The uses and purposes of the Statement of cash flow
Different parties use the statement of cash flow for different purposes. The parties interested in the usage of cash flow statements are accountants, creditors, investors, contractors, employees, and shareholders. Financial analysts require cash flow statements to know if the corporation is enabled to cover payroll and any other immediate expenses. Prospective lenders seek to get a true perspective of the firm’s ability to repay credit advanced to them while potential investors need to make decisions on whether the firm has a sound financial base. Other parties who require these statements include prospective employees and contractors. They need to confirm whether the firm is enabled to compensate them. On the other hand, owners of the corporation need to have information from the cash flow statement on the continuity of the business.
Since cash flow statements are financial reports that show the firm’s liquidity, the statements are used to provide information about the company’s liquidity and solvency. It includes the ability to change the cash flows in the future period’s circumstances. Additionally, cash flow statements provide information that is useful in evaluating alterations in assets, liabilities, and financing items. Cash flow statements improve comparability among firms regarding their operating performances. This is made possible through the elimination of different accounting methods. Besides, these reports show the amount, timing, and the chances of future company’s cash resource (Kieso 44).
Another use of the cash flow statements is that it is one of the standard financial statements used to get rid of allocations. Allocations may be derived from other accounting techniques. Such distributions include different time frames that help to reduce the value of non-current assets or amortize inventory. An example of a standard financial statement is the balance sheet and income statement. Assessment is a reflection of a company’s financial resources and obligations in a particular period. Statement of operations is a summary of the company’s financial transactions representing the specified fiscal year.
In summary, a cash flow statement is used as a representative of the chances realized during a specified time and the number of resources that the corporation will retain in the future. These financial statements add value to the comparison process with another firm’s statement. This is because they eliminate issues that involve different accounting methods.
An analysis of the objectives and purposes of International Accounting Standard 7 (Statement of cash flows)
The presentation of financial data on historical changes in an entity’s cash and cash equivalents is a primary goal of IAS 7; this is done through the statement of cash flows that classify them into operating, investing, and financing activities in a given fiscal year (Pavlovic and Bogdanovic 129).
These standards are set to ensure uniformity for all the firms that are in operation. Firms, in this perspective, involve both private and public firms. Acknowledging uniform standards governing reporting firms, comparison of such statements will be fair enough, and thus executives would have useful information in their policy decisions (Kondor and Dimitri 48).
IAS 7 focuses mainly on the analysis of cash flows that helps professional accountants to demonstrate a wider and more thorough knowledge that is required to be exceptional and informed. This is made possible through awareness of all principles, supporting theories, evidence, and techniques. Professionals in these firms should be exceptional in any theoretical application that boosts the profession’s goals (Tiffin 20). They do this while maintaining the much-needed originality. Proper selection, evaluation, and response to various source materials should be used along with proven techniques that seek higher confidence levels and accurate measures. However, they are at liberty to use any new information acquired that is of material to their profession.
The purpose of IAS 7 can be attributed to the rules followed while preparing cash flows. Operating activities in cash flows are derived through adjusting net income on the changes in opening and closing balances. In the case of comparing long-term assets of more than a financial year, the accountant preparing reporting statements must know changes causing devaluation.
The rules governing the cash flow statement preparation are classified in the following ways:
- If there is any decrease in non-cash items, then short-term assets are added to net income,
- Any increment in non-cash current assets is subtracted from net income,
- An increase in short-term liabilities is added to the net income,
- A decrease in current liabilities is reduced from net income,
- Revenues that have no cash inflows are reduced from net income while non-operating losses are added to net income; non-operating gains are subtracted from net income (“Preparation of the Statement of Cash Flows” n.pag.).
Analysis of the cash and cash equivalents
The cash flow statement entails the inflows and outflows of cash and cash equivalents. Cash equivalents are those items that are easily convertible to cash and may also be converted back to assets (Hoggett 24). These transactions are non-cash items that include depreciation, losses on credit, and bad debts written off. These activities include operating, investing, and financing activities. Non-cash activities do not appear as a basic component in the statement, and, instead, they are reported as footnotes. The financial statement is partitioned into three distinct segments. They include the cash flows from operating activities, cash flows from investing activities, and the cash flows from financing activities (Grosu and Bostan 29).
An analysis of the key terms of the cash flow statement – IAS 7
Operating activities are those that affect production and sales (Cochrane 12). The operating cash flow activities include cash received from selling goods and services, cash received from selling loans, and debt instruments in a portfolio for trading and loan interest received. Additionally, they include cash outflow for supplies, goods, services, wages, remunerations to workers or on their behalf, payments of interests, and the purchase of merchandise.
There exist some items that are added back. Here, adding back means subtracting from the net income figure from the income statement. To attain the cash flows from operating activities, it includes items like depreciation (described as the decrease of asset value with time), deferred tax, amortization (described as the decrease of asset value with time), dividends received, revenue from some investing activities and gains earned or incurred losses due to the disposal of a non-current asset. This is because the cash flows are not part of the operating activities. Unrealized gains and losses are added back from the statement of comprehensive income.
This category has items of long-term nature. They either increase or reduce tangible fixed assets. Some investing activities items are the purchase or sale of assets, loans to suppliers, loans from customers and mergers, and acquisition payments among others.
These are activities that involve cash inflow from investors. The investors include banks and owners. Cash outflow to shareholders, as dividends, is also a way in which the firm generates income.
An opinionated view about the importance of cash flow statement and its preparation to Thorne Ltd
In my opinion, Thorne Ltd should start preparing the cash flow statement. There are many advantages that the firm will gain by preparing a cash flow statement. One key advantage of the statement is that it acts as a controlling device to internal financial management planning and gives the proper co-coordination of commercial operations and short-term financial decisions.
Additionally, the firm should prepare a cash flow statement because it acts as a managerial control device. This is possible when two fiscal years reports are compared. With this, a firm will have a strong indication of the extent to which resources should be raised and applied or will even have an optimal mix that is valuable to both long-term and short-term objectives. Comparison with the original statements helps in highlighting trends that could remain unnoticed.
Since Thorne Ltd needs proper planning and coordination of operations to evaluate the current cash position, it should prepare the cash flow statement. Cash is a fundamental resource for carrying out operations. Cash flow preparation will enable the managing team to plan correctly and coordinate financial operations. The team will know an almost exact amount of financial resources needed in the coming period. They would be in a position to arrange the amount that needs to be outsourced if the retained earnings together with reserves are fully exhausted. Cash flow techniques are necessary for the preparation of capital budgets (Velez-Pareja 67).
Internal financial management uses cash flow statements for various purposes and, therefore, the firm must prepare the cash flow statement with other financial statements. The internal control system will be enabled to enhance the retirement of long-term debts, plan the replacement of facilities, and formulate dividend policies. This will be possible since the cash flow statement offers a snapshot of cash flows from operations.
Thorne Ltd will attain a proper profit and cash position with the efficient use of a cash flow statement; therefore, it must prepare it alongside other financial statements. The statement will enable the management to account for transactions with enormous profits and losses. Also, the firm may realize benefits, as it is operating without money while losses may still be made with plenty of funding (Braun 23). Cash flow statements must be prepared alongside other reporting financial statements. They are normally prepared at the end of a financial year.
Statement of cash flows is a financial statement that shows the alterations in balance sheet accounts, cash and cash equivalent income changes, and the analytical breakdown of activities in operating, investing, and financing categories. It is concerned with the cash inflows and outflows from the firm. The balance sheet changes due to this kind of financial statement. It determines the viability of a firm. The ability to pay bills is included in the current viability. Therefore, from the above illustrations, it will be necessary for Thorne Limited to prepare this kind of statement as per the International Accounting Standard 7 (IAS 7) (Whittington 22).
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