Overview
This lecture covers internal controls for cash management, focusing on the purpose and structure of the statement of cash flows and its three key sections: operating, investing, and financing activities.
Internal Control Mechanisms for Cash
- Cash is the easiest asset to lose or have stolen, requiring strong internal controls.
- Bank reconciliation statements are standard mechanisms to control and protect cash.
Purpose and Use of Statement of Cash Flows
- Tracks cash inflows and outflows for a specific period (month, quarter, or year).
- Prepared on a cash basis, not an accrual basis.
- Helps assess how well the business collects cash through its operating cycle.
- Critical for managing working capital and ensuring immediate debts can be met.
- Businesses can be profitable but still fail without good cash flow management.
Cash vs. Accrual Accounting
- Accrual accounting records income and expenses when they occur, not when cash is exchanged.
- Cash accounting records transactions only when cash is received or paid.
- There can be significant differences between profit and cash position.
Comparing Profit or Loss and Cash Flow Statements
- Both are for a period of time, unlike the balance sheet which is at a point in time.
- Profit does not always equate to positive cash flow; negative cash balances are a warning sign.
- Some expenses like depreciation affect profit but do not involve cash outflow.
Users and Importance of Cash Flow Statements
- Provides extra information not shown in profit or loss or balance sheet.
- Important for lenders, suppliers, and potential investors to assess financial health.
Three Sections of the Statement of Cash Flows
- Operating Activities: Cash from core business operations (sales, payments to suppliers/employees).
- Investing Activities: Cash from buying/selling long-term assets (plant, equipment).
- Financing Activities: Cash from borrowing, repaying loans, issuing shares, or paying dividends.
Examples of Cash Flow Categories
- Operating inflows: cash sales, receipts from customers, interest/dividends received.
- Operating outflows: payments to suppliers, salaries, interest, tax.
- Investing inflows: sales of non-current assets.
- Investing outflows: purchases of non-current assets.
- Financing inflows: issuing shares, loan proceeds.
- Financing outflows: dividend payments, loan repayments.
Warning Signs in Cash Flows
- Operating cash receipts consistently less than cash payments is a concern.
- Net cash from operations lower than profit after tax may signal issues.
- Frequent reliance on issuing shares or borrowing for regular expenses can indicate cash flow problems.
Key Terms & Definitions
- Internal Control — Policies and procedures to safeguard assets like cash.
- Bank Reconciliation Statement — Document ensuring cash book and bank statement balances match.
- Statement of Cash Flows — Financial report showing cash inflows and outflows over a period.
- Working Capital — Current assets minus current liabilities; measures liquidity.
- Operating Activities — Day-to-day cash-generating business activities.
- Investing Activities — Transactions involving non-current (long-term) assets.
- Financing Activities — Transactions involving borrowing, repaying, or owner investment.
- Cash Equivalents — Short-term, highly liquid investments convertible to cash within three months.
Action Items / Next Steps
- Review upcoming recording focused on cash controls and bank reconciliation.
- Understand differences between profit, cash flow, and their importance for business survival.