Case study: cash-flow statement
By analyzing this water utility’s statement, which includes a comparison to the previous year, decision-
makers can base future plans on past cash flows (at the time, the exchange rate was £1 = $1.58).
Cash-flow statement
The cash-flow statement shows the movement of cash during the last
accounting period. It is important because it reveals a company’s
liquidity—whether or not it has more money coming in than going out.
How to read a cash-flow statement
The statement of cash flows, to give it its official title, answers the key question of whether a
business is making enough money to sustain itself and provide surplus capital to grow in the
future, pay any debts, and give out dividends. Figures in parentheses are negative numbers.
Net cash inflow from operating activities 334.6 303.2
Returns on investments and servicing of finance (80.0) (79.2)
Taxation (21.8) (31.5)
Capital expenditure and financial investment (215.4) (149.7)
Dividends paid (129.6) (129.4)
(Decrease)/increase in cash—above (33.2) 135.6
Movement in loans and leases (79.0) (222.2)
Movement in net debt (112.2) (86.6)
Opening net debt (1,626.1) (1,539.5)
Closing net debt (1,738.3) (1,626.1)
Cash outflow before financial investment (112.2) (86.6)
Financing 79.0 222.2
Reconciliation of cash movement to the movement in net debt
(Decrease)/increase in cash (33.2) 135.6
Using profit before tax as a starting
point, non-cash income and expenses
are deducted to reach net cash inflow
from operating activities
Returns on investment in this case
is total interest received minus total
interest paid, as well as interest paid
on finance lease rentals
Taxation is the sum of all taxes paid
and tax credits received
Capital expenditure and financial
investment is, here, the sum of the
sale of tangible assets plus connection
charges, grants, and deferred income
Dividends are sums of money paid
to shareholders, typically each year
This is the sum of all the figures above
Financing describes how much money
the company has made or lost from
loans, finance leases, and bonds
This is the change from last year’s
figures to this year’s, and the total
of the two figures above
A utility company can afford
to operate with more debt than
companies with a less stable base
Year to
March 31,
2013
£m
Year to
March 31,
2012
£m
$
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120 121
HOW FINANCE WORKS
Financial accounting
How it works
The cash-flow statement is often more useful for
investors assessing a business’s health than other key
statements, because it shows how the core activities
are performing. The profit-and-loss statement, for
example, obscures this by adding in non-cash factors
such as depreciation. Similarly, the balance sheet is
more concerned with assets than liquidity.
Three types of cash flow
Cash refers to actual money as well as cash equivalents including cash in the bank; bank lines
of credit; and short-term, highly liquid investments for which there is little risk of a change in
value. Cash does not include interest, depreciation, or bad debts (debts written off).
Cash flow from operating activities
The bulk of cash flow usually comes from operations, and is worked out with a
formula. The change in working capital (current assets minus current liabilities)
can be a negative figure.
In this example, a juice company sells $100 worth of orange
juice after spending $20 on oranges. It pays 25 percent of its
$80 earnings in tax. Its juicing machine incurs a depreciation
expense of $20 over the period (a positive adjustment on the
orginal outlay for the machine). There is no change in working
capital (short-term assets to cover short-term debt).
$100
$20
$20
$0
$80
=++-
-
A JUICE
COMPANY SELLS
WORTH OF
ORANGE JUICE
AND SPENDS
ON ORANGES
OVER THE
PERIOD
ITS JUICING
MACHINE INCURS
A DEPRECIATION
EXPENSE OF
IT PAYS
25%
OF ITS EARNINGS
IN TAX
DEPRECIATION
REVENUE –
COST OF SALES
TAXES
– + + =
ANY CHANGE
IN WORKING
CAPITAL
NO CHANGE
IN WORKING
CAPITAL
CASH FLOW
FROM OPERATING
ACTIVITIES
CASH FLOW
FROM
OPERATING
ACTIVITIES
Total cash flow
Adding all three cash flows
gives the total. Separating
out the three types shows decision-
makers the health of core activities
as opposed to financing and
investing, which bear little relation
to day-to-day operations.
Cash flow from
investing activities
Buying or selling assets
or investments is in this category.
This figure is usually a cash outflow
(negative figure) due to buying more
than selling, but can be positive if
there are significant sales.
Cash flow from
financing activities
This includes buying or
selling stock and paying out debt
or dividends. Money made from
selling something is called cash
inflow; money lost through paying
out is cash outflow.
Cash flow from operating activities in practice
=
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HOW FINANCE WORKS
Financial accounting
How it works
The cash-flow statement is often more useful for
investors assessing a business’s health than other key
statements, because it shows how the core activities
are performing. The profit-and-loss statement, for
example, obscures this by adding in non-cash factors
such as depreciation. Similarly, the balance sheet is
more concerned with assets than liquidity.
Three types of cash flow
Cash refers to actual money as well as cash equivalents including cash in the bank; bank lines
of credit; and short-term, highly liquid investments for which there is little risk of a change in
value. Cash does not include interest, depreciation, or bad debts (debts written off).
Cash flow from operating activities
The bulk of cash flow usually comes from operations, and is worked out with a
formula. The change in working capital (current assets minus current liabilities)
can be a negative figure.
In this example, a juice company sells $100 worth of orange
juice after spending $20 on oranges. It pays 25 percent of its
$80 earnings in tax. Its juicing machine incurs a depreciation
expense of $20 over the period (a positive adjustment on the
orginal outlay for the machine). There is no change in working
capital (short-term assets to cover short-term debt).
$100
$20
$20
$0
$80
=++-
-
A JUICE
COMPANY SELLS
WORTH OF
ORANGE JUICE
AND SPENDS
ON ORANGES
OVER THE
PERIOD
ITS JUICING
MACHINE INCURS
A DEPRECIATION
EXPENSE OF
IT PAYS
25%
OF ITS EARNINGS
IN TAX
DEPRECIATION
REVENUE –
COST OF SALES
TAXES
– + + =
ANY CHANGE
IN WORKING
CAPITAL
NO CHANGE
IN WORKING
CAPITAL
CASH FLOW
FROM OPERATING
ACTIVITIES
CASH FLOW
FROM
OPERATING
ACTIVITIES
Total cash flow
Adding all three cash flows
gives the total. Separating
out the three types shows decision-
makers the health of core activities
as opposed to financing and
investing, which bear little relation
to day-to-day operations.
Cash flow from
investing activities
Buying or selling assets
or investments is in this category.
This figure is usually a cash outflow
(negative figure) due to buying more
than selling, but can be positive if
there are significant sales.
Cash flow from
financing activities
This includes buying or
selling stock and paying out debt
or dividends. Money made from
selling something is called cash
inflow; money lost through paying
out is cash outflow.
Cash flow from operating activities in practice
=
US_120-121_Cashflow_statement_Steve.indd 121 09/11/2016 11:01
How it works
Globally, there are reams of different environment
acts spread across multiple jurisdictions that affect
the companies operating within their borders in
different ways. Areas protected by environment acts
include the atmosphere, fresh water, the marine
environment, nature conservation, nuclear safety, and
noise pollution. International acts are usually ratified
by each country individually before taking effect
there. An example of a common global means of
reducing greenhouse gas emissions is emissions
trading (“cap and trade”), by which companies must
buy a permit for each ton of CO
2
they emit over a
certain level. Those emitting under the agreed level
can sell their permits to other companies.
Environmental
accounting
Environmental regulations force companies to consider the impact of
their activities and to adopt corporate social responsibility (CSR) as
they grapple with legislation, climate change, and public opinion.
Environmental credentials
Most companies include a section on environmental
accounting in their financial statement. Some details are
required by law, but the statement also gives an opportunity
to showcase environmental credentials to stakeholders.
Product
responsibility
Life-cycle stages in which the
health-and-safety impact
of products and services are
assessed for improvement
Adherence to laws,
standards, and voluntary
codes relating to marketing
communications
Society
Programs and practices
that assess and manage
the impact of operations
on communities
Fines and sanctions for
noncompliance with
regulations
Cleaning up rivers
Wessex Water’s impressive record on pollution is
mentioned several times in its statement, including in
the chairman’s introduction. This prominence shows
that the company believes acting in an environmentally
conscious manner is important to its investors. The
company illustrates several areas where it has acted
with others to positively affect the environment:
Work with the charity Surfers Against Sewage,
which campaigns for clean seawater
Its river strategy: collaborating with pressure groups
and organizations to reduce pollutants and the impact
of habitat alteration, and so increase the numbers
of aquatic plants, invertebrates, and fish in local rivers
Improving water quality at swimming beaches in the
region, in compliance with mandatory standards
Case study
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How finance works
Financial accounting
Environmental
Direct and indirect energy
consumption
Waste by type and disposal method
Water withdrawal by source;
discharge by destination and quality
Fines and sanctions for
noncompliance with regulations
Human rights
Investment agreements
that include human rights
clauses or that have undergone
human rights screening
Suppliers and contractors
that have undergone screening
on human rights; actions taken
to address any issues
Economic
Financial implications, risks,
and opportunities for the
organization’s activities
due to climate change
Financial assistance received
from the government
Greenhouse Gas emissions
Appointed
business
Direct fuel
use
Grid
electricity
Third
parties
Total
2012–13
Total
2011–12
Gas, diesel,
other fuels
6 0 4 10 8
Grid electricity 0 115 0 115 107
Transportation 9 0 1 11 11
Methane 17 0 2 20 20
Nitrous oxide 10 0 7 17 19
Exported
renewable
0 (3) 0 (3) (4)
TOTAL (net
emissions)
42 112 14 169 161
In some countries, companies are
required by law to provide details
of their greenhouse gas emissions.
This is usually presented as a table
in the environmental accounting
section of the annual report. It
includes direct and indirect
emissions—by the company itself and
by third parties—of gas, diesel, and
other fuels; sulfur oxides and nitrous
oxides; methane; and other ozone-
depleting substances. In this table,
from the Wessex Water utility
company, emissions are shown
as ktCO
2
equivalents.
Labor practices
Workforce by employment
type, contract, and region
Average hours of training
per year, per employee by
employee category
Ratio of basic salary
of men to women by
employment category
$
US_122-123_Environment_acts_and_crs.indd 123 21/11/2014 14:25
122 123
How finance works
Financial accounting
Environmental
Direct and indirect energy
consumption
Waste by type and disposal method
Water withdrawal by source;
discharge by destination and quality
Fines and sanctions for
noncompliance with regulations
Human rights
Investment agreements
that include human rights
clauses or that have undergone
human rights screening
Suppliers and contractors
that have undergone screening
on human rights; actions taken
to address any issues
Economic
Financial implications, risks,
and opportunities for the
organization’s activities
due to climate change
Financial assistance received
from the government
Greenhouse Gas emissions
Appointed
business
Direct fuel
use
Grid
electricity
Third
parties
Total
2012–13
Total
2011–12
Gas, diesel,
other fuels
6 0 4 10 8
Grid electricity 0 115 0 115 107
Transportation 9 0 1 11 11
Methane 17 0 2 20 20
Nitrous oxide 10 0 7 17 19
Exported
renewable
0 (3) 0 (3) (4)
TOTAL (net
emissions)
42 112 14 169 161
In some countries, companies are
required by law to provide details
of their greenhouse gas emissions.
This is usually presented as a table
in the environmental accounting
section of the annual report. It
includes direct and indirect
emissions—by the company itself and
by third parties—of gas, diesel, and
other fuels; sulfur oxides and nitrous
oxides; methane; and other ozone-
depleting substances. In this table,
from the Wessex Water utility
company, emissions are shown
as ktCO
2
equivalents.
Labor practices
Workforce by employment
type, contract, and region
Average hours of training
per year, per employee by
employee category
Ratio of basic salary
of men to women by
employment category
$
US_122-123_Environment_acts_and_crs.indd 123 21/11/2014 14:25
How it works
If a business buys a long-lived
asset, such as a building, factory
equipment, or computer, to help it
earn income, this expenditure can
be offset as a cost against income
earned. However, not all this
income will be generated in the
year of purchase and, over time,
the asset will age and become less
beneficial to the business, until
it becomes outdated or unusable.
Accountants do two things to
turn the declining value into a
tax advantage. Firstly, they work
out how much the asset’s value
decreases over a period of time—
typically a year. Secondly, they
match that loss in value to the
amount of income earned in that
period, so depreciation becomes
a deduction from taxable income.
There are several different
ways to calculate depreciation.
The method a company uses may
depend on the kind of business, the
type of asset, tax rules, or personal
preference. In the United States,
per IRS guidelines, companies
must use MACRS (Modified
Accelerated Cost Recovery System),
a combination of straight-line and
double declining balance methods
(see below and p.126).
Depreciation
When a company buys an asset, its cost can be deducted from income
for accounting and tax purposes. Depreciation allows the company to
spread the cost, by calculating the asset’s decline in value over time.
USEFUL ECONOMIC
LIFE (YEARS)
ANNUAL
DEPRECIATION ($)
=
Example
A landscaping business buys a
new van for $25,000. The IRS
sets its scrap value at $5,000
after five years of use.
Year 1 After a year, the van’s
value has depreciated by $4,000
(its purchase value minus its scrap
value, divided by its useful economic
life). Its value is now $21,000.
$25,000 – $5,000
5
$4,000
=
Fixed/tangible assets Items that
enable a business to operate but are
not a part of trade; assets lasting a
year or more qualify for depreciation
Useful/economic life Length of
time an asset is fit for its purpose
and has monetary value
Salvage/scrap/residual value
Worth of an asset once it has
outlived its useful life—often set
by the tax authority
Book value An asset’s worth on
paper at any point between its
initial purchase and salvage
NEED TO KNOW
The straight-line method is the simplest way of working out
depreciation and can be applied to most assets. Depreciation is
calculated along a timeline, with value loss spread evenly over
the asset’s economic life. Scrap value is deducted from purchase
value and the remainder is split into equal portions over time.
Calculating depreciation
$21,000
VALUE ($)
$25,000
$20,000
$15,000
$10,000
$5,000
1
0
PURCHASE
VALUE
SCRAP
VALUE
–
$
$
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124 125
how finance works
Financial accounting
Year 2 After the second year, the
value has depreciated by another
$4,000. The van will lose an equal
amount of value each year for the next
three years of its useful economic life.
Year 3 At the end of the third
year, the van has depreciated
by another $4,000, and its book
value is $13,000, although its
actual value may be more or less.
Year 4 The van
has depreciated by
$4,000, to $9,000,
at the end of four
years of life.
Year 5 By the
end of year five,
the van is valued
at only $5,000—
its scrap value.
RACEHORSES
2 years
COMPUTERS
3 years
OFFICE
FURNITURE
6 years
ROADS
15 years
BOATS
20 years
FRUIT-
BEARING TREES
10 years
Time
(years)
5 15
10 20
$17,000
$13,000
$9,000
$5,000
TIME (YEARS)
2 3 4
5
Typical life of fixed asseTs
Tax authorities often specify the typical useful (economic) life of a particular asset.
This helps to standardize depreciation, and to eliminate uncertainty about value
and the number of years over which an asset can be depreciated.
60%
the value the
average car
loses after
three years
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