Chapter 5: Statement of Cash Flows
Objectives of the SCF
•Companies are required to include statement of cash flows (SCF) as part of their F/S.
•Historical CF are often used as indicator of amount, timing, and uncertainty of future CF.
•The objective of the SCF is to disclose the historical cash flows of the enterprise during the reporting period for both feedback and predictive purposes.
Classification and Organization
The SCF is classified on the basis of the type of cash flow:
•Operating activities are the principal revenue-producing activities of the enterprise and the related expenditures.
* Cash inflow from operations is measured as cash ...view middle of the document...
1. Cash – includes currency on hand, which is cash held for daily operating purposes, and the amount that is held in the company's current account(s) with the bank.
2. Cash Equivalents –investments that meet two conditions:
* They are held for the purpose of meeting short-term cash commitments and not for investing or other reasons; and
* They are readily convertible into a known amount of cash and are subject to an insignificant risk of change in value.
3. Overdrafts – bank overdrafts are included as a component of cash and cash equivalents when the bank balance fluctuates from positive to negative on a regular basis.
* If the current account is always overdrawn, it is a bank loan and not cash equivalent.
•Line of credit are preapproved short-term bank loan that have been negotiated with the lender in advance. However, lines of credit and other types of short-term bank loans (and a permanently overdrawn cash account) normally are viewed as financing activities and are not part of the cash definition.
•Reconciliation: Components of cash & cash equivalents (+ overdrafts) must be disclosed.
* The cash amount that is reported in the SCF must be reconciled to the equivalent items in the statement of financial position.
Interpreting the Statement of Cash Flows
•Interpretation involves examining the SCF for the major sources and uses of cash.
•The following questions must be considered, with professional judgement:
* Has operations provided cash or used cash? Why are earnings different than cash from operating activities? What are the major adjustments? Has cash, overall, increased or decreased for the period? How do the company's cash activities compare with prior years? With competitors?
•Since non-cash transactions are omitted, it is important to review transactions included in disclosure note, to gather a complete picture of company's strategic activities for the year.
•Note that a company can report a loss and still have positive cash flows from operations.
* Commonly happens when net earnings include a large depr. of capitalized costs.
Basic Approach to Preparation
•The SCF is a statement that is prepared by analyzing changes in account balances.
•It is not enough to know by how much an asswer balance has changed over the course of an accounting period; one must analyze the sources of the accounting entries in the account
Analyzing Cash Flows
•It seems logical to start by analyzing the cash in and out of the cash account(s).
•The entries to the general ledger cash account are usually summary entries from subsidiary records such as specialized journals or cumulative transaction records.
•Unfortunately, direct analysis of the cash account is difficult and time consuming.
•Therefore, the normal approach is to describe the cash activities by analyzing the changes in all of the non-cash accounts.
Presentation of Operating Activities
•There are two approaches for presenting cash provided...