Understading Cash Flow Statement

In the next few articles we will begin to understand Cash Flow Statement. This is just an introductory article to get started.

The IASC issued revised IAS 7, Cash Flow Statements, in 1992, superseding the original standard, also denoted as IAS 7, which had been issued in 1977 and required enterprises to prepare the statement of changes in financial position (commonly referred to as the funds flow statement) as an integral part of the financial reporting process. This revised standard, which established the currently applicable rules for cash flow reporting, became operative in 1994. The primary purpose of the statement of cash flows is to provide information about the cash receipts and cash payments of an entity during a period. A secondary purpose is to provide insight into the investing and financing activities of the entity. More specifically, the statement of cash flows should help investors and creditors assess

·         The ability to generate future positive cash flows

·         The ability to meet obligations and pay dividends

·         Reasons for differences between income and cash receipts and payments

·         Both cash and noncash aspects of entities' investing and financing transactions

The adoption of a requirement for cash flow reporting by the IASC completed a universal movement away from the formerly popular funds flow mode of reporting to cash flow reporting. In the United States, the move was completed with the issuance of SFAS 95 in 1988. A similar change in the United Kingdom occurred with the issuance of FRS 1 in 1991. (However, the UK rules were substantially revised in October 1996, so that financial reporting of cash flow information in the UK now differs significantly from practice under both US and International standards, as noted in greater detail below.) The purpose of this shift was to provide external users of financial statements with a better tool to project future cash flows, which is now deemed to be the ultimate concern of investors and creditors.

While the formerly popular concept of funds did permit this assessment to be made, albeit with difficulty on the part of the users of the statements, cash flow reporting is now seen as being a central objective of the financial reporting process. The requirements of IAS 7 are generally similar to the requirements of both SFAS 95 and the original UK FRS 1, as it stood before its overhaul in 1996, although IAS 7 does contain a few peculiarities.

Definitions of Terms

Cash

Cash on hand and demand deposits with banks or other financial institutions.

Cash equivalents

Short-term highly liquid investments that are (1) readily convertible to known amounts of cash, and (2) so near their maturity (original maturity of three months or less) that they present negligible risk of changes in value because of changes in interest rates. Treasury bills, commercial paper, and money market funds are all examples of cash equivalents.

Direct method

A method that derives the net cash provided by or used in operating activities from major components of operating cash receipts and payments.

Financing activities

The transactions that cause changes in the size and composition of an enterprise's capital and borrowings.

Indirect (reconciliation) method

A method that derives the net cash provided by or used in operating activities by adjusting net income (loss) for the effects of transactions of a noncash 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 activities.

Investing activities

The acquisition and disposal of long-term assets and other investments not included in cash equivalents.

Operating activities

The transactions not classified as financing or investing activities, generally involving producing and delivering goods or providing services.

Cash Flow Statement will be continued in the next article.