Cash flow statement
Note: the profit on the sale of fixed tangible assets (£100,000) was to be included in the income statement. I noticed that it was not included in the income statement.
Cash flows and retained earnings
Despite having retained earnings of £900,000 in the year ended 31st December, 2012, the company had a large bank overdraft. Retained earnings is the portion of the company’s profit that is not distributed. Profit considers that company’s revenues and expenses and does not consider whether the revenues or expenses are in cash. The cash flow statement includes cash items only. Thus, there is a difference between cash flow and profits due to the inclusion of non-cash items in the determination of the net profit such as depreciation, among others.
Besides, not all revenues earned are received in cash, some are in accounts receivables (debtors). Despite the increase in the company’s revenues, its cash flows during the year was a net decrease of £446,000. The company had more inventory in the current year denoting a decline in operating cash flows. Debt collection also declined as shown by the increase in the balance of debtors account. There was also an increase in prepayments thus lowering the cash flows from operations.
As shown in the statement of cash flows, the total cash used during the year was more than the total cash received by the company. The deficit explains why it had a bank overdraft despite having a large balance in the retained earnings account. However profitable a company is, it can still have a negative net cash flow if it uses more cash than it receives since cash flows are different from profits. The company can improve its cash flows situation by improving debt collection, delaying the payment of creditors, raising long-term finance to fund long-term investments, among other ways. If the company relies on operating cash flows to finance long-term investments, daily operations will be crowded out thus forcing it to borrow resulting in large bank overdrafts.
