Statement of Cash Flows Overview

Statement of Cash Flows

• A financial statement that tracks the inflow and outflow of cash and cash equivalents over a specific period.
• It's crucial for understanding a company's ability to generate cash from its core operations.
• This statement is presented along with the income statement and balance sheet.
• Classifies cash flows into three main categories: operating, investing, and financing activities.

Learning Outcomes

• Understanding the need for the Statement of Cash Flows (it helps to understand how a company generates funds for short-term and long-term liabilities).
• Cash flow classifications are Operating, Investing, and Financing.
• Different types of Cash Flow-related ratios are used to analyze a company's financial health.
• How to calculate Cash from Operations (CFO).
• The procedure to prepare a Cash Flow Statement.

The Statement of Cash Flows

• The International Accounting Standards Board (IASB) issued IAS 7, Cash Flow Statement in 1992 (effective since 1994).
• It became mandatory for businesses to include a statement of cash flows in their financial reports apart from the income statement and balance sheet.
• The Statement of Cash Flows (CFS) provides insights into the inflows and outflows of cash and cash equivalents during an accounting period.
• Cash equivalents are highly liquid, marketable securities or cash on deposit.
• The CFS breaks down cash inflows and outflows into operating, investing, and financing categories.
• The information concerning cash flow is also found in the balance sheet, however, it's not presented in the same way as the CFS.

Utility of the CFS

• Helps in determining a company's ability to pay dividends.
• Bankers use the CFS to analyze the ability of a firm to repay loans on time.
• Suppliers use it to check if the company can settle debts timely.
• Tax authorities use it to determine if the company is liable to pay tax.
• Competitors use it to examine the company's position in cash management.
• In case of negative cash, companies can explore options like short-term loans (overdraft) or selling accounts receivable to a bank.

Statement of Cash Flows - General Structure

• The statement is usually presented in a tabular format.
• Cash flow from operating activities (e.g., paying salaries, selling equipment) is shown in the table.
• Cash flow from investing activities (e.g., selling or purchasing plants and equipment) is documented.
• Cash flow from financing activities (e.g., contracting or repaying loans) is recorded.
• The net increase or decrease in cash and cash equivalents is presented.
• Cash and cash equivalents at the beginning of the year and the end of the year are indicated.
• The overall change in cash and cash equivalents is the difference between the beginning and ending balances.

The CFS Classification of Activities

• Operating: This concerns the normal business operations, including revenue and expenses.
• Investing: This concerns inflows and outflows from long-term assets like purchases or sales of land, property, and equipment.
• Financing: This relates to financing activities such as issuing bonds, paying dividends, retiring loans and issuing equity.

Calculating Cash from Operating Activities (CFO)

• This is a crucial step to calculate the Cash Flow Statement.
• The CFO can be positive or negative.
• A negative CFO means that the company used more cash in its operations than it generated.
• This is a warning signal to financial analysts.
• The CFO can be calculated using the direct method or the indirect method.
  • Direct method: involves adding up cash inflows and subtracting outflows.
  • Indirect method: starts with net income and makes adjustments for non-cash items and changes in working capital.

Changes in Working Capital

• The indirect method requires adjustments to Net Income for changes in working capital.
• Working capital includes current assets and liabilities.
• The rule to decide whether increases or decreases in working capital are inflows or outflows.
  • Decrease in current assets (except cash) generally indicates an inflow.
  • Increase in current liabilities or current assets (except cash) generally indicates an outflow.

Exercise Examples

• Multiple exercises are provided to illustrate how to apply the different concepts in the statement of cash flows.
• Different situations are presented, requiring selections of growth firms, firms in danger of bankruptcy, etc.