Accounting Business Reporting for Decision Making

CHAPTER 7 Statement of cash flows 295

its obligations, carry on as a going concern and to expand. If an entity has negative cash flows from

operations, it might have difficulty in meeting its finance and investing obligations.

• Cash receipts from customers are less than cash payments to suppliers and employees. This could

indicate that insufficient cash is being generated from the entity’s operations. Possible reasons for this

situation include the entity underpricing its goods, having too few sales, or not being paid by its cus-

tomers. In any case, immediate action is warranted for the entity’s long-term survival.

• Net cash from operating activities is lower than profit after tax. Profit includes non-cash items such as

depreciation, so generally cash from operating activities should be higher.

• Proceeds of share capital are used to finance operating activities. Once again, this indicates that the

entity might be having difficulty meeting its financial obligations.

• Inflows from investing activities are inconsistent. Generally, spending cash on investments (outflow)

indicates a healthy growth entity. It is these investments that will generate future cash flow. Inconsistent

inflows from investing activities would mean that the entity is selling off major assets, indicating that

it is downsizing or needing to sell assets to pay debts.

• Proceeds from borrowing are continually much greater than the repayment of borrowings. If proceeds

from borrowings are significantly greater than the repayment of borrowings over a long period, it

might indicate that borrowings are continually being used to finance investment and operations.

Again, it is important for the cash flow from operations to be positive to ensure the entity’s long-term

survival.

Trend and ratio analysis

The preceding section provided a general analysis of the statement of cash flows. Such analysis gives

a general feel for the activities of the business, but trend and ratio analysis can provide a more detailed

evaluation of an entity. This will be discussed in more detail in chapter 8.

Trend analysis is conducted by comparing information about an entity (including key financial data

and ratios) over a long period of time. Recall that figures from the previous year are often presented for

comparison purposes in financial statements. Figure 7.4 shows key figures from the statement of cash

flows of JB Hi-Fi Ltd over the period 2005–15. Examining each component over the ten years can help

identify trends and give the user a picture of past and current performance.

In figure 7.4, comparing the statement of cash flows for 2014 and 2015 indicates that the

cash position of JB Hi-Fi Ltd has increased. The overall cash position at the beginning of 2015 was

$43.4 million compared to $49.14 million at the end of 2015. Cash flows from operating activities,

which provide the lifeblood of the entity, increased from $41.3 million to $179.8 million. Given

the general economic downturn, this is a great result; however, a watchful eye over the next year

is necessary, especially given that sales increased only slightly. Comparing the operating cash flow

individual balances across 2014 and 2015 shows that receipts have increased more significantly than

payments to suppliers. This was discussed earlier in regard to the management of that inventory cycle

and points to firm management of the working capital cycle that was introduced at the beginning of

the chapter.

In 2005, there was a negative cash flow from operating activities, suggesting that not enough of the

sales were collected to cover operating expenses. Also that year, significant investments were made both

in payments for plant and equipment and in buying other businesses as compared to the previous year.

The group bought a 70 per cent stake in Clive Anthonys and the remaining 30 per cent stake in 2008.

Then, in the following years, the group carried out its strategy of opening new stores across Australia

and New Zealand. The overall inflows of cash from financing activities had been relatively low from

2005, and then in 2011 large borrowings were drawn. Except in the years 2007 to 2009, there does seem

to be significant payment of dividends each year relative to the cash from operating activities.

Generally, a comparison of the years from 2005 to 2015 shows that cash from operating activities

fluctuated, major businesses were acquired and significant dividends were paid.