The third section of a statement of cash flows is for financing activities.
So what are financing activities?
Financing activities are those activities, which relate to changes in the size and composition of the contributed equity and borrowings of the entity.
This shows how the entity has been funded, its financial structure, and allows you to see how much debt and equity the entity has.
This, in turn, allows you to estimate the future requirements to service this debt, or provide returns to shareholders.
Examples of cash flows from financing activities include:
- Cash inflows from sale of equity/shares
- Cash inflows from raising loans, mortgages and other borrowings
- Cash outflows from buying back equity/shares
- Cash outflows from payments of interest which isn’t covered by operating activities
- Cash outflows to pay dividends
- Cash outflows to repay borrowings
Interest paid is normally considered a cash flow from operating activities.
If you look at what the loans relating to the interest are for, it could be more appropriate to classify it as a financing activity.
This is true if the loan is not used as an integral part of the cash management function of the business.
Dividends paid are normally treated as financing activity, because they are a cost of obtaining financial resources, in the form of equity investment.
Shareholders who buy shares in the entity may expect dividends in the same way a bank will expect interest on a loan.
Some entities prefer to disclose dividends as part of operating activities, to show users of the financial statements that it can make these dividend payments from operating cash flows. This is fine too.
Make sure you only include dividends actually paid during the year in the statement of cash flows.
This might include the final dividend from the previous financial period, and an interim dividend issued during the period, if any.
If the dividend for this year is only proposed, but not paid, it should be excluded from the statement of cash flows.
Dividend payments in the year will normally be contained in the Statement of Changes in Equity.
However, if you need to calculate the amount of dividends paid during the year, but only have retained earnings and profit after tax figures, here’s how to do it.:
|Retained Earnings at start of period||X|
|Add: Net profit after tax for period||X|
|Deduct: Retained earnings at end of period||(X)|
|Dividends paid to ordinary shareholders||X|
To calculate the cash raised from the issue of shares during the period, compare the ordinary share capital and share premium account at the start of the period to the end of the period.
We saw how assets acquired under finance leases are not included in the purchase of assets for cash purposes.
However, the payment of interest and principal element of finance leases will need to be reflected in the statement of cash flows.
The payment to the leasing company is split between an interest portion and a principal portion.
The interest element is treated as a standard interest payment and is included as either a cash flow from operating activities or financing activities.
The repayment of the principal is included as a cash flow from financing activities, because it is the same as the repayment of a debt.
If loans and borrowings increase during the period, this means there has been an inflow of cash into the entity.
If the loans or borrowings decrease, this is due to a repayment, which is an outflow of cash.
Loans at beginning of period – Loans at end of period = Difference = Inflow/(Outflow)