A cash flow statement is an important report prepared by companies at the end of the financial year. The report gives information on cash transactions undertaken by a company during a given financial year. The paper seeks to carry out an evaluation of statement of cash flow. The paper will discuss the use, importance and the sections of a cash flow statement. Further, statement of cash flow for Hope Ltd will be prepared.
Statement of cash flow for hope Limited
Use and purpose of statement of cash flow
A statement of cash flow is used to relay information on the movements of cash and cash equivalents within a given financial year. Cash and its equivalents comprise of items that can quickly be changed to cash. Besides, there is less risk associated with changing such items to cash and the amount that will be received after the conversion is known. Basically, the cash flow statement focuses on movement of cash within and outside the business. Thus, it provides information on the cash received and payments made during a specific financial year. In a business cash is generated from numerous sources. Examples are loans, sale of goods and services, sale of assets, bank overdrafts, and equity among others. On the other hand, cash is used for different activities such as payment of salaries, purchase of debt, repayment of loan and payment of suppliers, among others. It is worth mentioning that the cash payments are different from expenses. Some expenses do not involve actual movement of cash. Such items should not be included in a cash flow statement. Examples are depreciation, accruals, prepayments, and amortization. Some of these items involve regrouping of cost. Thus, the statement of cash flow captures the movement of cash in the balance sheet and income statement and categorizes these movements into three.
The cash flow statement gives information to external users on how an entity handles cash. Such external users are not privy to the daily operations of the business. Thus, a cash flow statement shows the volume and timing of cash flow and possible future trend of the same. Specifically, it reveals information on the liquidity, creditworthiness, and the ease with which a company can convert current assets to cash flow in the future. It also shows the movements in net assets of equity. The statement also enables companies to compare the performance of various companies. Finally, the cash flow statements help a user to review the association between the bottom line and net cash flow and the effect of price movements.
Objective and purpose of International Accounting Standard 7 (IAS 7)
IAS 7 outlines that a company should prepare and present the statement of cash flow at the end of a financial year. It further states that this should be carried out as an essential part of the main financial statements. The standard further outlines that the statement of cash flow should comprise of three sections, these are, operating, investing, and financing activities. Further, the standard also states how the three sections of the statement of cash should be prepared. The key objective of this standard is to give directions and to instruct all companies to give information that relate to the past movements of cash and cash equivalents. The companies that prepare their financial statements using IFRS are mandated to present the statement of cash flow.
This section captures cash movements arising from the primary activities of a business. This also includes cash movements from other activities other than investing and financing activities. The amount of cash flow generated from operating activities is an indicator of a company’s ability to make adequate cash that can pay obligation and maintain operations of the entity. Thus, the items that are listed in operating activities come from the operating activities and other items are used in the determination of profit and loss. Examples of these items are cash received from sale of goods and services and other revenues, cash paid to suppliers, workers, taxes, and insurance premiums. Further, disposal of fixed assets that a business owns can generate some gains or losses. These are recorded under investing and not operating activities. This does not apply in case the entity holds such assets for the purpose of resale. Such will be treated as inventory and will be recorded under operating activities. This also applies to securities and debt instruments that are held for resale. They will be treated as inventories (Wood & Sangster 2008).
The second category is the cash flow generated from investing activities. It shows how much cash flow is generated from resources bought for the purpose of creating cash flow in the future. Examples of items that are recorded under this category are cash paid for the purchase of property, plant and equipment, and other long term assets. Payments that are made in relation to capitalize assets are also included in this section. Further, cash received from the sale of these assets. Under this category, cash paid and received from equity and debt of other companies and interest in joint ventures are also included. Another item that is included is cash received and given out in the form of loans and advances to other entities. The final category comprises of cash received and paid for future, forward, option, swap contracts. Therefore, all the items included in this category are intended to generate a future stream of cash flow to the business.
This group is used to record activities that have an impact on the capital structure of an entity. Such activities touch on borrowing and equity. Some of the items that are recorded in this category are repayments of loans borrowed, proceeds from issue of debt instruments such as notes, bonds and mortgages, the amount spent on share repurchase, and proceeds from issue of shares among others (Brigham & Michael 2009).
How net cash flow from operating activities is calculated
The cash flow generated from operating activities is calculated using two approaches. First is the direct method. In this case, main groups of cash payments and receipts are recorded. These major categories of payments and receipts are obtained by adjusting the amount of sales cost of sales and some items from the statement of comprehensive income and from the accounting records of the company. The second approach is through the indirect method. In this case, profit at the end of the year is adjusted for items that do not entail movement of cash. Profit at the end of the year is adjusted for item such as change in inventory, receivables and payables, items that do not involve actual movement of cash such as deferred taxes, and other items that fall under investing and financing activities. IAS 7 encourages companies to use the direct method because it gives information that is vital in forecasting the future (Abraham, Glynn, Murphy & Wilkinson 2010).
In summary, the cash flow statement is a vital document that a company must prepare. Users depend on information from the cash flow statement to see the cash movement during a given financial year. Hope Ltd. will benefit from the statement of cash flow because it will enable them to monitor liquidity and solvency. Also the company will be able to ascertain if the cash flow generated by the business can adequately cover all the daily operational needs of the business. As a recommendation, the management should prepare the cash flow statement alongside the other major financial statements. These statements are often prepared to revenue the monthly, quarterly and annual results.
Abraham, A, Glynn, J, Murphy, M & Wilkinson, B 2010, Accounting for managers, South-Western Cengage Learning, USA.
Brigham, E & Michael, J 2009, Financial management theory and practice, South-Western Cengage Learning, USA.
Wood, F & Sangster, A 2008, Frank wood’s business accounting 1, Financial Times/Prentice Hall, United States.