McNeil Ltd Net Cash Flow from Operating Activities

Objective and Purpose of IAS 7

International Financial Reporting Standards (IFRS) entails different accounting standards that have been adopted by the International Accounting Standard Board in the quest to ensure transparency and accountability is enhanced during reporting. Organizations across the world have embraced these standards to enable easy accessibility, understanding, and utilization of financial reports by the shareholders and other managers at different management levels.

IAS 7 elaborates on the statement of cash flow, which majorly details cash and cash equivalents. Cashflows entail the virtual movement of money in and out of a business enterprise to improve income at the end of the financial year, thus the investing part, the operating and financing sections (Alver, 2005). The main objective of IAS 7 is to require in an organization all the cash and cash equivalent transactions both past and presents and the changes they have affected in the running of the investing, operating, and financing activities.

The IAS 7 generally prescribes how a cash flow statement should be presented, bearing in mind the three distinct parts. During a specific period, changes in the cash and cash equivalents will be detailed. It includes cash at bank, cash at hand, and highly liquid short-term investments. Additionally, any investment with a maturity of not more than three months since the date f inception can also be considered in the same category. Worth noting is the exclusion of equity investments provided they are not in the substance of cash equivalents. The fact that equity investments may have debts does not fit to be included in the cash and its equivalents without complete ascertainment of the type of liability and repayment period. Alternatively, organizations use the cashflow to ascertain the income generated during a period and how the cash was utilized in different growth sections.

Operating Activities Under IAS 7

As earlier stated, IAS 7 embraces three distinct sections in the statement of cash flow. Operating activities are significant parts considering all organizations have to get into business practice to generate an income. The amount of cash generated from operating activity can provide an organization with adequate estimates of whether or not the repayment of debts will be attained since it’s the main activity instituted to generate income for the firm (Ayoub et al. 2017)

Considering both direct and indirect methods can be adapted to attain the cash flow from operating activities, different organizations will go for their preferred approach judging from the availability of information. The direct method embraces the actual outflow and inflows of cash in the operations of a firm. Though attractive, it is considered hectic in some quarters since the FASB will demand a net income reconciliation. On the other hand, the indirect method mostly approaches the operating cash flow through the increases and decreases line items in the statement of financial position of a firm. Here modification of the accruals is done to arrive at the cash method of accounting.

Operating activities majorly includes cash receipts obtained from royalties’ fees and sale of goods, cash payments to employees and suppliers for their products and services. Additionally, cash refunds and payments emanating from the income taxes of a firm can also be considered.

Investing Activities Under IAS 7

The future expectations of every firm are to increase income, which will enhance growth and sustainable development. Investing activities according to IAS 7 detail the expenditures that have been put into use. It is with an eye for generating additional income for the firm in the future. Although much spending is included in a firm, only the balance sheet’s recognizable assets can pass the test and be considered part of the investing activities.

Investing activities transactions will include, among others, cash payments and cash receipts from sales in the event of acquisition or disposal of property, plant, and or equipment. Cash receipts and cash payments, both obtained from either the purchase or sale of a debt instrument. Furthermore, cash receipts received from prospective or futures contracts can also be considered. Additionally, loans that have been made or instead been issued to other parties on behalf of the company.

Financing Activities Under IAS 7

The creation of budgetary resources to provide funding for a project can be equated to financing activities (Bojinov, 2017). Most organizations will concentrate on finance and efficient management to steer their firms to grow. According to IAS 7, financing activities are a section of the cash flow statement that provides insights into the capital injected into the firm.

The financing activities will most definitely include;

• Proceeds of cash generated from the issuance of shares
• Proceeds of money generated from the issuance of loans to other parties, debentures, mortgages.
• Cash proceeds emanating from the issuance of both the short- and long-term borrowings and repayments received from the said borrowings
• Cash payments which have been obtained from a lessee to act as a reduction of the liability

Calculation of the Net Cash Flow from Operating Activities

In the Cashflow statement of McNeil Ltd for the period ending 31^st December 2019, the indirect method has been used to ascertain net cash flow from operating activities. As earlier mentioned, this method uses the elements in the statement of the balance sheet to arrive at the cash method.

When net profit is obtained, it should be less interest and corporation tax for the specific period to ascertain cash from operating activities. Both goodwill and depreciation are added to the profit at the beginning. Goodwill in companies varies and by so doing some increase every year whereas others remain constant for the business’s life hence the need for its involvement. During a financial year, organizations dispose of assets in a bid t either get funds for new assets or if the life span of the asset has diminished. Losses from the sale are obtained if the amount acquired from the sale is less than the expected net book value. Thus, the loss received on disposal is added. After that, increases and decreases in the balance sheet line items will be factored in. An increase in stock from one financial year to another will demand we deduct the increased amount. In the event of a decrease in stock from one period to the other, the addition will be done. The same will apply for the debtors who are still part of the receivables. At the end of the payable, an increase in creditors from the previous period to the current period will necessitate the increased amount. In contrast, a decrease will amount to the deduction of the decreased amount. Therefore, we can finally ascertain our net cash flow from operating activities.

Purpose and Use of Statement of Cash Flow

Organizations mainly indulge in preparing the statement of cash flow to ascertain the cash inflows and outflows, according to IAS 7. The long-term solvency of an organization will go a long way to determine the sustainable development and fulfillment of consumers’ future expectations. Financial analysis through the use of cash flow statements will give the management a heads up in increased investing with limited or no income generation, thus creating the need to change the market approach. It helps ensure losses are realized as soon as possible, judging from the periodic preparation hence preventing continued increases in costs.

Beaver, the first scientist who studied and ascertained cashflow indicators, are essential, justified financial ratios selected for the various cashflow statement analysis (Beaver, 1966). In his published study of 1966, he argued that the possibility of bankruptcy is highly accurate when he studied changes in shares of bankrupt companies. Other authors from time memorial have backed this argument with an additional basis for including all the three activities; operating, investing, and financing in cashflow analysis ratios (Bello et al. 2018). In consideration of the going concern concept, an organization needs to perform financial analysis using the inflows and outflows to support its future existence.

It will be of significant importance if McNeil Ltd adopts the idea of preparing the statement of cash flows as part of their annual financial accounts due to the advantages it brings to the firm such as;

• Ensuring the firm’s liquidity position is known at all times, and improvements are made on an annual basis.
• Creating a cash forecast by the management to ensure McNeil Ltd operates with all remaining relevant intentions in the future
• Helping the management of McNeil to ascertain the financial policy to be embraced
• Creation of capital budgeting and performance appraisal
• The optimum cash balance will be ascertained every financial year.

Conclusion

IAS 7 encourages companies to embrace cash flow statements in their annual accounts for ease of financial reporting. Firms with yearly reports of cash flows have maintained competence and ensured adequate planning and budgeting is managed hence a promise for sustainable development. A look at McNeil Ltd, adopting the preparation of cash flow statements, will be advantageous with the indirect method considering their balance sheet is very well outlined. Through the three sections in the cash flow statement, the firm can ascertain where expenditures are utilized and the returns obtained from each.

References

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Approach and Operating Profit Approach. Tallinn School of Economics and

Business Administration, Tallinn University of Technology, Working Papers.

Ayoub, Maysam & Jammoul, Weam & Mekdessi, Selim. (2017). International

Accounting Standard 7 – Statement of Cash flows – Compared to the Lebanese

General Accounting Plan. IOSR Journal of Business and Management. 19. 01

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Beaver, W.H 1966: ‘Financial ratios as predictors of failure.” Journal of Accounting

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Bello, Mohammed & Bala, Ado & Kofarmata, J & Falola. (2018). The Relevance of

Financial Ratio Analysis in Predicting Business Failures in Nigeria: A Study of

Selected Companies 1 2 3. 2.

Bojinov, Bojidar. (2017). Financing Activities of Modern Universities – Approaches,

Challenges, Problems. Juvenis Scientia. 25-26. 10.2139/ssrn.2944894.