addition of PPE.

I am now going to enter the PPE at the end of the year as a deduction.

I enter this on the bottom line of the working box, leaving room to enter the increases/decreases that have happened during the year.

PPE at end of year = (£77,736)

 

I have now dealt with all PPE figures in the SFP, and PPE is not part of the SPL as it’s an asset, so the only place left to look is in the additional information that we went through earlier.

There is a depreciation charge of £4,992,000.

(Number 1 in the additional information).

Now the PPE figures in the SFP are the carrying amount figures so all accumulated depreciation has been dealt with, but this depreciation charge will reduce the PPE value, so it does need to be included as a deduction.

(Knock off the three zeroes).

Depreciation charge = (£4,992)

 

An item of PPE was sold with a carrying amount of £543,000.

(Number 2 in the additional information).

This was part of the PPE and has been sold so it now needs removing from the PPE amount.

This will reduce the PPE value so is included as a deduction.

(Knock off the three zeroes).

Carrying amount of PPE sold = (£543)

 

Land was revalued upwards by £7,000,000.

(Number 3 in the additional information).

Land is part of the PPE so this will increase the value of PPE so is included as an addition.

(Knock off the three zeroes).

Revaluation = £7,000

 

That is the increases/decreases dealt with and I have no more room in the working box, so that is my working box completed. This has given me total PPE additions figure of (£44,309).

This means the purchase of PPE during the year was £44,309.

Statement of cash flows

I have filled in all my working boxes and I can now go back to the statement of cash flows and start to fill that in.

I have already entered my net cash from operating activities figure of £12,040 at the top.

The first thing I get to is the “Investing activities”.

This is going to be any proceeds from selling an asset or any purchases for buying an asset.

These are the two figures I have worked out in my working boxes so I can enter these straight away.

Proceeds on disposal of PPE = £682

(Money received so positive cash).

Purchases of PPE = (£44,309)

(Money being paid out so negative cash).

This gives me a “Net cash from investing activities” figure of (£43,627).

 

Financing activities

The next thing I get to is the “Financing activities”.

Here you will deal with things like shares, loans, and dividends.

The first thing I look for is shares

I check the additional information and I see nothing is mentioned in that about shares.

I then look at the SFP.

(Paying attention to the years at the top so I do not make an error).

Share capital at the start of the year = £20,000.

Share capital at the end of the year = £30,000.

This is an increase of £10,000 during the year.

I also need to include the share premium as this is extra cash received for the shares and I need to include that cash as I am doing a cash flow statement, so I am including any cash movements.

Share premium at start of year = £6,270.

Share premium at end of year = £9,340.

This is an increase of £3,070 during the year.

This gives me a total share increase of £13,070.

(£10,000 share capital + £3,070 share premium).

I will include this as an addition as this is cash received.

Proceeds of share issue = £13,070

 

The next thing is the loans

I check the additional information and I see nothing is mentioned in that about loans.

I then look at the SFP.

(Paying attention to the years at the top so I do not make an error).

Bank loan at start of year = £18,000.

Bank loan at end of year = £40,000.

This is an increase of £22,000 during the year.

This is entered as an addition as this is cash received.

Bank loans = £22,000

 

The next thing is dividends

This is mentioned in the additional information.

(Number 5 in the additional information).

There is a dividend paid during the year of £4,000,000.

There is nothing else mentioned anywhere about dividends, so this is the only dividend to deal with.

This was paid during the year so will be entered as a deduction.

(Money being paid out so negative cash).

Note* I must remember this is a figure from the additional information, so I need to knock off the three zeroes.*

Dividends paid = (£4,000)

 

This gives me a “Net cash used in financing activities” figure of £31,070.

 

Now I need to enter the cash figures from the SPL so I can work out the cash movement for the year.

I will fill in the bottom two entries of the statement of cash flows first which is cash and cash equivalents at the beginning and end of year.

I will find this information in the current assets and current liabilities section of the SFP.

Positive cash will be a current asset, negative cash (bank overdraft) is a current liability.

(I pay attention to the years at the top, so I do not make an error).

 

Cash and cash equivalent at the start of the year.

There is £372 (current asset), nothing in the overdraft (current liability).

Cash and cash equivalent at the end of the year.

There is nothing in the current assets but there is (£145) in the current liability…. (Bank overdraft).

 

I can now enter these figures into the statement of cash flows.

Cash and cash equivalent at beginning of year = £372
Cash and cash equivalent at end of year = (£145)

This is a decrease of £517 for the year.

There was £372 positive cash at the start of year, and I ended the year with negative cash of (£145).

£372………… £0………. (£145)

<————-£517————–>

This can now be entered into the statement of cash flows.

Net increase/(decrease) in cash and cash equivalents = (£517)

 

That is everything filled in…. Phew!!!!!

I now want to check that the statement of cashflows balances.

Net cash from operating activities = £12,040 Money in.

Net cash from investing activities = (£43,627) Money out.

Net cash from financing activities = £31,070 Money in.

Total = (£517) Money out. There was £517 more money going out, than coming in.

This does match the cash decrease of (£517) in the statement of cash flows.

 

My statement balances

WOOOOO HOOOOO!

That is a lot of work but was also a lot of fun.

It is such a good feeling to get a statement to balance.

This is worth 32 marks in the AAT mock so is definitely worth practicing.

I hope you find my thoughts on this useful and I will leave you with this final thought.

I still do not like Marmite!!!!!

Blog credit – Phil Toomer – AAT Tutor

 

Further reading

Want to learn more? Take a look at the following resources:

How to pass Financial Statements first time
AAT Optional Units
Life after AAT

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