Accounting Business Reporting for Decision Making

268 Accounting: Business Reporting for Decision Making

ILLUSTRATIVE EXAMPLE 7.1

Difference in profit and cash position

According to the statement of profit or loss of Mum’s Choc Heaven Pty Ltd, the entity made a profit

of $7900 for the month of March 2016. The statement of profit or loss reflects the transactions for

the month, which included sales of products worth $20 000 ($5000 of which has been collected),

rent paid of $1000 and wages paid of $4000. The depreciation relates to shop fixtures and fittings

the entity has been depreciating over a period of time. The entity also purchased and paid for $6000

worth of products from its supplier, but the cost of the products sold during the month amounted

to $5600. (The other $400 will form part of inventory and be recorded as an asset on the balance

sheet.) The statement of cash flows shows that the entity’s cash position is negative $4000 (i.e. the

bank account is in overdraft) at the end of March 2016, despite having a $2000 credit balance at the

beginning of the month.

A comparison of the two statements shows that, although Mum’s Choc Heaven Pty Ltd was quite

profitable for the month of March, the business will have trouble meeting its financial obligations. This

illustrates the importance of the statement of cash flows: it allows users of the statement to quickly see

what money is coming in and how the money is being used. The following statements demonstrate

that, although income of $20 000 was generated, only $5000 of the sales were collected in cash during

the period. It also demonstrates that, while depreciation is an expense incurred by the entity, it does

not involve an outflow of cash and, as such, is a non-cash item. Mum’s Choc Heaven Pty Ltd needs to

address the collection of debts if the entity is going to survive and meet its financial obligations when

they fall due. As you can observe, a quick glance at the statement of cash flows can show a user if an

entity has a good cash position or not. In general, for an entity to survive, the net cash flows from oper-

ating activities should be positive.

Mum’s Choc Heaven Pty Ltd

Statement of profit or loss for the month of March 2016

Income

Cost of sales

$20 000

5 600

Gross profit 14 400

Expenses

Rent

Wages

Depreciation

$ 1 000

4 000

1 500 6 500

Profit $7 900

Mum’s Choc Heaven Pty Ltd

Statement of cash flows for the month of March 2016

Beginning cash balance

Cash flows

Receipts from sales

Payments for inventory

Payments for rent

Payments for wages

($6 000

(1 000

(4 000

)

)

)

$ 5 000

(11 000)

$ 2 000

Net cash flows ( 6 000)

Closing cash balance ($ 4 000)