1. The statement of cash flows
Chapter 19
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2. Learning objectives
Understand how the statement of cash flows provides information that is a useful complement to the statement of financial position and the statement of comprehensive income.
Understand how ‘cash’ and ‘cash equivalents’ are defined for the purposes of a statement of cash flow and understand that these definitions mean that cash-flow statements address transactions beyond those involving merely ‘cash’.
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3. Learning objectives Know how cash flows are classified.
Understand how to construct a statement of cash flow in conformity with NZ IAS 7.
Understand the differences between cash flows from operations, cash flows from investing, and cash flows from financing activities.
Understand the contractual implications of the statement of cash flow.
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4. Introduction to cash-flow statements
Governed by NZ IAS 7 ‘Cash Flow Statements’.
Minimal differences between the old requirements of FRS-10 and the new requirements of NZ IAS 7.
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5. Comparison with other financial statements
Statement of financial position
Shows financial position at a certain date.
Statement of comprehensive income
Shows profit or loss that has been generated for a period of time using accrual accounting.
Cash-flow statement
Explains the movements in cash and cash equivalents for a given period.
Provides a reconciliation of opening and closing total of cash and cash equivalent balances appearing in the balance sheet.
Indicates sources of cash in terms of cash flows from operations, investing and from financing.
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6. Comparison with other financial statements
Information provided in a statement of cash flows may assist users to assess the ability of a reporting entity to:
generate cash flows from operating activities
to meet financial obligations
to pay dividends
obtain external finance
optimise cash resources and respond to unexpected adversity or unexpected opportunities.
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7. Comparison with other financial statements
Information provided in a statement of cash flows may assist users to:
compare the entity’s profit after tax with cash flows from operating activities
assess the need for external financing
assess possible liquidity shortages that may lead to the entity’s failure
Improve projections of future cash flows.
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8. Comparison with other financial statements
Purpose of the cash-flow statement:
By having knowledge of both cash flows and accrual of profits/losses, investors are likely to be better able to assess the performance and viability of the reporting entity.
Argued to be more reliable than profit data as profit data typically based on numerous subjective and sometimes ‘creative’ judgments.
Cash-flow data tends to be more ‘factual’ or ‘objective’.
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9. Comparison with other financial statements
Purpose of the cash-flow statement:
Considered by many to be more understandable to users, to give rise to fewer problems with key terms, and to provide greater comparability between companies.
Cash flows from operations to be considered to be a superior performance measure and useful in assessing liquidity and solvency.
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10. Defining ‘cash’ and ‘cash equivalents’
Objective of NZ IAS 7 ‘Statement of cash flows’ is:
to require the provision of information about the historical changes in cash and cash equivalents of an entity by means of a cash-flow statement, which classifies cash flows during the period from operating, investing and financing activities
NZ IAS 7 paragraph 6 defines cash flows as inflows and outflows of cash and cash equivalents.
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11. Defining ‘cash’ and ‘cash equivalents’
may relate to the total of a number of accounts shown in the balance sheet or accompanying notes.
include cash at bank, cash on hand, bank overdrafts, short-term money market deposits and demand deposits (deposits on call with a financial institution).
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12. Defining ‘cash’ and ‘cash equivalents’
‘Cash equivalents’ in the cash-flow statement
NZ IAS 7 (par. 7)
Cash equivalents are held for the purpose of meeting short-term cash commitments rather than for investment or other purposes. For an investment to qualify as a cash equivalent it must be readily convertible to a known amount of cash and be subject to an insignificant risk of changes in value. Therefore, an investment normally qualifies as a cash equivalent only when it has a maturity of, say, three months or less from the date of acquisition.
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13. Defining ‘cash’ and ‘cash equivalents’
‘Cash equivalents’ in the cash-flow statement
Cash equivalent in one entity might not be a cash equivalent in another.
Depends on the respective cash-management programs adopted — bank and non-bank bills (highly liquid investments) typically meet the definition of cash.
Account items such as accounts receivable, accounts payable, any borrowings subject to a term facility or equity securities would be excluded from cash equivalents.
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14. Disclosures on ‘cash’ and ‘cash equivalents’
‘NZ IAS 7 requires that the amount of ‘cash’ and ‘cash equivalents’ as at the end of the financial year as presented in the cash-flow statement be reconciled (by way of a note to the financial statements) to the related items in the balance sheet (refer to Exhibit 19.2).
Also required to disclose policy adopted by organisation for determining which items are classified as ‘cash’ in the statement of cash flows.
Explicit disclosure of this policy to assist users in understanding the cash-flow statement.
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15. Classification of cash flows
NZ IAS 7 paragraph 10 requires that cash flows be classified into those relating to:
Operating activities
the principal revenue-producing activities of the entity and other activities that are not investing and financing activities i.e. relate to the provision of goods and services, and other activities that are neither financing nor investing activities (refer to definitions of financing and investing).
Investing activities
the acquisition and/or disposal of long-term assets (including property, plant and equipment) and other investments (such as securities) not included in cash equivalents.
Financing activities
relating to changing the size and/or composition of the financial structure of the entity, including equity and borrowings not following within the definition of cash.
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16. Format of statement of cash flows
Appendix to NZ IAS 7 provides a suggested format:
Refer to Exhibit 19.3 (p. 694 of the text)
Cash flows from operating activities disclosed first, followed by investing and financing.
Prior-year comparisons required.
Some items ordinarily considered operating items for income statement purposes might not be treated the same for cash-flow purposes and vice versa (e.g. interest paid).
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17. Format of cash-flow statement
Cash flows from operating activities
Receipts from customers
Payments to suppliers and employees
Dividends received
Cash generated from operations
Interest paid
Income taxes paid
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18. Format of cash-flow statement
Cash flows from investing activities
Acquisition of subsidiary net of cash acquired
Purchase of property, plant and equipment
Proceeds from sale of equipment
Interest received
Dividends received
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19. Format of cash-flow statement
Cash flows from financing activities
Proceeds from issue of shares
Proceeds from borrowings
Repayment of borrowings
Dividends paid
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20. Format of cash-flow statement
Number of items to be separately disclosed:
Interest and other items of a similar nature received
Dividends received (NZ IAS 7 paragraph 31)
Borrowing costs, including interest and other costs of finance paid (NZ IAS 7 paragraph 35)
Dividends paid (NZ IAS 7 paragraph 31)
Income taxes paid (NZ IAS 7 paragraph 35).
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21. Format of cash-flow statement
Additional issues
Cash flows from operating activities to be disclosed using the direct method — relevant cash inflows and outflows reported in gross terms rather than in net terms (NZ IAS 7, par. 18).
An entity to report separately major classes of gross receipts and gross payments arising from investing and financing activities rather than as net amounts (NZ IAS 7, par. 21) — exceptions noted in paragraphs 22 and 24.
A reconciliation of cash flows from operating activities with net profit or loss as reported in income statement (NZ IAS 7, par. 20.1).
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22. Format of cash-flow statement
Reconciliation of operating profit with net cash flows from operating activities
Items that might cause a difference include:
depreciation and amortisation
increases/decreases in accounts receivable and payable, interest payable and receivable, accrued expenses, income tax payable, deferred taxes payable, prepaid expenses, inventories
loss/gain on sale of plant and equipment
refer to Exhibit 19.4, ‘Reconciliation of cash flows from operations to net profit’.
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23. Format of cash-flow statement
Non-cash financing and investing activities:
NZ IAS 7 requires that information about transactions and events that do not result in cash flows during the financial year but affect assets and liabilities that have been recognised are to be disclosed in the accounts or the consolidated accounts where the transactions and other events:
Involve parties external to the entity; and
Relate to financing and investing activities.
Refer to NZ IAS 7, par. 43.
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24. Format of cash-flow statement
Examples of non-cash financing and investing transactions:
Conversions of liabilities to equity.
Acquisitions of entities by means of an equity issue.
Acquisitions of assets by assumption of directly related liabilities such as purchase of a building by incurring a mortgage to the seller,
Acquisitions of assets by entering into finance leases.
Exchange of non-cash assets or liabilities for other non-cash assets or liabilities.
Refer to Exhibit 19.5.
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25. Format of cash-flow statement
NZ IAS 7 suggests that information should be disclosed about the external financing arrangements of the entity.
Additional information may be relevant to users in understanding the financial position and liquidity of an entity. Disclosure of this information, together with a commentary by management, is encouraged and may include the amount of undrawn borrowing facilities that may be available for future operating activities and to settle capital commitments, indicating any restrictions on the use of these facilities (NZ IAS 7, par. 50).
Refer to Exhibit 19.6 for an example of a ‘financing facility’ note.
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26. Calculating cash inflows and outflows
Cash flows from operating activities
Cash receipts from customers
sales + beginning receivables – ending receivables – bad debts expense (where bad debts are written off directly against debtors) – transfer from provision for doubtful debts (where debts that have previously been considered doubtful have subsequently proven uncollectable) – any discounts that may have been given to customers for early payment.
Refer to Worked Example 19.1, 'Calculating cash received from customers‘.
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27. Calculating cash inflows and outflows
Cash flows from operating activities:
Classification of interest and dividends received
NZ IAS 7 (refer to par. 33) provides choice as to where interest paid and dividends and interest received are to be presented.
Appendix A of NZ IAS 7 includes interest paid in operating activities but includes interest and dividends received as part of financing activities.
NZ IAS 7 (par. 34) states that dividends paid are to be classified as a financing cash flow as they relate to the cost of obtaining external resources.
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28. Calculating cash inflows and outflows
Cash flows from operating activities
Calculation of cash received from interest revenue:
interest revenue + opening interest receivable – closing interest receivable – discount amortisation + premium amortisation
Calculation of cash received from dividends:
dividend income + opening dividends receivable – closing dividends receivable
Cash payment of interest:
interest expense + opening interest payable – closing interest payable – discount amortisation + premium amortisation
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29. Calculating cash inflows and outflows
Cash flows from operating activities
Cash payment of income taxes:
income tax expense + opening income tax payable – closing income tax payable + opening deferred tax liability – closing deferred tax liability + closing deferred tax asset – opening deferred tax asset
Note (NZ IAS 7, par. 35):
Cash flows arising from taxes on income are to be separately disclosed and classified as cash flows from operating activities unless they can be specifically identified with financing and investing activities.
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30. Calculating cash inflows and outflows
Cash flows from operating activities
Cash payments to suppliers:
opening accounts payable – closing accounts payable + cost of sales + closing inventory – opening inventory – discounts given by suppliers + stock write-offs
Refer to Worked Example 19.2, ‘Calculating the cash payments made to suppliers’.
Refer to Worked Example 19.3, ‘Treatment of goods and services tax in accounts receivable and accounts payable’.
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31. Calculating cash inflows and outflows
Cash flows from investing activities
Cash payments for non-current assets
Closing balance of non-current assets – opening balance of non- current assets + original cost of assets sold – assets acquired through non-cash transactions – revaluation increases.
Need to exclude any increase in assets generated by non-cash transactions e.g. acquisition of plant by mortgage over other assets.
Refer to Worked Example 19.4, ‘Calculating cash flows from investing activities’.
Proceeds from sale of non-current assets
Specific information about the sale transaction required — actual receipt of cash recorded in cash-flow statement, not gain or loss on sale.
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32. Calculating cash inflows and outflows
Cash flows from financing activities
Payment of cash dividends
Dividends paid + dividends proposed + opening dividends payable – closing dividends payable
Includes issue of shares, issue of debt, repayment of debt.
Note: To determine cash flows from the issue of equity securities, need to consider whether any share issue has been financed out of reserves (e.g. retained earnings or revaluation reserve) — if so, no related cash flow.
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33. Calculating cash inflows and outflows
Refer to Worked Example 19.5, ‘Preparation of a statement of cash flows – comprehensive example’, including:
Calculation and disclosure of cash flows from operating activities.
Calculation and disclosure of cash flows from investment activities.
Calculation and disclosure of cash flows from financing activities.
Reconciliation of net cash provided by operating activities with operating profit after tax.
Note concerning non-cash financing and investing activities.
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34. Contractual implications
To date, limited information is available on the use of cash-flow data in contractual agreements.
Cash flows from operations would appear to provide an indication of ability to service debt.
Perhaps more so than interest coverage.
Could argue that traditional financial ratios (current ratio, acid test ratios) are deficient in monitoring the liquidity of the organisation.
Has been argued that use of cash-flow data would provide an earlier indication of solvency problems than that provided by using conventional financial ratios.
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35. Summary
Cash-flow statement considered to be very useful complement to an entity’s balance sheet and income statement.
It provides information useful for making assessments about such things as an entity’s ability to:
generate cash flows
meet financial commitments as they fall due
finance changes in operating activities
obtain and service external debt.
As not based on accrual accounting, its compilation is not greatly influenced by professional judgment.
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36. Summary
Cash-flow statement provides a reconciliation of opening and closing cash with cash being described as ‘cash on hand’ and ‘cash equivalents’.
Cash equivalents
Highly liquid investments with short periods to maturity readily convertible to cash on hand at investor’s option.
Borrowings integral to the cash management function of the entity and not subject to a term facility.
Cash flows to be divided into:
operating activities
investing activities
financing activities.
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37. Summary Direct method to be applied:
Relevant cash inflows are reported in gross terms rather than being netted off against each other.
NZ IAS 7 requires a number of notes to be provided, including:
Reconciliation of cash balance per cash-flow statement with related balance sheet items.
A reconciliation of cash flows from operating activities with profit or loss as reported in income statement.
Material financing and investing transactions and events that do not result in cash flows.
Calculation of cash flows can be applied using either:
equation approach; or
t-account approach.
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