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M17EFA Interpretation of the statement ofcash flowsSeminar questions (Solutions)Exercise 1Exercise 2 (Direct method)Alpha LimitedStatement of cash flows at 31 December 20X6££Cash flows from operating activitiesReceipts from customers 250,000 Payments to supplier of goods and services(185,000) (£175,000 + 10,000)Payments to employees (55,000) Cash generated from operations 10,000 Interest paid (350) Net cash inflow from operating activitiesCash flows from investing activitiesPurchase of office equipment 15,000Sale of property (25,000)Interest received 1,150Net cash inflow from investing activities11,150 Cash flows from financing activitiesLoan repaid (25,000)Net cash inflow from financing activities(25,000) Net decrease in cash and cash equivalentsCash and cash equivalents at 1 January 20X610,600 Cash and cash equivalents at 31 Dec 20X66,400Exercise 3(a) The direct method calculates the cash generated from operations by analysing totaloperating cash flows into:∙Cash received from customers∙Cash payments to suppliers∙Cash paid to and on behalf of employees∙Other cash paymentsThe indirect method takes the figure for profit before tax and adjusts it toconvert it into the cash flow from operations. Adjustments are made for non operating expenses (eg: interest payable and interest received), non-cashexpenses such as depreciation, and for changes in current assets and liabilities associated with operating profit eg changes in stock, trade debtors, prepaid expenses, trade creditors and accrued expenses.The direct method has been used in the statement of cash flows given.Explanation of direct method 2Explanation of indirect method 2Method used identified 1(5)(b) ReportSubject: Performance of AngeloTo: Treasury ManagerFrom:Date:The statement of cash flows is easy to understand because every figure represents an actual cash flow into or out of the business. It provides a bridge between the information in the Profit and Loss Account and that in the Statement of financial position. The statement of cash flows can provide useful information about the financial and liquidity management of the company.Many aspects of the cash flow of Angelo Ltd over the past three years give cause for concern. During the last three years the net cash flow from operations has fallen from an inflow of £937,000 to an outflow of £39,700. This seems due to a combination of falling cash receipts from customers, and increasing cash payments to suppliers and employees.The falling receipts from customers may be evidence of falling sales, an increasing period of credit being taken by customers, or even perhaps increasing discounts being given to customers to make early payment in order to improve cash flow.The cash payments to suppliers seem to be increasing relative to the cash collected from customers. This may be evidence of increasing purchase costs (which appear not to be being passed on to customers), or tighter credit control by suppliers (which is perhaps not being matched by tighter control on credit customers).The above is evidence of there being some pressure on profit margins. Further evidence of this is the increasing payments to employees. Other cash payments have been falling. However, it should be checked whether this is due to effective cost control or delays in paying invoices.The falling amounts of interest received may be due to falling interest rates and or a reduction in deposits and other loan investments. There is some evidence to support the latter since there seem to be significant receipts from the sale of non current assets investments. It is not clear how much scope there is for further receipts from the sale of non current asset investments, but the significant amount raised from their sale may be a sign of desperation. Despite the falling interest receipts interest payments are increasing significantly. This could be due to increasing interest rates (although this would be inconsistent with the fall in interest received), or, as may be more likely, increasing borrowing.The changes in the cash flows associated with investing activities are revealing. Investment in non current assets decreased significantly between 2002 and 2003 and had all but ceased in 2004. There have been significant disposals of non current assets and non current asset investments over the past three years.There were issues of both debentures and shares in 2003. Given the circumstances, it would be interesting to know whether or not the shares were issued at a premium and to whom these issues were made. The £175,000 raised from the share issue would not appear to be associated with any increased long-term investment in the company. The £300,000 raised from the issue of the debentures would appear merely to replace some of loans repaid over the three years. The issue of ordinary shares would appear to be necessary to finance increasing working capital requirements. This plus the fact that the dividend paid (on an increased capital base) has plummeted in 2004 give real cause for concern.It should be borne in mind that the statement of cash flows provides limited evidence as to the past performance of the company. Also, it is the future performance of the company which matters –not its past. Nevertheless, Angelo Ltd’s statement of cash flows reveals a number of items which are of concern and which should be investigated further.Please do not hesitate to get back to me if you have any further queries.Report format 2 Each substantive point, if supported by evidence: 2 marks to a maximumof 18Conclusions and style 5(25)Exercise 4(a) The annual accounts of large limited companies must be audited by a suitablyqualified independent auditor. The auditor is required to give an opinion as towhether or not the financial statements show a true and fair view. This iscontained in the auditors report which explains the work done by the auditor,whether or not the accounts conform with (in the UK) the requirements of theCompanies Act 1985 and applicable accounting standards (either internationalor UK), and whether they present a true and fair view of the company’s resultsand financial position. If everything is satisfactory the auditor’s report will beunqualified. The auditor will qualify the report if there is any disagreement withthe company’s directors which cannot be reconciled.The st atement of cash flows falls within the scope of the auditor’s report. Hencethe full year’s figures here are from the audited accounts for the previous year.However, the interim (or half year) results need not be audited – and here thatfact is highlighted. The main reason for this is the need for the interim figuresto be produced as quickly as possible in order to be useful to the capitalmarkets. This does not necessarily mean that the figures are wrong or suspect– but they may be subject to change during the auditing process.The fact that the football club produces interim financial statements suggeststhat it is a listed company. Listed companies are currently required (in the UK)to produce six monthly financial statements. In the USA the requirement is toproduce quarterly results and UK practice may follow USA practice in duecourse.1 mark per valid point up to a maximum of (3)(b) The profit/loss for the financial period is the figure reported in the club’sstatement of comprehensive income. This is not necessarily the same as thecash flow from operations. There are three main areas of difference:(i) The profit for the period is adjusted to the operating profit for the period.Operating profit is profit before tax and interest. This means adding backcharges for interest (finance expenses) and taxation (income taxexpense) and excluding investment income and interest received (financeincome).(ii) Non-cash items are then excluded. These include depreciation, impairment and amortization charges. These are allocated costs and donot represent actual cash flows. Actual cash flows arising from thepurchase and sale of non-current assets appear later in the statement ofcash flows.Non-cash items also include profits/losses on the disposal of non-currentassets and player registrations. These are excluded because the actualamounts of cash received will be reported later on in the statement ofcash flows.(iii) Finally, there are adjustments for movements in the working capital of the club, for example changes in inventories, receivables and payables.This adjustment is necessary to convert the performance measure of‘profit’ to the equivalent cash flow.The statement of cash flowss provided show all the above adjustments clearlyand account for the difference between profit and the movement in cash. Forexample, the most recent figures show an overall loss of £6,330,000 for the sixmonths –but the cash generated from operating activities is a positive cashflow of £1,769,000.1 mark per valid point up to a maximum of (6)(c) Wages paid to players are not separately disclosed in the statement of cashflows. These would be classified as an operating expense, so the amount ofcash generated from operations [£1,769,000 for the first six months of thecurrent financial year] is after the deduction of the amounts paid as wages.This football club has adopted international accounting standards, which it isnow required to do as a listed company with subsidiaries. Had the statement ofcash flows been prepared according to UK standards and the direct method hadbeen used, the total paid as wages and salaries would have been separatelydisclosed - but it would have been all wages and salaries and not just thepayments made to players.(1)(d) The following points are valid:∙ A variety of comparisons is possible for the data given eg last six months with the equivalent six months in the previous year, last year’s sixmonths with the previous full twelve months. This could be useful inidentifying possible seasonal effects, and possible estimates of amountsfor the whole of the current year.∙In each of the three periods the amount of money spent by the club is greater than the amount of money received by the club.∙At the end of the previous financial year and the previous first six months the club had positive cash resources. At the end of the first six months ofthe current year that has changed significantly and the club has negativecash resources of just under £15 million, mainly in the form of whatseems to be a large bank overdraft.∙The main reason for the negative cash flow is the very large amount spent on acquiring players. The amount spent in the first six months ofthe current year is more than double the equivalent for the first sixmonths of the previous year. There may be a seasonal effect here; theprevious year’s figures suggest that most of the amount spent onacquiring new players occurs in the first six months of the financial year.∙While expenditure on new players seems to have increased significantly, proceeds from the sale of player registrations seems to have fallensignificantly –less than 60% of the amount raised in the equivalent sixmonths of the previous year.∙Investments in non-current assets (ie property, plant and equipment) have fallen significantly in the last six months –just about 25% of theequivalent figure for the previous year.∙There is a significant increase in the amount raised from the sale of non-current assets, although this is small relative to the other cash flows.∙The amounts paid as interest seem to be falling and this is consistent with the amounts being repaid on borrowings –although the amount ofborrowings repaid in the most recent six months is less than half theamount for the equivalent six months for the previous year. It might bethat the amounts of interest being saved because borrowings are repaid isbeing offset by increased interest payments on overdrafts.∙Apart from bank financing through overdrafts there has been no additional borrowing during the first six months of the current financialyear.∙Dividends paid seem to be very low compared with the previous periods.This may be due to reduced dividends or to the delay in the payment ofdividends. If control is in the hands of one or a few shareholders, thismay also be evidence of optimizing cash flows in the short term.∙There seem to be significant changes in the management of working capital in the first six months of the year, with significant decreases inreceivables and payables.∙There is a cash outflow for share issue expenses – but no evidence of an issue of shares in the last 18 months. This might be a forthcoming issueof shares, or a bonus issue of shares –but there is insufficientinformation here.∙It would be simplistic to say that there is a possibly worrying deterioration in the cash flow management of the club. Nevertheless, there is evidenceof significant changes which could usefully be investigated by seeking outinformation from elsewhere in the financial statements and from othersources – and the full year results should be interesting.∙Finally, it should be noted that the biggest cash outflow is in respect of investing activities. If these are well chosen investing activities theyshould result in enhanced cash flows in future years.2 marks per developed substantive point up to a maximum of (20)(30)。