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Corporate Accounting

Table of Contents

Abstract

Introduction.

Literature Review to examine the relative information content of the statement of cash flows and the income statement

Examination of the consolidated Cash Flow Statements.

Major sources and uses of cash.

The trend in cash flow from (continuing) operations.

Comparison of the net profit after tax with the cash flow from operations in income statement

Cash Flow to Capital Expenditures (CF to CAPEX) ratio.

Cash Flow from operations for the dividend payments.

Uses of excess generated Cash Flow from Operations.

Use of working capital as sources or uses of cash.

Other major items affected cash flows.

Trend in capital expenditures.

Trend in dividends.

Trend in net borrowing.

Trend in working capital accounts.

Evaluation of the financial strength based on the Statement of Cash Flows.

Evaluation of the three companies for lending purposes.

Summary.

Reference.

Introduction to Australian Evidence on Analysts' Cash Flow Forecasts

The income statement and the cash flow statement, the two financial statements provide different set of information. The income statement and the cash flow statement are essential parts of the balance sheet of a company. The statement of cash flows or the cash flow statement measures the sources of cash and its uses for a company over a specific period of time. On the other hand, the income statement deals with the financial performance of the company, such as profits, or losses, revenues or expenses for a specified period of time. That’s why income statement is sometimes called a statement of financial performance.

But the cash by accountants and financial experts have been considered to be the king as income statements are vulnerable to manipulations but cash cannot. Hence in the report, an evaluation of various cash perspective and the cash flow statement of three Australian listed companies will be conducted namely BHP Ltd, Santos Ltd, and Funtastic Ltd.

Literature Review to Examine the Relative Information Content of The Statement of Cash Flows and The Income Statement

Both the income statement and the cash flow statement (and the position statement) are considered to be the integral parts of company’s financial statements. The income statement determines the financial performance of a company by quantifying factors including sales, expenses, losses, or profits over a specific time period. On the other hand, the statement of cash flows (or the cash flow statement) determines the inflows and outflows of cash from the company, in other words, the sources of cash and its relevant uses for a company over a specific time period (Fang and Slavin 2019).

Income statement are prepared on accrual basis that means credit sales for which cash has not yet been received are also included to increase the profit figures. On the other hand cash flow statement is prepared on the cash basis and shows whether a company is actually generating cash or not, that means credit sales will not become a part of cash flow statements.

Cash flow statement is divided into three major parts including cash flow from:-

  1. Operating Activities
  2. Investing Activities
  3. Financing Activities

Cash flow from operating activities resembles income statement, but relatively produces better performance results. Although, large numbers of corporate managers, investors and other stakeholders are more relied toward net income, but cash flow statements can provide better metric of the financial health of the company due to the following two main reasons:-

  1. Cash is considered to be the king (popularly phrased as "Cash is king") because a company that is not able to generate cash for a long term is basically on its deathbed, irrespective of reporting positive “book-profits” (Aggarwal, Kulkarni and Ritadhi 2019).
  1. Cash flows are harder to manipulate if a company follows AASB (or GAAP or IFRS) accounting standards as compared to net income (as discussed in next section).

Cash is king

It is an accounting fact that cash flow position can remain negative while company is making a profit. It can be understand with the case study of rogue trader Nick Leeson, an employee at Barings banks, who booked huge profits on papers but there were zero cash inflows. Considering the large book-profits that Leeson showed, Barings kept on funding (cash outflow) him, which eventually led into bankruptcy of Barings- Bank.

Manipulations

An example of income manipulation can be "stuffing the channel". To increase sales, company liberates its credit policy and provides incentives to retailers. As a result accrued earnings get increased, but actual cash never get received. The company’s sales increase for one quarter, at the cost of next period called "stealing of sales” (Chen et al. 2019).

The cash flow statement can catch such gimmicks. For example, when operating cash flows are lower than net income, then it becomes evident that there are some errors or loopholes in the cash cycle of the company.

In extreme cases, a company could report negative operating cash flow in consecutive quarters, but legitimately report positive EPS in accordance with AASB, such situations indicates towards a cash hemorrhage (receivables, inventories, etc.). These situations can cause liquidity or solvency issues to the company.

Limitation of Financial Statements

The limitation of a statement of financial position (balance sheet) and financial performance (income statement) as a source of information for users of general-purpose financial statements are as follows:

  1. Only Interim Reports:

These statements are not able to give a clear picture of the business. The data provided are mere approximations, but the actual position can vary deeply, and is only determinable in situation of the liquidated of the business.

The allocation of incomes and expenses depends on the personal judgment of accountants. The existence of various accounting standards and their complexities makes these statements imprecise (Jaensirisak and Sangsawang 2016).

  1. No Precision:

Unlike cash flow statement, the precision of data related to balance sheet and income statement is not possible because these statements are based on various factors which are not stated precisely, but are based judgments and approximations. Also, the data keeps getting recorded by following the conventional procedures over years, when various conventions, personal judgments, postulates, etc. gets developed.

  1. Do not Give Exact Position:

Data manipulation (as discussed above) is very easy with both balance sheet and income statement. For example, when company sells largely on credit, it will have dual impact:

First: it will increase the revenues and eventually the net profits.

Secondly: It will increase the accounts receivables that will eventually inflates the overall assets in the balance sheet, but the most important point to be noticed is that there is no inflow of real cash into the business (Ciuhureanu 2019).

Similarly, at another times, businesses can overly charge their assets with large depreciations to reduce net profits and reduce net assets to wrongly gain tax benefits. But cash flow statements are negligibly impacted by non-cash charges like depreciation.

Examination of The Consolidated Cash Flow Statements

Major Sources and Uses of Cash

 

BHP

Santos

Funtastic

Major Source

Operating Cash through revenue generation

Cash Receipts through operations

Issuance of stock in investing activities

Major Use

Payment of dividend

Retirement or repayment of debt

Cash Payments for operations

The Trend in Cash Flow from (continuing) Operations

  1. BHP: The trend says that the cash flow from (continuing) operations increases in 2018 as compared to 2017 and again decreased in 2019. However there is an overall increment in 2019 as compared to 2016.
  1. Santos: The trend is a continuous increasing trend year on year from 2017 to 2019.
  2. Funtastic: The cash flow performance is very poor for Funtastic, the company’s overall cash generation from operations is negative in all the three years which is depleting further in 2018 as compared to 2017, and there is a heavy depletion year on year. A little recovery can be witnessed in 2019 but as compared to 2017, year 2019 still exposed to heavy fall in cash generation or making larger payments.

Comparison of The Net Profit After Tax with The Cash Flow from Operations in Income Statement

  1. BHP: The Company has generated larger cash from operations, then the net profit values. It indicates that the company has expensed very larger on non cash expenditures like depreciation which is increasing the cash flow and typically decrease the net profit
  2. Santos: Net income in 2017 remains negative, however recovered in future years and followed an increasing trend. The lower levels of income than cash indicate that company has larger expenses which are non-cash which is artificially inflating the cash flow from operations because the non-cash expenses gets add back in the amount of net profit to compute operating cash flow.
  3. Funtastic: The Company has very volatile net profit values which are heavily negative in the year 2017, and rose to equivalent positive position in the subsequent year. The net profit level again decreased in the year 2019, however remain positive. The cash flow performance is very poor for Funtastic, the company’s overall cash generation from operations is negative in all the three years which is depleting further in 2018 as compared to 2017, and there is a heavy depletion year on year. A little recovery can be witnessed in 2019 but as compared to 2017, year 2019 still exposed to heavy fall in cash generation or making larger payments.

Cash Flow to Capital Expenditures (CF to CAPEX) Ratio

BHP

 

2017

2018

2019

Cash From Operating Activities

16804

18461

17871

Capital Expenditure

4161

5921

2607

Ratio

4.04

3.12

6.86

The company is generating higher level of cash as compared to its capital expenditure or capex. That means the firm able to generate enough cash from operations to pay for all of its capital expenditures

Santos

 

2017

2018

2019

Cash From Operating Activities

1248

1578

2046

Capital Expenditure

534

2373

1033

Ratio

2.34

0.66

1.98

The company is generating higher level of cash as compared to its capital expenditure or capex. That means the firm able to generate enough cash from operations to pay for all of its capital expenditures

Funtastic

 

2017

2018

2019

Cash From Operating Activities

-2.75

-10.18

-8.03

Capital Expenditure

0.99

0.3

0.15

Ratio

-2.78

-33.93

-53.53

The company is not able to generate sufficient level of cash as compared to its capital expenditure or capex, in fact the company has negative cash flow from operations. That means the firm is not able to generate enough cash from operations to pay for all of its capital expenditures.

Cash Flow from Operations for The Dividend Payments

BHP

 

2017

2018

2019

Cash From Operating Activities

16804

18461

17871

Total Cash Dividends Paid

2921

5220

11395

Ratio

17.38%

28.28%

63.76%

 

Santos

 

2017

2018

2019

Cash From Operating Activities

1248

1578

2046

Total Cash Dividends Paid

0

73

251

Ratio

0.00%

4.63%

12.27%

 

Funtastic

 

2017

2018

2019

Cash From Operating Activities

-2.75

-10.18

-8.03

Total Cash Dividends Paid

0

0

0

Ratio

0.00

0.00

0.00

Uses of Excess Generated Cash Flow from Operations

  1. BHP: The Company has generated excess cash; it has used its excess cash in payments of asset purchase or capital expenditure and payments of dividend to the shareholders. Also the company has made a larger repayment of its outstanding debts.
  2. Santos: The Company has generated significant cash and also raised some funds through equity; it has used its excess cash in payments of asset purchase or capital expenditure and payments of dividend to the shareholders. Also the company has made a repayment of its outstanding debts.
  3. Funtastic: The Company has not generated significant cash; in fact the company has negative cash flow from operations. Thus there are zero dividend payments and minimal capital expenditures. The company also raised some funds through debt.

Trend in Capital Expenditures

BHP

 

2017

2018

2019

Cash From Operating Activities

16804

18461

17871

Capital Expenditure

4161

5921

2607

 

Santos

 

2017

2018

2019

Cash From Operating Activities

1248

1578

2046

Capital Expenditure

534

2373

1033

 

Funtastic

 

2017

2018

2019

Cash From Operating Activities

-2.75

-10.18

-8.03

Capital Expenditure

0.99

0.3

0.15

Trend in Dividends

BHP

 

2017

2018

2019

Cash From Operating Activities

16804

18461

17871

Total Cash Dividends Paid

2921

5220

11395

 

Santos

 

2017

2018

2019

Cash From Operating Activities

1248

1578

2046

Total Cash Dividends Paid

0

73

251

 

Funtastic

 

2017

2018

2019

Cash From Operating Activities

-2.75

-10.18

-8.03

Total Cash Dividends Paid

0

0

0

Trend in Net Borrowing

  1. BHP: The company is continuously making repayments of debt
  2. Santos: The company is continuously trying to lower its debt
  3. Funtastic: The Company has not generated significant cash; in fact the company has negative cash flow from operations. Thus there are zero dividend payments and minimal capital expenditures. The company also raised some funds through debt.

Evaluation of The Financial Strength Based on The Statement of Cash Flows

The statement of cash flow is one of the financial statements that can typically be used to quantify the financial strength of a business entity. Other financial statements include the balance sheet and the Income Statement.

On the basis of the analysis of the cash flow statements of the three companies, it can be clearly stated that BHP is in the best financial health as compared to the other two and Funtastic have the poorest financial condition. Funtastic is not able to generate sufficient cash flows and its cash payments are exceeding, it will soon face liquidity and later solvency issues which might affect the going concern concept of the company.

The first two companies doesn’t have higher issues related to liquidity, but Santos also is not in a very good shape, the cash generation is good but the net profit levels are increasing reasons for possible manipulations.

Evaluation of The Three Companies for Lending Purposes

As per the analysis of the cash flow statements of the three companies, it can be clearly stated that BHP is in the best financial health as compared to the other two and can be considered optimal for lending purposes.

Santos also is not in a very good shape, the cash generation is good but the net profit levels are creating doubts for possible manipulations. The company has also increased its dividend payments substantially.

Funtastic have the poorest financial condition. Funtastic is not able to generate sufficient cash flows and its cash payments are exceeding, it will soon face liquidity and later solvency issues which might affect the going concern concept of the company.

The first two companies doesn’t have higher issues related to liquidity, but Santos also is not in a very good shape, the cash generation is good but the net profit levels are increasing reasons for possible manipulations.

Summary of Australian Evidence on Analysts' Cash Flow Forecasts

Both the income statement and the cash flow statement (and the position statement) are considered to be the integral parts of company’s financial statements. The income statement determines the financial performance of a company by quantifying factors including sales, expenses, losses, or profits over a specific time period. On the other hand, the statement of cash flows (or the cash flow statement) determines the inflows and outflows of cash from the company, in other words, the sources of cash and its relevant uses for a company over a specific time period.

For the report, discussion has been focused on three Australian listed entities namely BHP, Santos and Funtastic. As per the analysis of the cash flow statements of the three companies, it can be clearly stated that BHP is in the best financial health as compared to the other two and can be considered optimal for lending purposes. Santos also is not in a very good shape, the cash generation is good but the net profit levels are creating doubts for possible manipulations. The company has also increased its dividend payments substantially. Funtastic have the poorest financial condition. Funtastic is not able to generate sufficient cash flows and its cash payments are exceeding, it will soon face liquidity and later solvency issues which might affect the going concern concept of the company. The first two companies doesn’t have higher issues related to liquidity, but Santos also is not in a very good shape, the cash generation is good but the net profit levels are increasing reasons for possible manipulations.

Reference for Australian Evidence on Analysts' Cash Flow Forecasts

Aggarwal, B., Kulkarni, N. and Ritadhi, S.K., 2019. Cash is King: The Costs of Digitization. Available at SSRN 3418430.

Carney, M., 2015. Breaking the Tragedy of the Horizon–climate change and financial stability. Speech given at Lloyd’s of London, 29, pp.220-230.

Chen, X., Lu, M., Shan, Y. and Zhang, Y., 2019. Australian evidence on analysts' cash flow forecasts: issuance, accuracy and usefulness. Accounting & Finance.

Ciuhureanu, A., 2019. Study on the Opportunities and Limitations of How to use the Information Provided by Financial Accountancy. Land Forces Academy Review, 24(3), pp.220-225.

Drake, M.S., Hales, J. and Rees, L., 2019. Disclosure Overload? A Professional User Perspective on the Usefulness of General Purpose Financial Statements. Contemporary Accounting Research, 36(4), pp.1935-1965.

Fang, J. and Slavin, N.S., 2019. Cash Is King: An Easy Way to Prepare Cash Flow Statements (A Workshop Manual). Available at SSRN 3419801.

Fuller, S. and McCauley, D., 2016. Framing energy justice: perspectives from activism and advocacy. Energy Research & Social Science, 11, pp.1-8.

Jaensirisak, S. and Sangsawang, P., 2016. Problems and Limitations on the Use of the Financial Statements for Business management of SMEs’ Entrepreneurs in Ubonratchathani Ubonratchathani. University of the Thai Chamber of Commerce Journal Humanities and Social Sciences, 36(4), pp.18-35.

Seve, F. and Wilson, M., 2019. Direct and substitution effects of regulations impacting the scope for classification shifting. Journal of Accounting and Public Policy, 38(3), pp.171-198.

Wang, X., 2019. Compliance Over Time by Australian Firms with IFRS Disclosure Requirements. Australian Accounting Review, 29(4), pp.679-691.

Remember, at the center of any academic work, lies clarity and evidence. Should you need further assistance, do look up to our Accounting and Finance Assignment Help

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