Cash Flow Statement

Cash Flow Statement

Introduction

The cash flow statement provides a summary of the financial transactions that affected cash equivalents or cash (such as Accounts Receivable) in a specific period. Thus, it is a summary of all cash receipts and the cash payments that have occurred during a specific period of time such as a month or a year (Kieso, Weygand, and Warfield, 2010).  There are two methods applied when preparing a cash flow statement: the indirect method and the direct method. The purpose of this report is to provide the objective and purpose of International Accounting Standard 7 (IAS 7) Statement of Cash Flows, explain the key terms Operating Activities, Investing Activities, and Financing Activities as defined by IAS, explain how the Net Cash Flow from Operating Activities is calculated, and evaluate the purpose and use of the Statement of Cash Flows. A recommendation is provided in regard to whether the use of Statement of Cash Flows would benefit Twice as Much Ltd to start preparing the Statement of Cash Flow.

Objective and purpose of International Accounting Standard 7 (IAS 7)

Standard 7 is about the statement of cash flows. According to the International Finance Reporting Standards (IFRS,2012), the statement of cash flows is used in conjunction with other financial statements to provide information that assists users in the evaluation of the changes in the net assets of an entity. It is also used to track changes in financial structure and the ability of cash flows to have an effect affect the amounts as well as the timing of cash flows so as to adjust to changing opportunities and circumstances (Bellandi, 2012). In addition, IAS 7 is responsible for the provision of cash flow information and it enables users to develop models as well provide a comparison of the current value of the future cash flows (European Commission 2010; IFRS,2012). The IAS 7 Statement of Cash Flows requires an organization to provide a statement of cash flows as an important part of its primary financial statements. Basically, Cash flows are categorized and presented into operating activities, investing activities, and financing activities.

Wiley-VCH. (2014) has pointed out that the primary objective of the IAS 7  “is to require the provision of information about the historical changes in cash and cash equivalents of an entity by means of a statement of cash flow which classifies cash flows during the period from operating, investing and financing activities” (p. 90). Thus, the objective of the standard is to ensure that organizations provide changes in cash and cash equivalents through the aid of financial cash flow statements based on financing, investing, and operating activities.

Operating Activities, Investing Activities, and Financing Activities as defined by IAS 7

A cash flow statement is composed of records of changes in cash and cash flow changes as a result of financial, investing, and operating activities (Faulkenberry, 2013). Operating activities are the amount of as flows that arise from business operations and are used to repay loans sufficiently, pay dividends, maintain the operating capability of a business, and make new business investments without the use of external sources of financing (Wiley-VCH., 2014). Examples of operating activities include cash receipts from royalties, fees, sales of goods, and rendering of services. The cash payments to employees and suppliers for services and goods are also classified as operating activities.

Investing activities are undertakings that are cash outflows and they include the outflow of cash for long-term assets including buildings land, and equipment, as well as the inflows generated from the sale of business, assets, and, securities (IFRS, 2012; Warren and Reeve, 2007). Thus, cash flow investing activities are associated with long-term investments for future growth and operations.

Cash flow from finance activities can be described as the cash-out flow to the entity’s investors and shareholders as well as the cash inflows from bond sales or the issuance of stock equity (Barker, 2011). Examples of cash flow that result from financing activities include cash repayments on borrowed amounts, cash proceeds from loans, debentures, notes, mortgages, and bonds as well as other short-term borrowing (IFRS,2012; Mohana, 2012). Cash proceeds from the issuance of shares and cash payments to business owners are also classified as financing activities.

How Net Cash Flow from Operating Activities is Calculated

Cash flows from operating activities for an entity are reported using the indirect method, whereby loss or profit is adjusted for the impacts of transactions of a non-cash nature, items of expense or income expense linked with financing or investing cash flows, and any accruals or deferrals of past or future payments, or operating cash receipts (Sullivan and International Monetary Fund., 2000; Warren, Reeve, and Duchac, 2009; Wiley-VCH., 2014). The formula used when calculating cash flow statements based on operating activities entails the following:  net income+ depreciation and amortization+/-time adjustments+/- changes in working capital (Faulkenberry, 2013). Thus, under the indirect method, the net cash flow from operating activities is calculated by adjusting loss and profit for the effects of the following: (a) changes experienced as a result of operating receivables and payables as well as inventories and; (b) non-cash items like provisions, depreciation, deferred taxes, undistributed profits of associates, unrealized foreign currency gains and losses, and non-controlling interests; and (c) Other financial items whereby the cash effects are financing or investing cash flows (Bonham and Ernst & Young, 2008).

Purpose and use of the Statement of Cash Flows

The primary purpose of the statement of cash flows is to offer information related to a company’s gross payments and gross receipts for a particular period of time. The information is required when making economic decisions because the users can effectively evaluate the ability of the business to generate cash and cash equivalents and use those cash flows (Maheshwari, Maheshwari, and Maheshwari, 2012). In addition, a statement of cash flow is used by organizations and companies to provide information related to cash payments and cash receipts during a specific accounting period (Needles, Powers, and Crosson, 2010).  For example, the purpose of the cash flow statement is to show cash inflows and outflows. Outflows are linked with payments to investing activities such as the purchase of land for business development, while the sale of the same land could be regarded as cash receipts or cash inflows. The secondary purpose of a cash flow statement is to offer information related to a company’s financing activities, investing, and operating activities within a particular accounting period (Mulford and Comiskey 2004). Thus, a cash flow statement is used by organizations to summarize all business transactions that have an effect on cash.

In reference to the uses of statements of cash flows, Needles et al. (2010) pointed out that it is useful for management as well as creditors and investors.  For example, creditors and investors can use statements of cash flows to assess the ability of a company to manage cash flows, pay its liabilities, generate positive future cash flows, speculate the need for extra financing, and pay interests and dividends to shareholders. To the management of a company, a cash flow statement is used to assess its liquidity and to evaluate the impacts of major policy decisions that involve financing and investments. Additionally, a statement of cash flows is used to determine dividend policy (Mulford and Comiskey 2004).  For example, a company can use statements of cash flows to determine whether short-term financing is required to settle its current liabilities, decide if to lower or raise dividends, and plan for financing and investing needs.

Recommendation for Twice as Much Ltd

For a company like Twice as Much Ltd, the preparation of a cash flow statement is recommendable because it would be beneficial. For example, Mathew Twice can use the information to make financial and economic decisions related to future investments. In addition, the owner can be in a position to evaluate the business to generate cash and cash equivalents in times of economic uncertainties (European Commission, 2015). Additionally, Mathew Twice needs to create a cash flow statement at the end of each ear to check the expected cash flows in the future and to examine the link between net cash flow and profitability. The information is important to Twice as Much Ltd because the use of cash flow statements can show the effects of changing prices (Mukherjee and Hanif, 2003; Shukla, 2009).  According to Chakraborty (2004), businesses require cash flow statements because “it enhances the comparability of the reporting of operating performance by different enterprises because it eliminates the effects of using different accounting treatments for the same transactions and events” (p. 874). Thus, for a business like Twice as Much Ltd, a cash flow statement is useful because it ensures better reporting of cash and cash equivalents.

Conclusion

The statement of cash flows is used to show the manner in which a company’s investing, operating, and financing activities have impacted cash within a certain accounting period. The statements of cash flows are important and beneficial to companies such as Twice as Much Ltd as it is used to provide information related to a company’s cash payments and receipts. It is used by investors and management as well as creditors to make financial and economic decisions.

References

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European Commission (2010) International Accounting Standard 7 Statement of cash flows.

Faulkenberry, K. (2013). Cash Flow Statement Analysis: Purpose, Components, and Format.

International Finance Reporting Standards (2012) Definitions of operating, investing and financing activities.

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