Cash Flow Statements

A cash flow statement (or statement of cash flows) shows a fairly detailed description of the movement (or flow) of cash over a period of time. The cash flow statement includes with the cash flows from operating activities, investing activities, financing activities and provides the cash and equivalents total for the end of the reported period.

There are two methods of measuring the cash flows from operating activities

Direct Method

This is the simplest, yet the least used method. The requirements are simply to add up all the payments and receipts over the reported period to give a total that reflects on the cash flow statement.

Indirect Method

This method is the more popular method and is based on the principal that the sales revenue increases cash inflow while expenses increases cash outflows. “The indirect method adjusts net income for items that affected reported net income but didn’t affect cash” (Anon, n.d.)

Examples

ABC Limited reported a revenue of $ 1 000 000 at the year ending 31 December 2010. The income statement reflected a $ 140 000 tax payment and a Net Income of $ 34 000. Accounts receivable increased by $ 200 000; therefore cash collected on the revenue is $ 800 000 ($ 1 000 000 – $ 200 000). ABC Limited reported operating expenses of $ 825 000. Accounts payable (operating expenses) was reported as being $ 45 000; therefore cash operating expenses were $ 780 000 ($ 825 000 – $ 45 000). Tax payable at the end of the year was reflected as $ 0.00 which means the income tax payment was made during the year in cash.

Direct Method

Cash collected from revenues                                                   800 000
Cash payments for expenses                                                     780 000
Income before income taxes                                                            20 000
Cash payments for income taxes                                            140 000
Net cash flow from operating activities                                     (120 000)

Indirect Method

Net income                                                                                           35 000
Increase in accounts receivable                                         (200 000)
Increase in accounts payable                                              45 000         (155 000)
Net cash flow from operating activities                                    (120 000)

We can see that both methods result in the same net cash from operating activities. While direct looks directly at the cash in hand the indirect looks more at the income statement and uses trade payables and receivables to work out the cash flow from operating activities.

References

Anon (n.d.) Cash Flow Statement Example-Direct and Indirect Method [Online] Accounting for Management. Available from: http://www.accountingformanagement.com/preparation_of_statement_of_cash_flows.htm (Accessed: 16 April 2010).

Atrill, P. & McLaney, E. (2008) Accounting and Finance for Non-Specialists. 6th Edition. Financial Times Press.

Liability, Tax and Financial Reporting Requirements in South Africa

Legal Entity

Limited companies are, by law, legal entities that have a (perpetual) life of their own, irrespective of the owners/shareholders of the company. As stated by Atrill & McLaney (2011), this means that the company itself can be sued, or can sue another person/entity in its own capacity, irrespective of the owners. This is in direct contrast with sole proprietorships where, unlike the accounting (where the owner and the business is separate), the owner and the company are legally treated as the same entity, therefore the owner is the one who is liable if any legal issues arise.

Limited Liability

Perhaps one of the most important features of a company is that the shareholders of the company have a liability that is limited only to the equity (shares) they have in the business. If the company has a large outstanding debt which it is unable to repay, by law only the assets/equity the business itself owns can be liquidated to repay the outstanding amount, and the shareholders are not liable for any repayment in their personal capacities. Again this is in direct contrast, as mentioned above, with sole proprietorship where the sole proprietor themselves would be liable for any bad debts in their personal capacity and therefore even their “non-business” assets may be liquidated to fulfil debt payments.

Tax

Due to the two points mentioned above, a limited company therefore must be taxed as an entity. Most countries have separate taxation percentages for legal entities. These taxes are charged to the company and this does not exempt shareholders from their personal tax requirements, for example; receiving a dividend pay-out from the already taxed profits does not mean the shareholder doesn’t have to pay tax on the dividend pay-out as the dividend pay-out is a taxable income to them personally, the tax the company has paid is for the company.

South Africa – Accounting and Financial Reporting

South Africa currently has limited companies as well as another form of entity called a close corporation. Closed corporations are much easier to incorporate than regular companies and do not require full accounting audits, but have a number of other limitations compared with regular limited companies which are represented by (Pty) Ltd (eCompanies, n.d.). Close corporations in South Africa have, however, been phased out as of this year.  Regulations for limited companies in South Africa, as mentioned, require the financials to be audited by a firm of Chartered Accountants.  With effect from July 1, 2010, a new legislation amendment has been made to the companies act that states financial reporting standards “must be consistent with the International Financial Reporting Standards of the International Accounting Standards Board” (eStandardsForum, 2009).

References

Atrill, P. & McLaney, E. (2011) Accounting and Finance for Non-specialists. 7th Edition. England: Pearson Education Limited.

eCompanies (n.d.) What is a close corporation? [Online]. Available from: http://www.ecompanies.co.za/cc.htm (Accessed: 16 April 2011).

eStandardsForum (2009) South Africa – International Financial Reporting Standards [Online]. Available from: http://www.estandardsforum.org/south-africa/standards/international-financial-reporting-standards (Accessed: 16 April 2011).