IAS 7: Statement of Cash Flow:

Single Company
Uses and Advantages
 Statements of cash flows are a useful addition to the financial
statements of companies because it is recognised that accounting
profit is not the only indicator of a company's performance.
 Statements of cash flows concentrate on the sources and uses of
cash and are a useful indicator of a company's liquidity and
solvency.
 Uses and Advantages:
 (a) Survival of a company depends on its ability to generate cash.
Cash flow accounting directs attention towards this critical issue.
 (b) Cash flow is more comprehensive than 'profit' which is dependent
on accounting conventions and concepts.
Uses and Advantages
 (c) Creditors (long- and short-term) are more interested in an
entity's ability to repay them than in its profitability. Whereas
'profits' might indicate that cash is likely to be available, cash flow
accounting is more direct with its message.
 (d) Cash flow reporting provides a better means of comparing the
results of different companies than traditional profit reporting.
 (e) Cash flow reporting satisfies the needs of all users better.
 (i) For management. It provides the sort of information on which
decisions should be taken (in management accounting, 'relevant
costs' to a decision are future cash flows). Traditional profit
accounting does not help with decision-making.
 (ii) For shareholders and auditors. Cash flow accounting can provide a
satisfactory basis for stewardship accounting.
 (iii) For creditors and employees. Their information needs will be
better served by cash flow accounting.
Uses and Advantages
 (f) Cash flow forecasts are easier to prepare, as well as more
useful, than profit forecasts.
 (g) Cash flow accounts can be audited more easily than accounts
based on the accruals concept.
 (h) The accruals concept is confusing, and cash flows are more
easily understood.
 (i) Cash flow accounting can be both retrospective, and also
include a forecast for the future. This is of great information value
to all users of accounting information.
 (j) Forecasts can subsequently be monitored by the use of variance
statements which compare actual cash flows against the forecast.
Uses and Advantages
 Looking at the same question from a different angle, readers of
accounts can be misled by the profit figure.
 (a) Shareholders might believe that if a company makes a profit after
tax of, say $100,000 then this is the amount which it could afford to
pay as a dividend. Unless the company has sufficient cash available to
stay in business and also to pay a dividend, the shareholders'
expectations would be wrong.

 (b) Employees might believe that if a company makes profits, it can

afford to pay higher wages next year. This opinion may not be
correct: the ability to pay wages depends on the availability of cash.
Uses and Advantages

 (c) Creditors might consider that a profitable company is a going

concern.
 (i) If a company builds up large amounts of unsold inventories of
goods, their cost would not be chargeable against profits, but cash
would have been used up in making them, thus weakening the
company's liquid resources.
 (ii) A company might capitalise large development costs, having spent
considerable amounts of money on R & D, but only charge small
amounts against current profits. As a result, the company might show
reasonable profits, but get into severe difficulties with its liquidity
position.
Uses and Advantages
 (d) Management might suppose that if their company makes a
historical cost profit, and reinvests some of those profits, then the
company must be expanding. This is not the case: in a period of
inflation, a company might have a historical cost profit but a
current cost accounting loss, which means that the operating
capability of the firm will be declining.
 (e) Survival of a business entity depends not so much on profits as
on its ability to pay its debts when they fall due. Such payments
might include 'profit or loss' items such as material purchases,
wages, interest and taxation etc, but also capital payments for new
non-current assets and the repayment of loan capital when this
falls due (eg on the redemption of debentures).
IAS 7: Statement of cash flows: Single company

 The aim of IAS 7 is to provide information to users of financial

statements about the cash flows of an entity's ability to generate
cash and cash equivalents, as well as indicating the cash needs of
the entity.

 The statement of cash flows provides historical information about

cash and cash equivalents, classifying cash flows between
operating, investing and financing activities
IAS 7: Scope

 A statement of cash flows should be presented as an integral part

of an entity's financial statements.

 All types of entity can provide useful information about cash flows
as the need for cash is universal, whatever the nature of their
revenue-producing activities. Therefore all entities are required by
the standard to produce a statement of cash flows
IAS 7: Definitions
 Cash comprises cash on hand and demand deposits.
 Cash equivalents are short-term, highly liquid investments that are
readily convertible to 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 entity 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 equity capital and borrowings of the entity
IAS 7: Presentation of a statement of cash flows
 IAS 7 requires statements of cash flows to report cash flows during
the period classified by operating, investing and financing
activities.
 The manner of presentation of cash flows from operating,
investing and financing activities depends on the nature of the
entity.
 By classifying cash flows between different activities in this way
users can see the impact on cash and cash equivalents of each one,
and their relationships with each other.
Operating activities
 This is perhaps the key part of the statement of cash flows because
it shows whether, and to what extent, companies can generate
cash from their operations.
 It is these operating cash flows which must, in the end pay for all
cash outflows relating to other activities, ie paying loan interest,
dividends and so on.
 Most of the components of cash flows from operating activities
will be those items which determine the net profit or loss of the
entity, ie they relate to the main revenue-producing activities of
the entity. The standard gives the following as examples of cash
flows from operating activities
Items treated as Operating activities
 Cash receipts from the sale of goods and the rendering of services
 Cash receipts from royalties, fees, commissions and other revenue
 Cash payments to suppliers for goods and services
 Cash payments to and on behalf of employees
 Cash payments/refunds of income taxes unless they can be
specifically identified with financing or investing activities
 Cash receipts and payments from contracts held for dealing or trading
purposes
 Certain items may be included in the net profit or loss for the
period which do not relate to operational cash flows, for example
the profit or loss on the sale of a piece of plant will be included in
net profit or loss, but the cash flows will be classed as financing.
Items treated as Investing activities
 The cash flows classified under this heading show the extent of
new investment in assets which will generate future profit and
cash flows.
 Cash payments to acquire property, plant and equipment, intangibles
and other long-term assets, including those relating to capitalised
development costs and self-constructed property, plant and
equipment
 Cash receipts from sales of property, plant and equipment,
intangibles and other long-term assets
 Cash payments to acquire shares or debentures of other entities
Items treated as Investing activities

 Cash receipts from sales of shares or debentures of other entities

 Cash advances and loans made to other parties

 Cash receipts from the repayment of advances and loans made to

other parties

 Cash payments for or receipts from futures/forward/option/swap

contracts except where the contracts are held for dealing purposes,
or the payments/receipts are classified as financing activities
Items treated as Financing activities
 This section of the statement of cash flows shows the share of
cash which the entity's capital providers have claimed during the
period. This is an indicator of likely future interest and dividend
payments.
 Cash proceeds from issuing shares
 Cash payments to owners to acquire or redeem the entity's shares
 Cash proceeds from issuing debentures, loans, notes, bonds,
mortgages and other short or long-term borrowings
 Cash repayments of amounts borrowed
 Cash payments by a lessee for the reduction of the outstanding
liability relating to a finance lease
Reporting cash flows from operating activities
 The standard offers a choice of method for this part of the
statement of cash flows.
 (a) Direct method: disclose major classes of gross cash receipts
and gross cash payments.
 (b) Indirect method: net profit or loss is adjusted for the effects of
transactions of a non-cash nature, any deferrals or accruals of past
or future operating cash receipts or payments, and items of
income or expense associated with investing or financing cash
flows.
Reporting cash flows from operating activities
 The direct method is the preferred method because it discloses
information, not available elsewhere in the financial statements,
which could be of use in estimating future cash flows.
 The example below shows both methods.
 Using the direct method
 There are different ways in which the information about gross cash
receipts and payments can be obtained. The most obvious way is
simply to extract the information from the accounting records.
This may be a laborious task, however, and the indirect method
below may be easier-
Reporting cash flows from operating activities
 Using the indirect method
 This method is undoubtedly easier from the point of view of the
preparer of the statement of cash flows.
 The net profit or loss for the period is adjusted for the following.
 (a) Changes during the period in inventories, operating receivables
and payables
 (b) Non-cash items, eg depreciation, provisions, profits/losses on the
sales of assets
 (c) Other items, the cash flows from which should be classified under
investing or financing activities
Reporting cash flows from operating activities
A proforma of such a calculation is as follows:
Particulars Amount (Tk.)

Profit before taxation (statement of P/L and other comprehensive income) ***
Add depreciation *
Loss (profit) on sale of non-current assets *
(Increase)/decrease in inventories (*) *
(Increase)/decrease in receivables (*) *
Increase/(decrease) in payables * (*)
Cash generated from operation **
Interest (paid)/received (*) *
Income taxes paid *
cash flows from operating activities **
Basic format of the statement of cash flows
A proforma of such a calculation is as follows:
Particulars Amount (Tk.)

Cash flows from operating activities XXX

Cash flows from investing activities XXX

Cash flows from financing activities XXX

Net increase (decrease) in cash XXX

Cash at beginning of year XXX

Cash at end of year XXX

Format of the Statement of Cash Flows
Reporting cash flows from operating activities
 It is important to understand why certain items are added and
others subtracted. Note the following points.
 (a) Depreciation is not a cash expense, but is deducted in arriving at
the profit figure in the statement of comprehensive income. It makes
sense, therefore, to eliminate it by adding it back.
 (b) By the same logic, a loss on a disposal of a non-current asset
(arising through under provision of depreciation) needs to be added
back and a profit deducted.
 (c) An increase in inventories means less cash – you have spent cash
on buying inventory.
 (d) An increase in receivables means the company's credit customers
have not paid as much, and therefore there is less cash.
 (e) If we pay off payables, causing the figure to decrease, again we
have less cash.
Indirect versus direct

 The direct method is encouraged where the necessary information

is not too costly to obtain, but IAS 7 does not require it, and
favours the indirect method.

 In practice, therefore, the direct method is rarely used. It is not

obvious that IAS 7 is right in favouring the indirect method.

 It could be argued that companies ought to monitor their cash

flows carefully enough on an ongoing basis to be able to use the
direct method at minimal extra cost.
Interest and dividends

 Interest and dividends Cash flows from interest and dividends

received and paid should each be disclosed separately. Each should
be classified in a consistent manner from period to period as either
operating, investing or financing activities. Dividends paid by the
entity can be classified in one of two ways:
 (a) As a financing cash flow, showing the cost of obtaining financial
resources.
 (b) As a component of cash flows from operating activities so that
users can assess the entity's ability to pay dividends out of
operating cash flows.
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.

 Taxation cash flows are often difficult to match to the originating

underlying transaction, so most of the time all tax cash flows are
classified as arising from operating activities.