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The purpose of this Standard is to necessitate the presentation of information regarding a corporation’s historical changes in cash and cash equivalents through a statement of cash flows that distinguishes cash flows throughout the period into operating, investing, and financing activities.
The inflows & outflows of cash, as well as cash equivalents, are referred to as cash flows. The term “cash” refers to both cash on hand and demand deposits too. Cash equivalents are short-term, extremely liquid assets that are easily converted into known sums of cash and have a low risk of value fluctuations.
Information on an entity’s cash flows is valuable in supplying the users of financial statements with a basis to determine the capability of the business to generate cash & cash equivalents, as well as the entity’s needs to employ those cash flows. The economic/financial decisions of the users necessitate an assessment of the ability of companies to earn cash and cash equivalents, as well as the timing and predictability with which they do so.
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The statement of cash flows is the sole statement that does not use an accrual basis and is instead based on cash. All other financial statements adhere to the accrual principle, which implies that we have a large number of non-cash transactions in our financial accounts that must be eliminated in order to calculate cash flows. The statement of cash flows demonstrates a corporation’s ability to create cash. Many investors investigate the statement of cash flows immediately after looking at the profit figure because they suspect that the profit could be influenced by non-cash activities such as various provisions, fair value adjustments, and so on.
The cash flow statement needs to report cash flows during the relevant period divided into operating, investing, and financing activities.
Operating activities include the entity’s primary revenue-generating activities, as well as any additional activities that are not investing or financing. The principal revenue-producing operations of the organization generate the majority of the cash flows from operating activities. As a result, they are usually the result of the transactions and other events that go into determining profit or loss.
The quantity of cash flows procured out of operating activities is a crucial indication of the degree to which the operations of the company have produced enough cash flows to repay the loans, sustain the entity’s operating capability, pay a dividend, and make new investments without relying on outside funding sources.
A company can report cash flows from operating activities using either of the two methods, namely the direct method or indirect method. The direct approach discloses significant categories of gross cash collections and gross cash payments.
The indirect method states that the company’s profit or loss has to be adjusted/modified for a number of things such as the impacts of transactions of a non-cash nature, the effects of any deferrals/accruals of past or future operating cash receipts or cash payments, and also the items of income or expenditure related to investing or financing cash flows.
The following are some examples of cash flows obtained by operating activities:
Investing operations include the purchase and sale of long-term assets as well as other investments that are not cash equivalents. The specific and detailed presentation of cash flows resulting from investing operations is significant since these cash flows show the degree to which expenditures in a company have been made for resources that are expected to generate future income and cash flows.
Moreover, the aggregate cash flows resulting from the acquisition and loss of control of subsidiaries or other enterprises must be stated separately and classed as investment activities.
The following are some examples of cash flows obtained by investing activities:
Financing operations are those that cause changes in the size and mix of the corporation’s contributed equity and borrowings. The separate declaration of cash flows deriving from financing activities is significant because it aids in projecting the claims of capital providers on the future cash flows of the enterprise.
The following are some examples of cash flows generated by financing activities:
The principal kinds of gross cash receipts and gross cash payments originating from investing and financing activities must be reported separately by an entity. Further, the investing and financing operations that do not necessitate the use of cash or cash equivalents must be eliminated from a cash flow statement. Such transactions must be declared elsewhere in the financial statements in such a way that all vital and relevant information about these investing and financing operations is provided.
Cash flows from investing & financing activities must always be reported in their entirety (gross figures), with no netting. This means that you cannot display the cash paid to acquire one vehicle and the cash obtained from the sale of another vehicle on the same line; instead, you must present these cash flows separately on two lines.
But, IAS 7 provides two exceptions in which you can present net figures. The first is cash collections or payments effected on behalf of the customers where the cash flows represent the customer’s actions rather than the entities. Some real estate companies, for example, can collect rent from renters and pay it to the property owners. Secondly, receipts and payments in cash for items with a high turnover rate, huge amounts, and short maturities may be shown in net figures. For example, changes in principal amounts linked to credit card clients. In addition, financial institutions also have the option of reporting some transactions on a net basis.
Cash flows resulting from foreign currency transactions must be documented in a corporation’s functional currency by applying the exchange rate between the functional currency and the foreign currency to the foreign currency amount at the time of the cash flow generation. Similarly, a foreign subsidiary’s cash flows must be translated using the exchange rates prevailing between the functional currency & the foreign currency on the dates of the cash flows.
Changes in foreign currency exchange rates result in unrealized gains and losses, but these are not cash flows. The impact of exchange rate fluctuations on cash & cash equivalents that are held or outstanding in a foreign currency, on the other hand, is recorded in the statement of cash flows in order to reconcile cash or cash equivalents at the start and end of the period.
In general, cash flows from income taxes are categorized as cash flows from operating activities. However, if you can clearly associate these taxes with financing or investing operations, you should disclose your cash flows from taxes in these sections.
Furthermore, interest and dividends received and paid can be categorized as operational, investing, or financing cash flows, as long as the classification is constant from one quarter to the next.
A company must disclose all the constituents of cash and cash equivalents as well as provide a reconciliation of the figures in its statement of cash flows to the equivalent items reported & disclosed in its statement of financial position. In addition, the amount of significant cash and cash equivalent balances held by a business that is not accessible for use by the group must be disclosed, together with a remark by management.
IAS 7, i.e., Statement of Cash Flows mandates that a business should include a cash flow statement as part of its primary financial statements. Operating activities (whether using the direct or the indirect technique), investing activities, and financing activities are the three types of cash flows that are categorized and presented, with the latter two being presented on a gross basis.
Read our Article: Is it possible for a profitable business to have cash deficiency? (Low Current Ratio)
A CA together with MBA (Fin) and M Com, she relishes taking interest in insightful writing in the domain of taxation and finance. She has gained experience as a full-time author and has also served an accounting role in industry.
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