Statement of Cash Flow

The day-to-day activities of enterprises are characterized by cash inflows and cash outflows. Receipt of payment from debtors, loan advances, proceeds of sales of assets and dividend income from investments form part of cash inflows. On the other hand, the firm is required by means of payment to settle obligation they owe to suppliers, financiers and employees, constituting to cash outflow. For this reason, business entities require to keep on evaluating their cash position to enable them to settle conveniently their cash obligations when they fall due, therefore, business enterprises prepare statement of cash flow to provide them with information pertaining to cash receipts and cash payment in that particular reporting period. According to Deloitte (2013) statement of cash flow is a financial reporting statement prepared for the primary objective of reflecting the liquidity position of a business entity. Kieso, Weygandt and Warfield (2011) observe that a cash flow statement plays a secondary role of reporting on a cash basis about operating activities, investing activities and financing activities of an enterprise in a particular financial period. This essay seeks to explain the purpose and preparation methods of a statement of cash flows.

Purpose and Presentation of a Statement of Cash Flows

Deloitte (2013) states that standards for the preparation and presentation of statement of cash flow are contained in IAS 7. The first draft that formed the basis of the current IAS 7 requirement came into effect in June 1976. Since then numerous changes have been made to the standard to enhance its reporting structure. The IAS 7 statement of cash flows requires reporting entities to present a statement of cash flows as a part of primary financial statement. Therefore, a statement of cash flows should be presented alongside the statement of financial position, income statement and statement of changes in equity. According to Kieso, Weygandt and Warfield (2011), a cash flow statement is a useful reporting tool that is used by investors, creditors, managers and tax authority to measure different performance metrics of a business entity.

A statement of cash flows is used to measure the ability of a reporting entity to generate future cash flows. Analysts using information contained in statements of cash flow can draw relationship that can help them, with accuracy, predict the amounts, timing and uncertainty of future cash flows. The statement of cash flow provides predictions that are more accurate because it is prepared using cash basis data. A statement of cash flows is used to evaluate the ability of a business enterprise to meet its future obligations such as salaries dividends and debts. Creditors, shareholder and employees use a statement of cash flow to analyze how a business enterprise generates and spends its cash, and therefore its liquidity position. A statement of cash flow helps users of financial statements to understand deeply the financial position of a business enterprise by reconciling figures contained in, for example, statement of financial position or the income statement with the statement of cash flows. For example, by examining a statement of cash flows, financial statement users can understand the reason behind an increase in cash though the entity reported a loss.

The statement of cash flows segments cash flows into three main categories: cash flows from operating activities, cash flows from investing activities and cash flows from financing activities. According to Kieso, Hong Kong Institute of Certified Public Accountants (2012), cash flows from operating activities constitute cash flows generated from revenue generating activities. Cash flows from investing activities is cash flow generated from acquisition and disposal of investments or fixed assets. Cash flows from financing activities constitute cash flows that alter the equity structure of the reporting entity. Cash flow generated from operating activities, in preparation of statement of cash flows, is presented in two ways, namely the direct method or indirect method. Deloitte (2013) observes that the direct method reports gross cash receipts and gross cash payments. The indirect method, on the other hand, adjusts net income for the effects of non-cash transactions. Though cash flow influences the expansion of firms, there are instances when expansion should not be tied to an increase in cash flow. These times include when the economy is in recession and there are no profitable investment opportunities. An enterprise should distribute excess cash to shareholders in the form of dividends.

Conclusion

Day-to-day activities of a business enterprise involve flow of cash, which constitute receipt and payment of cash on operating activities, financing activities and investing activities. Business enterprises report activities that affect their cash position using a statement of cash flows, helping users of financial statement assess the liquidity position of the firm. The statement of cash flows is prepared according to IAS 7, which categorizes cash flows based on three activities, namely operating activities, financing activities and investing activities. Reporting and preparation of statement of cash flow is on a cash basis method, and therefore helps explain the difference between net incomes and net cash flows.

References

Deloitte 2013. IAS 7- statement of cash flows.Deloitte Touch Tohmatsu Limited.

Hong Kong Institute of Certified Public Accountants 2012. Hong Kong Accounting Standard 7: statement of cash flows. Hong Kong.

Kieso, DE Weygandt, JJ & Warfield, TD. 2011. Intermediate Accounting: IFRS edition. New York: John Wiley & Sons.

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