د. عمر محجوب محمد الحسين

Statement of Cash Flows

A statement of cash flows-SCF- (also referred to as the cash flow statement) is a financial statement showing how changes in balance sheet accounts and income affect cash & cash equivalents, and this means financial statements that report the cash generated and spent during a specific period of time.

In financial accounting, a 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. A statement of cash flows required for each income statement period, when a balance sheet and income statement are presented. International Accounting Standard 7 (IAS 7).

Therefore, the purpose of the cash flows statement is to provide information about the cash receipt and cash disbursements.

The cash flow statement is intended to provide information on a firm’s liquidity and solvency, improve the comparability of different firms’ operating performance, and to indicate the amount, timing, and probability of future cash flows.

The cash flow statement has been adopted as a standard financial statement, because it eliminates allocations, which might be derived from different accounting methods, such as various timeframes for depreciating fixed assets.

The Structure of the Cash Flow Statement and Classification of Cash Flows:

According to IASB rules cash flow statement are set out in two standards: IAS 1 and IAS 7. Which's lays down a formal structure for the cash flow statement. Cash flows classified under the following three standard headings:

· Operating activities (the inflows and outflows of cash that result from activities in the income statement).

Inflows of cash include the production, sales of goods or services, and delivery of the company’s product as well as collecting payments from its customers, interest and dividends from investment.

Outflows of cash including cash paid for purchases inventory, salaries, wages, and other operating expenses, interest on debit, income taxes.

Note: some revenues and expenses (deprecation exp., don’t affect cash and not included as cash outflows from operating activities.

The difference between inflows and outflows is called net cash flows from operating activities.

· Investing activities, include the inflows and outflows of cash that related to the acquisition and disposition of long-lived assets used in the operation of business.

Inflows of cash such as purchases of assets (land, building, equipment, marketable securities, etc.).

Outflows of cash such as purchase of marketable securities, acquisitions, net of cash acquired, purchases of assets (land, building, equipment, marketable securities, etc.

Note: Net cash flows from investing activities represents the difference between inflows and outflows.

· Financing activities, relate to the external financing of the company, include:

Inflows of cash, include cash from investors, such as banks and shareholders (proceeds from issuing long-term debt).

Outflows of cash, include cash to shareholders as dividends as the company generates income.

In general, financing activities include, issuance of equity, repayment of equity, payment of dividends, issuance of debt, repayment of debt, capital/finance lease payments.

non-cash financing activities: 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, and issuing shares in exchange for assets.

Purpose of Cash Flow Statement

Preparation of a cash flow statement serves various purposes like:

· 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 in the forms of cash outflows, cash inflows, and cash being held.

· Improve the comparability of different firms’ operating performance by eliminating the effects of different accounting methods; and

· Indicate the amount, timing, and probability of future cash flows.

· Provide a view of management strategy. The information about inflows and outflows is used by the management to discern the ability of an organization to generate cash, and how the funds are then used. That’s important for making long term business plans.

· Legal requirement. The statement of cash flows is part of the financial statements, which also include the income statement and balance sheet.

Direct and Indirect Cash Flow Methods

Direct Method: According to this method, the net cash flow represents the difference between the amounts of cash received and the amounts of cash paid out from operating activities, the direct method shows the actual cash flows from operating activities.

Indirect Method: According to this method, the net income figure appearing in the income statement is amended by adding or subtracting the non-cash operating activities items from the net income with the aim of converting the net income number from the accrual basis of the cash basis (changes in assets and liabilities accounts is adjusted in the net income to arrive cash flows from the operating activities). Indirect method reconciles profit before tax to cash generated from operating profit.

Both methods result in the SAME AMOUNT of cash flow from operating activities. They differ in the way they report cash flows from operating activities.

Companies favor the INDIRECT METHOD for two reasons:

1. Easier and less costly to prepare.

2. Focuses on differences between net income and net cash flow from operating activities.

Statement of cash flows: Statement of cash flows includes cash flows from operating, financing and investing activities.

Cash Flow Statement: Example of cash flow statement (indirect method)

It is important to note that investing activity does not concern cash from outside investors, such as bondholders or shareholders. For example, a company may decide to pay out a dividend. A dividend is often thought of as a payment to those who invested in the company by buying its stock. However, this cash flow is not representative of an investing activity on the part of the company. The investing activity was undertaken by the shareholder. Therefore, paying out a dividend is a financing activity.

Some examples of investment activity from the company’s perspective would include:

· Cash outflow from the purchase of an asset (land, building, equipment, etc.).

· Cash inflow from the sale of an asset.

· Cash outflow from the acquisition of another company.

· Cash inflow resulting from a merger.

· Cash inflow resulting dividends paid on stock owned in another company.

It is important to remember that, as with all cash flows, an investing activity only appears on the cash flow statement if there is an immediate exchange of cash. Therefore, extending credit to a customer (accounts receivable) is an investing activity, but it only appears on the cash flow statement when the customer pays off their debt.

Purpose of Cash Flow Statement

Preparation of a cash flow statement serves various purposes like:

· Improve the comparability of different firms’ operating performance by eliminating the effects of different accounting methods; and

· Indicate the amount, timing, and probability of future cash flows.

· Legal requirement. The statement of cash flows is part of the financial statements, which also include the income statement and balance sheet.

Direct and Indirect Cash Flow Methods

Both methods result in the SAME AMOUNT of cash flow from operating activities. They differ in the way they report cash flows from operating activities.

Companies favor the INDIRECT METHOD for two reasons:

1. Easier and less costly to prepare.

2. Focuses on differences between net income and net cash flow from operating activities.

Statement of cash flows: Statement of cash flows includes cash flows from operating, financing and investing activities. Illustration 1

Cash Flow Statement: Example of cash flow statement (indirect method) illustration 2.

Some examples of investment activity from the company’s perspective would include:

· Cash outflow from the purchase of an asset (land, building, equipment, etc.).

· Cash inflow from the sale of an asset.

· Cash outflow from the acquisition of another company.

· Cash inflow resulting from a merger.

· Cash inflow resulting dividends paid on stock owned in another company.

The step in preparing the statement of cash flows are as follows:

Step 1. Find cash generated by operation by adjusting the net income as reported on the income statement using the procedures summarized in illustration 3.

Step 2. Identify any investing activities for example, purchases and sales of assets (Property, Plant & Equipment or marketable securities, etc.), loans made to suppliers or the ones received from the customer, and any payments related to merger & acquisitions.

Step 3. Identify any Financing activities such as transactions involving long-term liabilities, owner’s equity and changes to short-term borrowings. These activities involve the flow of cash and cash equivalents between the company and its sources of finance i.e. the investors and creditors for non-trading liabilities such as long-term loans, bonds payable etc.

Step 4. Sum the subtotals for the three sections of the stamen to determent the increase or decrease in cash and equivalents. Illustration 1

calculating operating cash flow from net income

Depreciation exp.

Increase in deferred taxes.

Decreased in accounts receivable.

Decreased in inventories.

Decreased in prepaid exp.

Increase in payables.

Loss on disposal.

Depreciation in deferred taxes.

Increase in accounts receivable.

Increase in inventories.