Cash flow statement

Theory and problems

Cash flow statement
Cash flow statement is a financial statement that
shows how changes in balance sheet accounts and
income affect cash and cash equivalents, and breaks
the analysis down to operating, investing, and
financing activities.
Essentially, the cash flow statement is concerned
with the flow of cash in and cash out of the business.
The statement captures both the current operating
results and the accompanying changes in the balance
sheet.
Definitions

Cash comprises cash on hand and demand deposits with banks.
Cash equivalents are short term, highly liquid investments that are readily
convertible into known amounts of cash and which are subject to an
insignificant risk of changes in value.
Cash flows are inflows and outflows of cash and cash equivalents.
Operating activities are the principal revenue-producing activities of the
enterprise and other activities that are not investing or financing activities.
Investing activities are the acquisition and disposal of long-term assets
and other investments not included in cash equivalents.
Financing activities are activities that result in changes in the size and
composition of the owners capital (including preference share capital in
the case of a company) and borrowings of the enterprise.

Purpose/use
Provide information on a firm's liquidity and
solvency and its ability to change cash flows in
future circumstances
Provide additional information for evaluating
changes in assets, liabilities and equity
Improve the comparability of different firms'
operating performance by eliminating the effects
of different accounting methods
Indicate the amount, timing and probability of
future cash flows



Cash flow activities

The cash flow statement is partitioned into three
segments, namely:
1) cash flow resulting from operating activities; 2)
cash flow resulting from investing activities;
3) cash flow resulting from financing activities.
The money coming into the business is called cash
inflow, and money going out from the business is
called cash outflow.
Operating activities
-Direct method
Under IAS 7, operating cash flows include:
Receipts from the sale of goods or services
Receipts for the sale of loans, debt or equity instruments in a
trading portfolio
Interest received on loans
Dividends received on equity securities
Payments to suppliers for goods and services
Payments to employees or on behalf of employees
Interest payments (alternatively, this can be reported under
financing activities in IAS 7, and US GAAP)

Operating activities - Indirect method
Items which are added back to [or subtracted from, as
appropriate] the net income figure (which is found on the
Income Statement) to arrive at cash flows from operations
generally include:
Depreciation (loss of tangible asset value over time)
Deferred tax
Amortization (loss of intangible asset value over time)
Any gains or losses associated with the sale of a non-current
asset, because associated cash flows do not belong in the
operating section.
Unrealized gains/losses are also added back from the income
statement

Investing activities

Examples of Investing activities are
Purchase or Sale of an asset (assets can be
land, building, equipment, marketable
securities, etc.)
Loans made to suppliers or received from
customers
Payments related to mergers and acquisitions

Financing activities

Financing activities include the inflow of cash from
investors such as banks and shareholders, as well as
the outflow of cash to shareholders as dividends as
the company generates income.
Other activities which impact the long-term liabilities
and equity of the company are also listed in the
financing activities section of the cash flow
statement.


Financing cash flows
Under IAS 7,
Proceeds from issuing short-term or long-term debt
Payments of dividends
Payments for repurchase of company shares
Repayment of debt principal, including capital leases
For non-profit organizations, receipts of donor-restricted cash
that is limited to long-term purposes
Other items under the financing activities section include:
Dividends paid
Sale or repurchase of the company's stock
Net borrowings
Payment of dividend tax

Disclosure of non-cash activities

Under IAS 7, non-cash investing and financing activities are
disclosed in footnotes to the financial statements. Under US
General Accepted Accounting Principles (GAAP), non-cash
activities may be disclosed in a footnote or within the cash
flow statement itself. Non-cash financing activities may
include:
Leasing to purchase an asset
Converting debt to equity
Exchanging non-cash assets or liabilities for other non-cash
assets or liabilities
Issuing shares in exchange for assets

Foreign Currency Cash Flows

Cash flows arising from transactions in a foreign currency
should be recorded in an enterprises reporting currency by
applying to the foreign currency amount the exchange rate
between the reporting currency and the foreign currency at
the date of the cash flow.
A rate that approximates the actual rate may be used if the
result is substantially the same as would arise if the rates at
the dates of the cash flows were used.
The effect of changes in exchange rates on cash and cash
equivalents held in a foreign currency should be reported as a
separate part of the reconciliation of the changes in cash and
cash equivalents during the period.

Extraordinary Items

The cash flows associated with extraordinary items are
disclosed separately as arising from operating, investing or
financing activities in the cash flow statement, to enable users
to understand their nature and effect on the present and
future cash flows of the enterprise.
These disclosures are in addition to the separate disclosures
of the nature and amount of extraordinary items required by
Accounting Standard (AS) 5, Net Profit or Loss for the Period,
Prior Period Items and Changes in Accounting Policies.

Interest and Dividends

Cash flows from interest and dividends received and paid
should each be disclosed separately. Cash flows arising from
interest paid and interest and dividends received in the case
of a financial enterprise should be classified as cash flows
arising from operating activities.
In the case of other enterprises, cash flows arising from
interest paid should be classified as cash flows from financing
activities while interest and dividends received should be
classified as cash flows from investing activities. Dividends
paid should be classified as cash flows from financing
activities.

Taxes on Income

Cash flows arising from taxes on income should be separately
disclosed and should be classified as cash flows from
operating activities unless they can be specifically identified
with financing and investing activities.



Investments in Subsidiaries, Associates and Joint
Ventures

When accounting for an investment in an associate or a
subsidiary or a joint venture, an investor restricts its reporting
in the cash flow statement to the cash flows between itself
and the investee /joint venture, for example, cash flows
relating to dividends and advances.

Acquisitions and Disposals of Subsidiaries and
Other Business Units

The aggregate cash flows arising from acquisitions and from
disposals of subsidiaries or other business units should be
presented separately and classified as investing activities.

Non-cash Transactions

Investing and financing transactions that do not
require the use of cash or cash equivalents should be
excluded from a cash flow statement.
Such transactions should be disclosed elsewhere in
the financial statements in a way that provides all the
relevant information about these investing and
financing activities.

Limitations of Cash Flow Statement

A Cash Flow Statement only reveals the inflow and outflow of
cash. The cash balance disclosed by the Cash Flow Statement
may not represent the real liquid position of the concern.
Cash Flow Statement is not suitable for judging the
profitability of a firm as non-cash changes are ignored while
calculating cash flows from operating activities.
Cash Flow Statement is not a substitute for Income Statement
or Funds Flow Statement. Each of them has a separate
function to perform. Net Cash Flow disclosed by cash flow
statement does not necessarily be the net income of the
business, because net income is determined by taking into
account both cash and non-cash items.

Limitations of Cash Flow Statement
Cash Flow Statement is based on cash accounting. It ignores
the basic accounting concept of and accrual basis.
Cash Flow Statement reveals the movement of cash only. In
preparation it ignores most liquid current assets (ex: Sundry
debtors, Bills Receivable etc.)
It is difficult to precisely define the term cash. There are
controversies among accountants over a number of near cash
items like cheques, stamps, postal orders etc., to be included
in cash.
Cash Flow Statement does not give a complete picture of
financial position of the concern.