What is a statement of cash flow? Financial definition

April 24, 2010 by Victorino
Filed under Financial Accounting

International Accounting Standard (IAS 7), issued by International Accounting Standards Board (IASB) states that the statement of cash flow analyzes changes in cash and cash equivalents during a period. Cash and cash equivalents comprise cash on hand and demand deposits, together with short-term, highly liquid investments that are readily convertible to a known amount of cash, and that are subject to an insignificant risk of changes in value. An investment normally meets the definition of a cash equivalent when it has a maturity of three months or less from the date of acquisition. Equity investments are normally excluded, unless they are in substance a cash equivalent (e.g. preferred shares acquired within three months of their specified redemption date). Bank overdrafts which are repayable on demand and which form an integral part of an entity’s cash management are also included as a component of cash and cash equivalents [IAS 7.7-8].

The statement of cash flows is presented into operating, investing and financing activities. Operating activities are the main revenue-producing activities of the entity that are not investing or financing activities. These activities may include cash received from customers, cash paid to suppliers or employees, interest paid, income taxes paid, and cash paid for other operating expenses.

Investing activities are the acquisition and disposal of long-term assets (such as property and equipment, investment in associates and subsidiaries and investments in bonds) and other investments not considered to be cash equivalents.

Financing activities are activities that alter the equity capital and borrowing structure of the entity. These activities include proceeds from issuance of shares, cash receipts from obtaining loans and payment of those loans.

Interest and dividends received and paid may be classified as operating, investing, or financing activities, as long as they are classified consistently from period to period. Cash flows arising from taxes on income are normally classified as operating, unless they can be specifically identified with financing or investing activities.

The operating portion of a statement of cash flow can be presented using direct method or indirect method. Direct method presentation is encouraged, but the indirect method is acceptable. The direct method shows each major class of gross cash receipts and gross cash payments. The indirect method adjusts accrual basis net profit or loss for the effects of non-cash transactions.

The statement of cash flows shows how the changes of accounts in the statement of financial position and income affect an entity’s cash and cash equivalents. The statement gives users a picture of the flow of cash flowing in and out of the business.

Users of statement of cash flow include creditors, who needs to know the entity’s ability to repay its obligations; investors, who want to know if a business is sound and can guarantee return of investment; employees, who need to know whether a company can pay them the right compensation; and owners and shareholders, who want to assess if the business can be able to distribute dividends.

Reference:
International Accounting Standards Board (IASB)