F5 STATEMENT OF CASH FLOWS
Chapter 22
IAS 7 Statement of cash flows
• This is the statement which concentrate on the
sources and uses of cash and cash equivalents.
• It recognizes the importance of liquidity to an entity
• The statement provides historical information
about cash and cash equivalents, by classifying
cash flows between operating, investing and
financing activities.
• Aim of IAS 7:
– Is to provide users of financial statements with
information about the entity’s ability to generate cash
and cash equivalents, and to indicate the cash needs
of an entity
Important Definitions
Cash – “Cash comprises cash in hand and demand deposits”
Cash equivalents – “Cash equivalents are 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’s maturity date should normally be three months form its
acquisition date to be a cash equivalent.
Example
Preference shares acquired within a short period (3 months) from their
maturity may be treated as cash equivalents.
Bank overdrafts repayable on demand are treated as part of cash equivalents
All short tem investments
Understand the need for management to control cash flow
The need for statement of cash flows:
Cash finances the day–to–day operations
Survival depends upon cash generating ability
Creditors and bankers determine creditworthiness based upon cash flows
In order to obtain an optimal balance between profitability & liquidity
Balance between profitability and liquidity
Management has to strike a balance
Increase in profitability
Decrease in Profitability
Decrease in liquidity
Increase in liquidity
Leads
Leads
to
to
Profitability Liquidity
Differences between cash and profit
• Profit:
– Is calculated by subtracting all expenses incurred from
revenue earned (whether paid for or not)
– Calculation included non-cash items such as
depreciation
– It is derived at by using the accruals concept
– It represents entity’s potential to receive cash
• Cash
– means survival – a company may be profitable but if it
does not have cash it may not survive.
– Shows the entity’s ability to met its cash needs
Statement of cash flows
3 reasons why cashflow ≠ profit:
1. Timing - profit is reported using the accruals
basis. Income and expenses are recorded but
the cash may not have been received or paid
2. Non-cash expenses – e.g. depreciation is
charged against profit but no cash is paid
3. Cash payments not charged against profit –
e.g. capital expenditure
Presentation of a statement of cash flows (general
principles of classification of cash flows)
According to IAS 7, the cash flows should be classified in the
following standard headings:
Operating Investing
Financing activities
activities activities
Operating Activities
Are the principal revenue-producing activities
of an entity
Activities which show to what extent the
Operating activities
company can generate cash from operations
Cash receipts or payments for all
items in statement of profit or loss
Examples
Cash receipts from the sale of goods and the rendering of services
Cash receipts from royalties, fees, commission and other revenue
Cash payments to suppliers for goods and services
Cash payments to and on behalf of the employees.
Investing Activities
Activities relating to acquisition and
disposal of non-current assets and
Investing activities long term investments
Activities relating to assets which
are acquired to bring future profits
Examples of cash flows from investing activities
Cash payments to acquire Property, plant and equipment, intangibles
and other non-current assets
Cash receipts from disposal of non-current assets ( tangible,
intangible and long term investments)
Financing Activities
Activities which change the size and
Composition of the contributed equity
Financing activities
Long term borrowings of the entity
Examples of cash flows from financing activities
Proceeds from issue of shares
Cash payment to acquire or for redemption of shares
Proceeds form issuing debentures, loans notes, bonds, mortgages and
other long-term borrowings
Cash payments or redemption of amounts borrowed.
Classification of Certain Specific Items
Item Classification
Interest Under operating activity since paid out of revenues from
paid operations
Interest Investment activity as it represents return on investments
received
Dividend Investment activity as represents return on investments
received
Dividend Financing activity as it represents the cost of obtaining a
paid financial resource
Income Operating activities
taxes paid
Sale of non Should be classified as an investing activity
– current
asset
Reporting cash flows from operating activities
• Following are the two methods given by the
standard :
1. Direct method: method which discloses the
major classes of gross cash receipts and
gross cash payments
2. Indirect method:
• Profit or loss before tax is adjusted for the
effects of transactions of non-cash nature,
any accruals, items of expenses and
income relating to investing and financing
activities.
Statement of cash flows
Cash flows from operating activities
$ $
Profit before tax (from P&L) X
Adjust for: X
Depreciation X
(Profit)/loss on disposal of non-current assets (X)/X
Changes in working capital items:
Increase/(decrease) in inventories (X)/X
Increase/(decrease) in trade receivables (X)/X
Increase/(decrease) in trade payables X/(X)
Cash generated from operations X
Interest paid (X)
Tax paid (X)
Net cash from operating activities X
Statement
Statementof
ofcash
cashflows
flows
Cash flows from investing activities
Purchase of property, plant and equipment (X)
Proceeds from sales of property, plant and equipment X
Interest received X
Dividends received X
Net cash from /used in investing activities (X)
Statement of cash flows
Statement of cash flows (cont’d)
Cash flows from financing activities
Proceeds of share issue X
Receipt of additional loans X
Repayment of loans (X)
Dividends paid (X)
Net cash from or used in financing activities (X)
Net change in cash and cash equivalents X
Cash and cash equivalents brought forward X
Cash and cash equivalents carried forward X
IAS 7 Statement of cash flows
Direct method
• The direct method proforma is the same except for the
cash flows from operating activities which appears as
follows
Slide 16
Statement of cash flows for sole
traders
• It is similar to that of the company and useful
source of information for any entity
• The difference is that dividends paid is
replaced by the drawings and issued share
capital replaced by the cash introduced by the
owner.
• Also there is no taxation element.
IAS 7 Statement of cash flows accounting
Advantages
• Business survival depends on its ability to generate
cash
• Cash flow is more objective than profit
• Trade accounts payable need to know if they will
be paid
• It enhances comparability between different
enitities
• Better basis for decision making
• Easy to understand, prepare and audit
Slide 18
IAS 7 Statement of cash flows
Criticisms of IAS 7
• Inclusion of cash equivalents does not reflect
the way businesses are managed
• The requirement that a cash equivalent has to
be within three months of maturity is
unrealistic
• Management of cash equivalents is not
distinguished from other investment decisions
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