Acca f3 Financial Accounting (int) Study Text

Part F  Preparing basic financial statements 

  23:  Statements of cash flows

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From these examples, it may be apparent that a company's performance and prospects depend not so 

much on the 'profits' earned in a period, but more realistically on liquidity or 

cash flows.

1.1 Funds flow and cash flow 

Some countries, either currently or in the past, have required the disclosure of additional statements 

based on 

funds flow rather than cash flow. However, the definition of 'funds' can be very vague and such 

statements often simply require a rearrangement of figures already provided in the statement of financial 

position and income statement. By contrast, a statement of cash flows is unambiguous and provides 

information which is additional to that provided in the rest of the accounts. It also lends itself to 

organisation by activity and not by statement of financial position classification. 

Statements of cash flows are frequently given as an 

additional statement, supplementing the statement of 

financial position, income statement and related notes. The group aspects of statements of cash flows 

(and certain complex matters) have been excluded as they are beyond the scope of your syllabus. 

1.2 Objective of IAS 7 

The aim of IAS 7 is to provide information to users of financial statements about an entity's 

ability to 

generate cash and cash equivalents, as well as indicating the cash needs of the entity. The statement of 

cash flows provides historical information about cash and cash equivalents, classifying cash flows 

between operating, investing and financing activities. 

1.3 Scope 

A statement of cash flows should be presented as an 

integral part of an entity's financial statements. All 

types of entity can provide useful information about cash flows as the need for cash is universal, whatever 

the nature of their revenue-producing activities. Therefore 

all entities are required by the standard to 

produce a statement of cash flows. 

1.4 Benefits of cash flow information 

The use of statements of cash flows is very much 

in conjunction with the rest of the financial statements.

Users can gain further appreciation of the change in net assets, of the entity's financial position (liquidity 

and solvency) and the entity's ability to adapt to changing circumstances by adjusting the amount and 

timing of cash flows. Statements of cash flows 

enhance comparability as they are not affected by 

differing accounting policies used for the same type of transactions or events. 

Cash flow information of a historical nature can be used as an indicator of the amount, timing and 

certainty of future cash flows. Past forecast cash flow information can be 

checked for accuracy as actual 

figures emerge. The relationship between profit and cash flows can be analysed as can changes in prices 

over time. All this information helps management to control costs by controlling cash flow. 

1.5 Definitions 

The standard gives the following definitions, the most important of which are 

cash and cash equivalents.

Cash comprises cash on hand and demand deposits. 

Cash equivalents are short-term, highly liquid investments that are readily convertible to known 

amounts of cash and which are subject to an insignificant risk of changes in value. 

Cash flows are inflows and outflows of cash and cash equivalents. 

Operating activities are the principal revenue-producing activities of the enterprise and other 

activities that are not investing or financing activities. 

Investing activities are the acquisition and disposal of non-current assets and other investments 

not included in cash equivalents. 

Financing activities are activities that result in changes in the size and composition of the equity 

capital and borrowings of the entity. 

(IAS 7)

Key terms 

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23: Statements of cash flows    Part F  Preparing basic financial statements 

1.6 Cash and cash equivalents 

The standard expands on the definition of cash equivalents: they are not held for investment or other long-

term purposes, but rather to meet short-term cash commitments. To fulfil the above definition, an 

investment's

maturity date should normally be three months from its acquisition date. It would usually 

be the case then that equity investments (ie shares in other companies) are not cash equivalents. An 

exception would be where redeemable preference shares were acquired with a very close redemption date. 

Loans and other borrowings from banks are classified as investing activities. In some countries, however, 

bank overdrafts are repayable on demand and are treated as part of an enterprise's total cash 

management system. In these circumstances an overdrawn balance will be included in cash and cash 

equivalents. Such banking arrangements are characterised by a balance which fluctuates between 

overdrawn and credit. 

Movements between different types of cash and cash equivalent are not included in cash flows. The 

investment of surplus cash in cash equivalents is part of cash management, not part of operating, 

investing or financing activities. 

1.7 Presentation of a statement of cash flows 

IAS 7 requires statements of cash flows to report cash flows during the period classified by 

operating,

investing and financing activities. 

The manner of presentation of cash flows from operating, investing and financing activities 

depends on 

the nature of the enterprise. By classifying cash flows between different activities in this way users can 

see the impact on cash and cash equivalents of each one, and their relationships with each other. We can 

look at each in more detail. 

1.7.1 Operating activities 

This is perhaps the key part of the statement of cash flows because it shows whether, and to what extent, 

companies can 

generate cash from their operations. It is these operating cash flows which must, in the 

end pay for all cash outflows relating to other activities, ie paying loan interest, dividends and so on. 

Most of the components of cash flows from operating activities will be those items which 

determine the 

net profit or loss of the enterprise, ie they relate to the main revenue-producing activities of the 

enterprise. The standard gives the following as examples of cash flows from operating activities. 

(a) 

Cash receipts from the sale of goods and the rendering of services 

(b) 

Cash receipts from royalties, fees, commissions and other revenue 

(c) 

Cash payments to suppliers for goods and services 

(d) 

Cash payments to and on behalf of employees 

Certain items may be included in the net profit or loss for the period which do not relate to operational 

cash flows, for example the profit or loss on the sale of a piece of plant will be included in net profit or 

loss, but the cash flows will be classed as 

financing.

1.7.2 Investing activities 

The cash flows classified under this heading show the extent of new investment in 

assets which will 

generate future profit and cash flows. The standard gives the following examples of cash flows arising 

from investing activities. 

(a) 

Cash payments to acquire property, plant and equipment, intangibles and other non-current assets, 

including those relating to capitalised development costs and self-constructed property, plant and 

equipment

(b) 

Cash receipts from sales of property, plant and equipment, intangibles and other non-current 

assets

(c) 

Cash payments to acquire shares or debentures of other enterprises 

(d) 

Cash receipts from sales of shares or debentures of other enterprises  

(e) 

Cash advances and loans made to other parties 

(f) 

Cash receipts from the repayment of advances and loans made to other parties 

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