IAS 7 Cash Flow Statement

Objective

To provide information about historical changes in cash and cash equivalents by means of cash flow statement, which classifies cash flows during the period from the operating, investing and financing activities.

Scope

A. Applies to all entities

• Users of financial statements are interested in cash generation regardless of the nature of the entity’s activities.
• Entities need cash for essentially the same reasons:
1. To conduct operations
2. To pay obligations
3. To provide returns to investors

• Profit is not as cash and profitability does not mean liquidity.

B. Importance of cash

• To show that profits are being realized
• To pay dividends
• To finance further investments

C. Benefits of cash flow information

• Provides information that enables users to evaluate changes in:

Ø net assets;

Ø financial structure

Ø ability to affect amounts and timing of cash flows

• Useful in assessing the ability to generate cash and cash equivalents.
• Users can develop models to assess and compare the present value of future cash flows of different entities.
• Enhances comparability of reporting operating performance by different entities.
• Historical cash flow information may provide an indicator of the amount, timing and certainty of future cash flows.

Definitions

Cash—cash on hand and demand deposits.

Cash equivalents-- short term, highly liquid investments:

• Readily convertible in known amount of cash;
• Subject to an insignificant risk of changes in value;
• Excluding equity investments unless they are, in substance, cash equivalents (e.g. preferred shares acquired within a short period of their maturity and a specified redemption date).

Cash flows—inflows and outflows of cash and cash equivalents.

Operating activities—principal revenue producing activities 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—result in changes in the size and composition of equity capital and borrowings. Bank borrowings generally included.

Presentation of a cash flow statement

Classification:- IAS 7 requires cash inflows and outflows to be analyzed across three headings:

Operating

- Key indicators of sufficiency of cash flows to:

o repay loans;

o maintain operating capability;

o pay dividend;

o Make new investments.

Without recourse to external sources of finance

- Useful in forecasting future operating cash flows.

- Primarily derived from principal revenue-producing activities.

- Generally results from transactions and events so included in net profit or loss.

Investing

- Separate disclosure is important – cash flows represent extent to which expenditures have been made for resources intended to generate future income and cash flows

Financing

Separate disclosure is useful in predicting claims on future cash flows by providers of capital

Reporting cash flows from operating activities

There are two ways permitted to present cash flows from ordinary activities:

Direct Method

- Disclosure major classes of gross cash payments.

- Information obtained either from accounting records; or

- By adjusting sales, cost of sales for:

o Changes during period in inventories and operating receivable and payables:

o Other non-cash items:

o Other items for which cash effects are investing/ financing cash flows.

Indirect Method

- Adjusts net profit or loss for effects of:

o Non-cash transactions (e.g. depreciation);

o Any deferrals or accruals of past or future operating cash receipts or payments;

o Items of income or expense associated with investing or financing cash flows.

Techniques

Direct method:-

Step 1: Cash receipts from customers

Less: cash paid to suppliers and employees

= Cash generated from operations

Step 2: Payments for interest and income taxes

= net cash from operating activities

Indirect method:-

Step I (i) Profit before tax

Step (ii) Adjust for non-cash items and investing and financing accounted for on the accruals basis.

= Operating profit before working capital changes

Step (iii) Making working capital changes

=cash generated from operations (same as figure calculated under direct method).

Indirect Method is much more widely used in the practice.

Reporting cash flow from investing and financing activities

Separate reporting

· Major classes of gross cash receipts and gross cash payments arising from investing and financing activities should be reported separately.

Investing activities

· Purchase of property plant and equipment –this must represent actual amounts paid.

· Proceeds from sales of tangible assets.

Financing activities

· Again the approach is to reconcile balance sheet moments to identify the cash element.

Components of cash and cash equivalents

Reconciliation

· Disclose components of cash and cash equivalents and present a reconciliation of amounts in cash flow statements with equivalent items reported in balance sheet (if necessary, in a note to the cash flow statement).

Proforma of

Direct method (mostly in use)

Cash flows from operating activities

Cash receipts from customers X

Cash paid to suppliers and employees (X)

----

Cash generated from operations X

Interest paid (X)

Income Taxes paid (X)

----

Net cash flow from operating activities X

Purchase of property, plant and equipment (X)

Proceeds from sale of equipment X

Interests received X

Dividends received X

----

Net cash used in investing activities X

Cash flows from financing activities

Proceeds from issuance of share capital X

Dividends received X

----

Net cash used in financing activities X

-----

Net increase in cash and cash equivalents X

Cash and cash equivalents at beginning of period X

-----

Cash and cash equivalents at the end of period X

-----

Indirect Method

Cash flows from operating activities

Net profit before taxation

Adjusted for

Depreciation

minus Investment Income

Plus Interest expenses

Operating profit before working capital changes

Minus Increase in trade and other receivables

Plus Decrease in inventories

Minus Decrease in trade payables

Cash generated from operations

Note to Cash Flow Statement

Cash & cash equivalents: cash on hand and balances with banks

Short term investments

Additional Disclosures

· There are a number of extra disclosures which should be made in most cases to support the main cash flow statement:

o Analysis of cash & cash equivalents

o Major non cash transactions;

o Cash and cash equivalents held by the groups

o Reporting futures, options and swaps;

Voluntary disclosers.