The document describes how to derive a cash flow statement from a company's balance sheet and profit and loss account. It involves adjusting the profit figure for non-cash items, analyzing movements in working capital accounts, and explaining changes in other balance sheet items like fixed assets, borrowings, and share capital to account for the change in cash from the opening to closing balance.

1. Unit 3
Derived Cash Flow Statements

2. Derived Cash Flow Statement
Typical accounting systems work on an “accruals” rather than a “cash” basis
For example, revenue is logged when the work is done (products delivered etc)
NOT when the cash is received

3. Derived Cash Flow Statement
Typical accounting systems work on an “accruals” rather than a “cash” basis
For example, revenue is logged when the work is done (products delivered etc)
NOT when the cash is received
So accounting systems do not cope well with producing cash flow statements
A derived cash flow statement is one arrived at using the company’s profit and
loss account and its opening and closing balance sheets.

4. Derived Cash Flow Statement
Start End of year
Fixed assets 1,000 1,500
Debtors (receivables) 500 425
Stocks (inventories) 300 325
Cash 25 75
Other current assets 100 125
Creditors (payables)<12m (350) (400)
Borrowings (750) (1,000)
Net assets 825 1,050
Share capital 500 550
Retained profits 325 500
825 1,050

5. Derived Cash Flow Statement
Start End of year
Fixed assets 1,000 1,500
Debtors (receivables) 500 425
Stocks (inventories) 300 325
Cash 25 75
Other current assets 100 125
Creditors (payables)<12m (350) (400)
Borrowings (750) (1,000)
Net assets 825 1,050
Share capital 500 550
Retained profits 325 500
825 1,050
The cash flow
statement maps
the opening cash
figure to the
closing one.

6. Derived Cash Flow Statement
Start End of year
Fixed assets 1,000 1,500
Debtors (receivables) 500 425
Stocks (inventories) 300 325
Cash 25 75
Other current assets 100 125
Creditors (payables)<12m (350) (400)
Borrowings (750) (1,000)
Net assets 825 1,050
Share capital 500 550
Retained profits 325 500
825 1,050
The cash flow
statement maps
the opening cash
figure to the
closing one.
As the balance sheet has to
balance we can show the
movement of cash by
explaining the movements of
everything else and picking out
those caused by cash.

7. Derived Cash Flow Statement
Start End of year
Cash 25 75
Fixed assets (1,000) (1,500)
Debtors (receivables) ( 500) (425)
Stocks (inventories) (300) (325)
Other current assets (100) (125)
Creditors (payables)<12m 350 400
Borrowings 750 1,000
Share capital 500 550
Retained profits 325 500
25 75

8. Derived Cash Flow Statement
Start End of year
Cash 25 75
Fixed assets (1,000) (1,500)
Debtors (receivables) ( 500) (425)
Stocks (inventories) (300) (325)
Other current assets (100) (125)
Creditors (payables)<12m 350 400
Borrowings 750 1,000
Share capital 500 550
Retained profits 325 500
25 75
Explain this
movement
By explaining
each of these
movements

9. Derived Cash Flow
We will need some extra information (this is all on the sheet posted to the TGF)
1 Summarised profit and loss account
Sales 10,000
Cost of sales 3,500
Operating costs 1,250
Operating profit 5,250
Interest 2,000
Tax 1,500
Net profit (earnings) 1,750
Dividends 1,575
Retained profits 175
2 Fixed assets were purchased for an unknown amount. A depreciation charge of £250 is included in
the above p&l
3 There was a bad debt write down of £100 in the above figures
4 New loans were taken out amounting to £250 and new shares were issued for £50.

10. Derived Cash Flow
Opening cash balance 25
Closing cash balance 75
Cash inflow for the year 50
Lets start with the easy
bit - what is the cash
flow? The rest of the
statement has to
explain this figure.

11. Operating profit
By convention we start with the operating profit.
This is £5,250.
But we know that some of the items were not related to cash:

12. Operating profit
By convention we start with the operating profit.
This is £5,250.
But we know that some of the items were not related to cash:
Specifically: Depreciation £250 and bad debt write off £100
So we adjust the operating profit by adding back these deductions
Adjusted operating profit 5,250 + 250 + 100 = £5,600

13. Derived Cash Flow
Opening cash balance 25
Closing cash balance 75
Cash inflow for the year 50
Adjusted operating profit 5,600

14. Working capital movements
Next we calculate the cash flow effects of the movements in working capital.
The working capital items are:
Start End
Debtors (receivables) 500 425
Stocks (inventories) 300 325
Other current assets 100 125
Creditors (payables)<12m (350) (400)

15. Working capital movements
Start End
Debtors (receivables) 500 425
Some of the debtors have been written off. So we know that part of the movement is “non-cash”.

16. Working capital movements
Start End
Debtors (receivables) 500 425
Some of the debtors have been written off. So we know that part of the movement is “non-cash”.
So, let us adjust the starting debtors by the write down.
Start End
Debtors (receivables) 500 – 100 = 400 425
So, has there been a positive or adverse cash flow relating to debtors?

17. Working capital movements
Start End
Debtors (receivables) 500 425
Some of the debtors have been written off. So we know that part of the movement is “non-cash”.
So, let us adjust the starting debtors by the write down.
Start End
Debtors (receivables) 500 – 100 = 400 425
So, has there been a positive or adverse cash flow relating to debtors?
As debtors have increased, this is adverse: our customers are paying more slowly.
So we put (25) on the cash flow.

18. Working capital movements
Start End
Stocks (inventories) 300 325
Other current assets 100 125
Creditors (payables)<12m (350) (400)
Let us consider the other working capital items.
Stocks have increased – good or bad for cash flow?
Creditors have gone up – good or bad for cash flow?

19. Working capital movements
Start End
Stocks (inventories) 300 325
Other current assets 100 125
Creditors (payables)<12m (350) (400)
Let us consider the other working capital items.
Stocks have increased – good or bad for cash flow?
Creditors have gone up – good or bad for cash flow?
Stocks increasing is bad for cash flow (25)
Creditors increasing in good for cash flow +50
What about other current assets?

20. Working capital movements
Start End
Stocks (inventories) 300 325
Other current assets 100 125
Creditors (payables)<12m (350) (400)
Let us consider the other working capital items.
Stocks have increased – good or bad for cash flow?
Creditors have gone up – good or bad for cash flow?
Stocks increasing is bad for cash flow (25)
Creditors increasing in good for cash flow +50
What about other current assets?
Now we can conclude from debtors and stocks that an increase in working capital assets is adverse,
so we treat this increase as (25)

21. Working capital movement
Start End of year Movement
Debtors (receivables) 500 425 50-100 = -25
Stocks (inventories) 300 325 -25
Other current assets 100 125 -25
Creditors (payables)<12m (350) (400) 50

22. Derived Cash Flow
Opening cash balance 25
Closing cash balance 75
Cash inflow for the year 50
Adjusted operating profit 5,600
Movements in working capital
Debtors (25)
Stocks (25)
Creditors 50
Other current assets (25)
Cash from operations 5,575

23. Fixed Assets movement
Let us now look at other movements on the balance sheet.
Start End of year
Fixed assets 1,000 1,500
We need to explain the £500 movement.

24. Fixed Assets movement
Let us now look at other movements on the balance sheet.
Start End of year
Fixed assets 1,000 1,500
We need to explain the £500 movement.
Opening fixed assets 1,000
Additions (cash) x
Depreciation (250)
Closing fixed assets 1,500

25. Fixed Assets movement
Let us now look at other movements on the balance sheet.
Start End of year
Fixed assets 1,000 1,500
We need to explain the £500 movement.
Opening fixed assets 1,000
Additions (cash) x
Depreciation (250)
Closing fixed assets 1,500
So the additions must be £750. This is cash spent and is called “capital
expenditure” or “capex”.

26. Derived cash flow, so far
Opening cash balance 25
Closing cash balance 75
Cash inflow for the year 50
Adjusted operating profit 5,600
Movements in working capital
Debtors (25)
Stocks (25)
Other current assets (25)
Creditors 50
Operating cash flow 5,575
Capital expenditure (750)

27. Borrowings and share capital
The next item on the balance sheet to explain is the movement in borrowings.
Start End
Borrowings (750) (1,000)
So the company must have borrowed £250 and nothing else happened.

28. Borrowings and share capital
The next item on the balance sheet to explain is the movement in borrowings.
Start End
Borrowings (750) (1,000)
So the company must have borrowed £250 and nothing else happened.
Similarly with the share capital
Share capital 500 550
Shares must have been issued to a value of £50.

29. Derived cash flow, so far
Opening cash balance 25
Closing cash balance 75
Cash inflow for the year 50
Adjusted operating profit 5,600
Movements in working capital
Debtors (25)
Stocks (25)
Other current assets (25)
Creditors 50
Operating cash flow 5,575
Capital expenditure (750)
New borrowings 250
Share issue 50

30. Retained profits
Next is the movement in retained profits.
Start End
Retained profits 325 500
The £175 is the retained profit on the profit and loss account. But we have only
accounted for the operating profit. We must therefore look at the items below
that:

31. Retained profits
Next is the movement in retained profits.
Retained profits 325 500
The £175 is the retained profit on the profit and loss account. But we have only
accounted for the operating profit. We must therefore look at the items below
that:
Interest 2,000
Tax 1,500
Dividend 1,575
If any of these were not paid then they would be included in creditors, which we
have already adjusted for. So we now can simply put these figures straight
into our cash flow.

32. Derived cash flow complete
Opening cash balance 25
Closing cash balance 75
Cash inflow for the year 50
Adjusted operating profit 5,600
Movements in working capital
Debtors (25)
Stocks (25)
Other current assets (25)
Creditors 50
Operating cash flow 5,575
Capital expenditure (750)
New borrowings 250
Share issue 50
Interest paid (2,000)
Tax paid (1,500)
Dividends paid (1,575)
Cash flow 50

33. I will put an excel spreadsheet
with this example on the TGF
Next Time
We shall look at Portfolio Theory and CAPM from unit 4