Cash Flow Statements: Indirect Method

notes Flow Statements Indirect Methoda) world-wide story Standard 7 (IAS 7) lays down the standards evaluate by companies when presenting information almost changes in change or bills equivalents. Under IAS 7, a gild is required to present a teaching of coin flow wake the changes in specie and notes equivalents from the three key argonas of operating, investing and backing (Wheetman, 2006)1.The definition of notes and cash equivalents includes cash, as well as some(a)(prenominal) another(prenominal) investments that ar considered high runniness and can be easy converted into a known amount of cash. When presenting cash flow statements, in that location are two main ways that are recognised by IAS 7 direct and corroborative, although a preference is shown for the direct system.The direct order involves reporting the cash flow gross, as it happens, so that all cash out and all cash in are precisely interpreted gross without all adjustments do for other facto rs.On the other hand, the indirect method shows the net cash flows once all other factors deport been taken into account. It is non necessary for companies to use the direct method and receivable to the costly process of looking through all receipts and expenses, it is practically more common for companies to use the indirect method (Schwartz, 1996)2 .b) China humans Limited (CWL), as is the depicted object with m some(prenominal) large companies, has opted to report its cash flow statements in an indirect way. The cash flow statement in the published accounts year ended 31st December 2007 reflects this choice fully however, there is no discussion as to why the direct method was not used.During the prepaproportionn of the accounts, CWL has made several assumptions in order to produces the cash flow statements. For example, wear and tear is accounted for during the cash flow statement, as it is not a true expense. When the pull in figure, which is the starting point for the cash flow statements, is calculated, the depreciation is taken into account based on the depreciation policies being followed by the union. In the cheek of CWL, the property owned by the alliance is depreciated over 20 old age, fixtures and fittings over a range of 5 to 10 years and motor vehicles over a period of 5 years. As these amounts are merely policy choices and are d angiotensin-converting enzyme on a swell line method, the actual amount allocated to depreciation has no immediate posture on the actual cash flow statement and is, therefore, added back on to the ultimate net profit figure during the indirect method calculation. A kindred approach is taken with amortisation of intangible assets where the initial be of these assets are spread across the expected life span of the asset. This is not an actual cash movement and is, therefore, added back on to the final profit figure during the cash flow statement (Mills, 1991)3.Additional adjustments are indeed made to i nclude cash based transactions such as interest receivable in an attempt to show a really accurate fancy of cash flow movement. Changes in inventory levels are assumed to reflect the amount of cash available, directly. This is not necessarily the case and it is merely an assumption that CWL has made for the benefit of the cash flow statement (Mills Yanamura, 1998)4.Other assumptions that deal been made are likely to have an allude on the cash flow. For example, when calculating the net profits, there is an allowance made for bad debtors. This figure is purely an estimate based on introductory experiences and the perceived risks associated with the various creditors that are related to the company at any time. In using the indirect method, these assumptions provide still bear some relevance to the bottom line, meaning that a change of policy or assumption can have a direct impact on the way in which the cash flow statement looks (Barth, 2006)5.As CWL has internationalistic op erations, it has to deal with the currency fluctuations that occur throughout the year. As the consolidated accounts are presented in pounds sterling, cash values in local currency accept to be converted at the exchange rate between the democracy in which the transaction occurs and British sterling. CWL takes the approach of averaging the exchange rate over the period in which the transactions took place. This assumption is necessary as it simply is not possible to take an accurate exchange rate at the exact point in which a transaction is undertaken. However, it does have a potentially misleading impact on the cash flow statement. extension 1 contains a copy of CWLs accounts as they would appear, had the direct cash flow approach been taken.c) The cash flow statement is merely one aspect of the financial analysis of the companys financial status. Although cash flow and the fluidity of the company is vital in the overall wellness of the company, it is not the only measure of succe ss. Firstly, let us consider the liquidity of the liquidity role of CWL.One of the most commonly used ratios is that of the liquidity ratio known as the underway ratio. This shows the companys power to meet its veritable liabilities with its current assets. For true financial health, a company wishes to see a ratio that is as high as possible, and at an absolute minimum at least 11. In the case of CWL the ratio in 2007 was 1.905, which in itself is particularly level-headed and is even better when it is compared with the previous years figure of 1.734. This increase in the current ratio is primarily due to better management of the money owed by creditors to the company.A further liquidity test is that of the acid test, which is similar in nature to the current ratio but shows a practically starker picture as it looks at the ability of the company to meet its current liabilities purely by the use of cash or cash equivalents. In reality, this is a more realistic view of the comp anys liquidity position as its main aim is to be able to pay any liabilities that are imminently due, without the need to cash in any other assets, even if they are considered current. In analysing the acid ratio, it is possible to see a different picture of CWL. Although the current ratio shows a particularly healthy liquidity position, it is clear that much of the current assets of CWL are tied up in inventories or in receivables (Chirinko Schaller, 1995) 6. CWL should aim to manage receivables and inventories better in order to bring the quick ratio closer to the desirable 11 position. Although the figure of 0.508 falls considerably short of this ideal ratio, it is a vast approach on the 2006 figure of 0.383.As well as liquidity the positiveness of the company should be considered. This is the view of how well the company is using its assets to produce a suitable rate of devolve. The main profitability ratio is that of gross profit margin. As CWL is a manufacturing based comp any, it is expected that the figure will be at the lower end of the case however, the figure of 35.95% is relatively healthy and shows a good rate of profit. scorn this, attention should be given to the cost of sales relative to revenues as they have dropped substantially since 2006 where the figure was 50.19%. This could be attributed to the acquisition of a sore subsidiary. Therefore, it is anticipated that, in time, better use of the cost of sales will be made and the gross profit margin will recoup to a figure closer to 50%.A final ratio of importance is that of the give on beauteousness. As CWL relies heavily on the shareholders equity, it is of abundant importance whether or not the shareholders are receiving a good return on their investment. In its broadest terms, the return on equity ratio shows how much return the company is generating in return for every pound that is lay out into the company. As a general rule, the high the return on equity ratio, the better the company is doing, although it should be noted that some companies that require poor in the way of financial investment such as consulting firms will almost always have a better return on equity ratio than manufacturing firms such as CWL (Costales Szurovy, 1994)7.Once again, in canvass the return of equity in relation to CWL, a downward campaign between 2006 and 2007 can be seen. This is almost entirely due to the sore acquisitions. Therefore, the direct investment in the consolidated company is considerably higher yet, there has been insufficient time to allow this cash injection to be suitably used to generate increased returns. In a similar way to the gross profit margin, it would be expected that this figure would return to the 2006 figure rapidly and would in the long term be an improvement on the 2006 figures.It should be noted that when looking at these ratios the consolidated accounts have been used. There was a large acquisition made during the year at bottom the grou p and this has had an impact on the ratios, during 2007. The overall health of the company in terms of liquidity and profitability is good and the slight apparent change over in the figures will be reversed in the years to follow due to the increasing investments being put into the ongoing expansion of the company.The calculations and dilate of the ratios referred to above are contained in Appendix 2.Appendix 1 direct Cash FlowCash flows from operating activitiesCash receipts from customers 2,336,967Cash paid to suppliers and employees (1,496,917)Cash generated from operations (sum) 840,050 engross paid (8,615)Income taxes paid (52,188) nett cash flows from operating activities 779,247Cash flows from investing activitiesProceeds from the sale of equipment/assets (60,247)Interest received 3,336Acquisition of subsidiaries (88,209) mesh cash flows from investing activities (145,120)Cash flows from financing activitiesIssue of ordinary share capital 202,500Costs of issue (13,750) ent hronement from minority interests 48,360Interest paid (8,615)Proceeds from bank borrowings 138,172Net cash flows from financing activities366,667Appendix 2 Ratios Relating to CWLRatioCalculationFiguresResult sure ratio 2007 new assets / current liabilities2,284,972 / 1,199,2641.905Current ratio 2006Current assets / current liabilities1,187,951 / 684,8961.734Quick Ratio 2007Current assets (cash equivalents) / Current liabilities609,391 / 1,199,2640.508Quick Ratio 2006Current assets (cash equivalents) / Current liabilities262,080 / 684,8960.383 revenue Profit Margin 2007(Revenue Cost of sales) / Revenue(2,336,967 -1,496,917) / 2,336,96735.95%Gross Profit Margin 2006(Revenue Cost of sales) / Revenue(1,064,479 530,234) / 1,064,47950.19%Return on right 2007Net income / total equity266,372 / 3,148,5768.46%Return on Equity 2006Net income / total equity155,506 / 1,133,96613.71%BibliographyBarth, Mary E., Including Estimates of the emerging in Todays fiscal Statements, story Horizons, Vol. 20, 2006Carslaw, Charles A., Mills, John R., Developing Ratios for Effective Cash Flow Statement Analysis, ledger of Accountancy, Vol. 172, 1991Chirinko, Robert S., Schaller, Huntley, Why Does Liquidity Matter in Investment Equations? diary of Money, credit Banking, Vol. 27, 1995Costales, S.B., Szurovy, Geza, The Guide to Understanding Financial Statements, McGraw-Hill Professional, 1994Elliott, Barry, Elliott, Jamie, Financial write up, Reporting and Analysis International Edition, Pearson Education, 2006Mills, John R., Yamamura, Jeanne H., The Power of Cash Flow Ratios, ledger of Accountancy, Vol. 186, 1998Schwartz, Donald, The Future of Financial Accounting Universal Standards,Journal of Accountancy, Vol. 181, 1996Shim, Jae K., Siegel, Joel G., Financial Management, Barrons Educational Series, 2000Weetman, Pauline, Financial Accounting An Introduction, Pearson Education, 2006Footnotes1 Weetman, Pauline, Financial Accounting An Introduction, Pearson Education, 20062 Sch wartz, Donald, The Future of Financial Accounting Universal Standards, Journal of Accountancy, Vol. 181, 19963 Carslaw, Charles A., Mills, John R., Developing Ratios for Effective Cash Flow Statement Analysis,Journal of Accountancy, Vol. 172, 19914 Mills, John R., Yamamura, Jeanne H., The Power of Cash Flow Ratios, Journal of Accountancy, Vol. 186, 19985 Barth, Mary E., Including Estimates of the Future in Todays Financial Statements, Accounting Horizons, Vol. 20, 20066 Chirinko, Robert S., Schaller, Huntley, Why Does Liquidity Matter in Investment Equations?Journal of Money, Credit Banking, Vol. 27, 19957 Costales, S.B., Szurovy, Geza, The Guide to Understanding Financial Statements, McGraw-Hill Professional, 1994