The notion of cash flow and funds flow has been included in accounting standards for almost three decades. For example in the UK, SSPA 10 (1976), Source and Application of Funds Statement, was an early attempt by standard setters to provide a link between the balance sheet at the start of the accounting period, the profit and loss for the period and the balance sheet at the end of the period.
When the Accounting Standards Boards in the UK, took over the work of the Accounting Standards Committee in 1991, its first significant revision was to replace SSAP10 by FRS 1, Financial Reporting Standard 1, Cash Flow Statement. This transition from funds flow to cash flow was also reflected in the revision of the IASC’s, International Accounting Standards Committee, IAS 7, Statement of Changes in Financials Position (1977) to IAS 7 Cash flow Statement (1992) which became operative for financial statements covering periods beginning on or after 1 January 1994.September 2007 re titled
Statement of Cash Flows 2009/10
revision and subsequent
amendment in 2017
Readers will be aware that International financial Reporting Standards (IFRS’s) including the IAS’s were adopted by all listed companies in the EU from 1 January 2005.
IAS7 required enterprises to present a cash flow statement as part of their financial statements.
A cash flow statement is needed as a consequence of the difference between profits and cash and thus provide the use with a facility for:
- assessing the current liquidity of a business
- providing additional information on business activities
- providing an overview of the major sources for cash inflow and outflow from business
- a guide to estimate future cash flows; and
- determining cash flows generated from trading as opposed to other sources of finance
The purpose of the statement is to provide information on changes in cash and cash equivalents and to classify cash flow under three standard headings:
- Operating Activities
- Investing Activities
- Financing Activities
and to determine whether the operating activities reveal a positive cash flow and the manner in which such activities have been funded.
What items comprise these standard headings and thus net cash flow from each?
The Standard defines the following:
“Operating activities are the principal revenue-producing activities of the entity and other activities that are not investing or financing activities”.
“Investing activities are the acquisition and disposal of long-term assets and other investments no included in cash equivalents”.
“Financing activities are activities that result in changes in the size and composition of the contributed equity and borrowings of the entity”.
The standard details two formats:
- Direct Method
- Indirect Method
The Standard states that “entities are encouraged to report cash flows from operating activities using the direct method”.
The case study that follows illustrates both formats:
The following are given as a guide to the figures shows on the cash flow statement:
You will have noted that the significant difference between the two formats is the section on cash flows from operating activities.
The standard sates “an entity shall report cash flows from operation activities using either:
- The direct method, whereby major classes of gross cash receipts and gross cash payments are disclosed: or
- The indirect method, whereby profit or loss is adjusted for the effects of transactions of a non-cash 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 cash flows.”
Research suggests that previously in the UK where the ABS’s FRS 1 cash flow statement was used the most widely published forma was the indirect method.
Internationalisation and the global focus on harmonisation and the use of IFRS’s in an exciting development which faces the professions and one which the Finance Staff working under the guidance of the Financial Director needs to address with enthusiasm.