Why do we need projected statement of cash flows?According to former examiner,Ann Irons,forecast income statement reflects the 'profit' that a business hope to make,whereas projected statement of cash flows reflects the increase or decrease in cash that a business anticipated over a period of time.Projected statement of cash flows play a key role in the management of business's finance and therefore a key role in CAT paper 10 syllabus.
When the question asks for projected statement of cash flows,there will be forecast income statement,forecast statement of financial position(which show the closing balance of the items) and historical statement of financial position(which show the opening balance of the items) given.Students are required to use the information given to produce a projected statement of cash flows(format of IAS 7 is not required).The problem is how to determine the cash movement from these items?Let me guide you step-by-step.
Most of the time you should start from using the operating profit figure,then remember to add back the depreciation because it is a non-cash adjustment.Next check the additional information given carefully,if information given was "all interest charges are paid in the year in which they are incurred",then you can straight away deduct the interest charges because the information shows that money is paid for the interest.
Next,the more complicated items are tax and dividends paid.This is because the charge for tax and dividends in the income statement is not the same as the actual amount of cash to be paid out in the year.Therefore how to determine the actual cash paid by the company?Simple,just open an account for both of the items as working,so for example,in tax account,the debit side will be the balance b/d which is the balance given in historical statement of financial position's current liabities and also the tax charge in the forecast income statement,the credit side is the balance c/d which is the balance given in forecast statement of financial position,the balance of the tax account is the actual amount of cash paid for tax and it will be deducted in the projected statement of cash flows.Using the same method to find out the actual cash paid for dividends.
Next,another complicated one is to find out the cash paid for non-current assets.It is not possible to simply look at the difference between closing and opening balance of the assets because this amounts are net of depreciation(Net Book Value).Therefore,you need to know the amount of depreciation that is included in the forecast income statement,and any disposals that are anticipated during the year.After that,you need to use the closing balance of the assets to add back the depreciation because it is a non-cash adjustment and also add the disposal figure because you get money from sales of non-current assets,then only minus the opening balance of the assets,the balance will be the purchase of non-current assets.
After that,the items left to be considered should be the inventory,receivables in current assets and payables in current liabilities.So how to determine our cash inflows or outflows from these items?These items need your understanding,to find out the cash inflows or outflows from these items,you just need to take their closing balance and minus opening balance,that's all,simple right?But why it does not need to consider the sales,purchases or cost of sales value?The reason is because we are starting from OPERATING PROFIT,which means sales,purchases and cost of sales are already taken into account,so the things left is to find out the difference between closing and opening balance of these items.Ok here's the key point to understand,an increase in current assets such as inventories or receivables will cause a CASH OUTFLOW.This is because the company has brought more inventory or has effectively lent its customers some cash.Therefore for example,after using closing balance of inventory to minus opening balance of it,if you get a positive amount,it means increase in inventory,you will then need to include this inside the projected statement of cash flows as a deduction to operating profit.Another key point to understand is increases in current liabilities such as payables will cause a CASH INFLOW.This is because suppliers have lent the company money to buy supplies.Therefore for example,after using the closing balance of payables to minus opening balance of it,if you get a positive amount,it means increase in payables,you will need to include this inside the projected statement of cash flows as an increase to operating profit.
Finally you will get the projected cash balance after adding or deducting these items.To check whether your projected cash balance is correct or wrong,simply just perform a reconciliation of cash amount in the historical and forecast statement of financial position to get a cash balance,if your projected cash balance is same as this cash balance,you are doing a right thing and full marks are going to go into your pocket.
Seems like the projected statement of cash flows is not easy to do right?But it is not true,this type of question can be easily scored if you had understand how to treat different items in different ways rather than memorising like formula.I had provided some explaination on different items and I hope students can understand it,not memorising it.
It came out before as a 16 marks question in june 2006 exam and it was quite easy to score it if you follow the steps,I will provide a format of projected statement of cash flows.
Projected statement of cash flows
Operating Profit
Add depreciation
Less interest payment
Less tax payment(use account)
Less dividend payment(use account)
Less purchases of non-current assets(balance c/d+depreciation+disposal-balance b/d)
Less increase in inventory(balance c/d-balance b/d)
Less increase in receivables(balance c/d-balance b/d)
Add increase in payables(balance c/d-balance b/d)
Projected cash balance
I had fully explained how to do a projected statement of cash flows and as I said in previous blog that advance level papers of CAT require you to apply the knowledge,actually you need to analyse it too,when you really understand how to do it,you do not need to memorise anything,it comes naturally.Remember this was useful when working too,know what you are doing rather than do for passing exam.I hope this guidance is able to help students of CAT paper 10,good luck :)
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