IAS 7 - Statement of cash flows

The objective of IAS 7 is to require the presentation of information about the historical changes in cash and cash equivalents of an entity by means of a statement of cash flows. IAS 7 Statement of Cash Flows requires an entity to present a statement of cash flows as an integral part of its primary financial statements. Statement of cash flows shows inflows and outflows of cash and cash equivalents from various activities of an enterprise during a particular period. ‘Cash’ comprises of cash in hand and demand deposits with banks, and ‘Cash equivalents’ means 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.

Advantages of statement of cash flows

• Assess the Liquidity Status of Company

Statement of cash flows helps in knowing the liquidity position of the company. In case of shortage required funds can be raised through external sources. If there are excesses of funds, these can be used for growth of the business.

• Assist in Planning, Budgeting and Controlling

The financial planning and analysis is done with the help of statement of cash flows. It helps the top-level management to coordinate financial operations properly. Management can prepare estimates about various inflows of cash and outflows of cash so that it becomes helpful to take future actions.

• Performance Appraisal

The management can evaluate the performances regarding cash by comparing actual cash with projected cash flow statements. Management can take appropriate actions if any variance is found.

• Movement of Cash

Statement of cash flows represents the ins and outs of cash meaning the flows of cash on the basis of which future estimate can be made. Cash flow information is useful in assessing the ability of the enterprise to generate cash and cash equivalents. It enables users to develop models to assess and compare the present value of the future cash flows of different enterprises

Limitations of statement of cash flows

• Fails to Present Net Profit

Statement of cash flows fails to present the net income of a firm as it ignores non-cash items which are considered by income Statement. It does not help to assess profitability as it neither considers cost nor revenues. However, it can be used as supplement to income statement.

• Not a substitute to Income Statement

The functions which are performed by an income statement cannot be done by cash flow statement.

• Industry Comparison not possible

Statement of cash flows does not measure the efficiency of firm. Therefore, comparisons with other companies are not possible. A firm having less capital investment shall have less cash flow than the firm which has more capital investment resulting in higher cash flows.

• Does not Properly Assess Liquidity position

Statement of cash flows does not assess liquidity or solvency position of the firm in practice as it presents cash position only on a particular date. It only helps to know what amount of obligation can be met. Therefore, it does not represent the real liquidity position.

Classification

Cash flows are classified and presented into operating activities (either using the 'direct' or 'indirect' method), investing activities or financing activities, with the latter two categories generally presented on a gross basis.

Cash from Operating Activities

These are the principal revenue generating activities of the enterprise. They generally result from the transactions and other events that are used to determine net profit or loss. The amount of cash from operations’ indicates the internal solvency level of the company, and is regarded as the key indicator of the extent to which the operations of the enterprise have generated sufficient cash flows to maintain the operating capability of the enterprise, paying dividends, making of new investments and repaying of loans without recourse to external source of financing.

The statement of cash flows direct method uses actual cash inflows and outflows from the company's operations, instead of modifying the operating section from accrual accounting to a cash basis. The direct method shows each major class of gross cash receipts and gross cash payments.

The indirect method adjusts accrual basis net profit or loss for the effects of non-cash transactions. The operating cash flows section of the statement of cash flows under the indirect method is prepared as follows:

Examples of cash flows from operating activities are:

Cash Inflows from operating activities

• Cash receipts from sale of goods and income from services.
• Cash receipts from royalties, fees, commissions and other revenues.

Cash Outflows from operating activities

• Cash payments to suppliers for goods and services.
• Cash payments to and on behalf of the employees.
• Cash payments to an insurance enterprise for premiums and claims, annuities, and other policy benefits.
• Cash payments of income taxes
• Payment of interest of debentures (Finance cost)

Cash from Investing Activities

Investing activities are the acquisition and disposal of non-current assets and other investments not included in cash equivalents. Transactions related to long-term investment are also investing activities. Separate disclosure of cash flows from investing activities is important because they represent the extent to which expenditures have been made for resources intended to generate future income and cash flows.

Examples of cash flows arising from investing activities are:

Cash Inflows from Investing Activities

• Cash receipt from disposal of non-current assets including intangibles.
• Interest received in cash from loans and advances.
• Dividend received from investments in other enterprises.

Cash Outflows from investing activities

• Cash payments to acquire non-current assets including intangibles and capitalised research and development.

Cash from Financing Activities

Financing activities relate to long-term funds or capital of an enterprise. Financing activities are activities that result in changes in the size and composition of the owners’ capital (including preference share capital in case of a company) and borrowings of the enterprise. Separate disclosure of cash flows arising from financing activities is important because it is useful in predicting claims on future cash flows by providers of funds (both capital and borrowings) to the enterprise.

Examples of financing activities are:

Cash Inflows from financing activities

• Cash proceeds from issuing shares (equity or/and preference) at a premium.
• Cash proceeds from issuing debentures, loans, bonds and other short/ long-term borrowings.

Cash Outflows from financing activities

• Repayment of debentures / loan
• Dividends paid on equity and preference capital.

Format of preparing Statement of cash flows

Worked Example

The directors of Hank Limited provide the following statements of financial position at 31 March:

Additional information:

The following information relates to the year ended 31 March 2016:

• The profit from operations was $30 000.
• During the year non-current assets with a cost of $24 000 and accumulated depreciation of $19 000 were sold for $8000.
• The depreciation charge for the year was $12 000. All non-current assets held at the end of the financial year are depreciated over 25 years using the straight-line method.
• Interest paid for the year was $9000.
• Dividends paid during the year were $25 000. A dividend of $30 000 had been proposed at the end of the year.
• The taxation charge was $20 000.

Prepare a statement of cash flows for Hank Limited for the year ended 31 March 2016 in accordance with IAS 7.

Step 1 – Calculate Operating profit

Step 2 – Calculate Increase / decrease in

Inventory – Increase by $26 000 (128 – 102)

Trade receivables – Increase by $14 000 (132 – 118)

Trade payables – Decrease by $7 000 (102 – 109)

Step 3 – Calculate Acquisition / Depreciation of Non Current Assets

Step 4 – Calculate profit / loss on disposal and Proceeds from disposal

Step 5 – In case 3 different figures are available for Interest, Tax and Dividend

Step 6 – Calculate changes in Equity

Step 7 – Calculate changes in Share premium

Step 8 –Calculate change in Non-current liabilities

Increase – cash inflow = $22 000 (42-20)

Decrease – Cash outflow

Q1. The  summarised  accounts  of  Sabrina  plc  for  2011  and  2010  are  set  out below. 

 Note:

All sales and purchases are made on credit.

Non-current assets costing $40 000, with accumulated depreciation of $25 000, were sold during the year.

REQUIRED 

1. Prepare reconciliation between cash flows from operating activities and operating profit for the year ended 30 June 2011.
2. Prepare a cash flow statement for the year ended 30 June 2011 in accordance with IAS 7.

Q2. The statement of financial position at 31 March 2010 and 2009 for Costello plc are shown below:      

During the year vehicles which had originally cost $200 000 were sold at a profit of $7000. The sales proceeds were $37 000.

Note 2

$140 000 debentures were paid on 30 September 2009.

Note 3

In May 2009 a bonus issue of 1 new ordinary share for every 4 held was made. It is company policy to maintain reserves in their most flexible form. A rights issue of 1 ordinary share for every 5 held at a premium of $2 each was made in February 2010.

REQUIRED

• Prepare a statement to show the reconciliation of profit from operations (operating profit) to net cash flow from operating activities for the year ended 31 March 2010.
• Prepare a statement of cash flows for the year ended 31 March 2010

Q3. The directors of Plantin plc have produced the following.

Statement of Financial Position at 1 April 2014

The following information is also available for the following year.

REQUIRED

Prepare Plantin plc’s statement of financial position as at 31 March 2015.