Financial analysis: Francis Braganza explains how to prepare a cash flow statement, using November 2005's question as an example, with dates advanced two years.
| Author | Braganza, Francis |
| Position | Study notes: PAPER P8 |
It is said that the aim of cash flow reporting is to explore ways in which the underlying liquidity of a reporting entity can be revealed in accounting terms. Profit is regarded as an indicator of financial success, but, as anyone running a business will tell you, cash is king. The measurement of profit is usually based on a mixture of factual transactions and unavoidable subjective accounting judgments.
"The stock market prefers the fantasy of smooth growth to the reality of fluctuating operational performance. It falls to the creative accountant to ensure that those fluctuations are removed by hoarding profits in years of plenty for release in years of famine ... Just like sin, cash flow will eventually find a company out." So wrote lan Griffiths in his bestseller Creative Accounting.
The Financial Analysis paper comes as a bit of a shock to some candidates, especially the area of consolidations. From time to time there is no balance sheet or income statement to prepare, but a group cash flow statement may be required. Sometimes cash flows are examined in the objective testing part of the paper (section A) and sometimes they are included as part of analysis and interpretation, as in May 2007's 25-marker in section C. But any syllabus topic can be examined in any section of the paper, so it's not out of the question that cash flow could be examined in section B.
I firmly believe that, if you know the three-category format prescribed by IAS7 and--crucially--you follow the non-T accounts approach, you will be pleased to see this topic on your question paper.
Consolidation--ie, presenting the financial information of the group as if it were a single economic entity--is based on the key principle that "no man can make a profit by trading with himself". Accordingly, internal cash flows should be eliminated in preparing a consolidated cash flow statement. A dividend paid to a minority interest crosses the boundary of the group and should be shown under category three, as in the list in the panel on the left.
I understand that no particular form of consolidation working schedule will be required, since the examiner recognises that a variety of good practices exists in this area. But I feel that, while they aid people's understanding of financial accounting, using T-accounts as workings for a cash flow statement may be a waste of precious time, so it's probably helpful to get accustomed to making a columnar presentation of workings in all contexts.
Let's consider the exam question from the November 2005 paper: extracts from the...
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