Cash flow statement
IAS 7 – STATEMENT OF CASH FLOWS
Cash flows information of an entity is useful in providing users of financial statements with a basis to assess the ability of the entity to generate cash and cash equivalents and the needs of the entity to utilise those cash flows. The economic decisions that users take require an evaluation of the entity’s ability to generate cash and cash equivalents. It reports a company’s inflows and outflows of cash.
Why is cash flow statement ….. ?
- It is very important because a company needs to have enough cash on hand to pay for its expenses, purchase assets and fund new prospects. While statement of income can tell you whether a company made a profit, the cash flow statement can tell you whether the company generated cash.
- A cash flow statement shows changes over time rather than absolute dollar amounts at a point in time. It uses and reorders the information from a company’s balance sheet and income statement.
The bottom line of the cash flow statement shows the net increase or decrease in cash for the period. Generally, cash flow statements are divided into three main parts.
Each part reviews the cash flow from one of three types of activities:
(1) operating activities;– like normal day to day operations
(2) investing activities; and — like investments for future returns example in PPE, funds etc..
(3) financing activities. These types are explained detailly below. — taking loan or borrowings..
IAS 7 statement of cash flows requires the presentation of the historical changes in cash and cash equivalents of an entity through a statement of cash flows.
Scope
An entity shall prepare a statement of cash flows in accordance with the requirements of this Standard and shall present it as an integral part of its financial statements for each period for which financial statements are presented.
Users of an entity’s financial statements are interested in how the entity generates and uses cash and cash equivalents under operating, investing and financing activities.
Cash: Cash on hand and demand deposits.
Cash equivalents: Short-term, highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value. An investment normally qualifies as a cash equivalent only when it has a short maturity of, say, three months or less from the date of acquisition.’
Cash flows: Inflows and outflows of cash and cash equivalents.
Operating activities: Principal revenue-producing activities of the entity and other activities that are not investing or financing activities.
Investing activities: Acquisition and disposal of long-term assets and other investments not included in cash equivalents.
Financing activities: Activities that result in changes in the size and composition of the contributed equity and borrowings of the entity.
Presentation of a statement of cash flows
The statement of cash flows shall report cash flows during the period classified by operating, investing and financing activities.
An entity presents its cash flows from operating, investing and financing activities in a manner which is most appropriate to its business i.e. an activity which is financing for manufacturing company could be operating activity for financing company.
Classification by activity provides information that allows users to assess the impact of those activities on the financial position of the entity and the amount of its cash and cash equivalents. This information may also be used to evaluate the relationships among those activities.
A single transaction may include cash flows that are classified differently. For example, when the repayment of a loan includes both interest and capital, the interest element may be classified as an operating activity and the capital element is classified as a financing activity.
What is a Non cash transactions:
These are the transactions that do not require any cash inflow/outflow. For example, creating a lease as per IFRS 16 doesn’t require any movement of cash. However, while preparing cash flow statement under indirect method, this transaction should be adjusted to remove the impact of such non cash movement. An entity should provide separate disclosure about the non-cash transactions to the user of the financial statements relevant information. Some of the examples of non cash
Presentation method:
The standard requires and entity to present the cash flows from operating activities using the following methods:
- Direct method or
- Indirect method:
The main difference of presenting direct method and the indirect method of cash flows lies in the cash flows from operating activities. However, there are no differences in investing and/or financing activities).
Direct method: Direct method determines changes in cash receipts and payments, which are reported in the cash flow from the operations activities i.e major categories of gross cash receipts and gross cash payments are disclosed.
Indirect method: Profit or loss is adjusted for effects relating to non- cash and further adjusted for items relating to investing and financing activities, such as changes in inventories and accounts receivables and payables; depreciation and amortisation; movements in provisions; deferred taxes and unrealised foreign currency gains and losses.
Restricted cash and cash equivalent
Restricted cash and cash equivalent balances are those which meet the definition of cash and cash equivalents but are not available for use by the entity.
In practice, these balances may arise when an entity is required to maintain balances as per legal requirement Ex: Contribution to employee pensions, pledged in escrow accounts. These types of restrictions do not affect the presentation of the statement of cash flows. However, IAS requires an entity to disclose the existence of any such significant restricted cash balances, along with narrative commentary. This is included in the notes to the financial statements, with a separate line item in the primary financial statements for ‘restricted cash and cash equivalents’.
Benefits of cash flow information
A statement of cash flows, when used with the rest of the financial statements, provides information which enables users to evaluate the changes in net assets of an entity and its financial status. Cash flow information is useful in assessing the ability of the entity to generate cash. Cash Flow Statement helps the management to ascertain the profitability and liquidity position of businesses i.e entity’s ability to pay the obligation as soon as it becomes due.
