Statement of Cash Flows: Introduction to IAS 7

IAS 1 – Presentation of Financial Statements requires the following components for a complete set of financial statements:

  • Statement of profit or loss and other comprehensive income
  • Statement of financial position
  • Statement of changes in equity
  • Statement of cash flows
  • Notes, containing explanatory information and a summary of significant accounting policies
  • Comparative financial information for the previous period

Statements of cash flows

We’ll now look at statements of cash flows. These provide information about:

  • the cash flows of the entity during the reporting period, and
  • the changes in cash and cash equivalents during the period.

When used in conjunction with the statement of financial position, the statement of cash flows provides information that allows users to evaluate the changes in the assets of the entity, its financial structure and the timing of cash flows.

This allows users to anticipate how the entity should respond to changing circumstances and opportunities.

A statement of cash flows allows users to assess the ability of an entity to:

  • generate cash
  • pay its creditors when they fall due
  • pay dividends
  • obtain finance, if required

Basic structure of a statement of cash flows

A statement of cash flows shows the change in the amount of cash and cash equivalents held by the entity during the reporting period.

This change is then added to the opening amount of cash and the total equals the closing cash on hand balance.

This closing cash balance should be the same amount contained in the statement of financial position.

Inclusions – what is cash?

The essential part of a statement of cash flows is cash and cash equivalents.

Cash is the actual cash on hand in notes and coins, and also demand deposits, such as money in a current account.

This also includes cash in foreign currency.

Cash equivalents are short-term, highly liquid investments that are readily convertible into known amounts of cash, which are subject to an insignificant risk of changes in value.

Examples of cash equivalents are:

  • investments with short term maturity dates (less than three months)
  • bank deposits which require some prior notice before withdrawal

Keep in mind that cash and cash equivalents are held in order to meet short-term requirement, not for investment other long-term requirements.

NB: As a rule, cash equivalents should have a maturity period of less than 3 months

Exclusions – what isn’t cash?

Cash does not include things like

  • accounts receivable
  • accounts payable
  • borrowings subject to a term facility.

Bank overdrafts may be included as cash where the overdraft is repayable on demand and is essential in the company’s cash management.

Overdraft facilities like this often go from being positive to overdrawn. When overdrawn, the overdraft is noted as negative cash.

If the overdraft is not repayable on demand, changes in the balance are treated as a financing activity, not a change in cash or cash equivalents.

If they’re treated as a financing activity:

  • an increase in the overdraft will be a source of finance
  • a repayment of the overdraft is a repayment of a borrowing

Example of statement of cash flows and a bank overdraft

So let’s say if a company had a bank overdraft of €10,000 at the beginning of the year and a bank overdraft of €15,000 at the end of the year.

The treatment of the bank overdraft depends on whether or not it is repayable on demand.

Therefore, the increase in the bank overdraft could be reported in the statement of cash flows as either:

  • a change in cash and cash equivalents of €5,000, or
  • a source of finance of €5,000, with no change in the cash and cash equivalents

Foreign Currency deposits

Foreign currency deposits are subject to changes in foreign exchange rates.

Cash and its equivalents are those with insignificant risk of changes in value.

The decision whether or not to include foreign currency deposits as a cash equivalent will depend on the circumstances and facts presented, including the stability of the exchange rate and the amount of the money on deposit.

Policies for identifying cash

Due to the different ways of interpreting cash and cash equivalents an entity should determine a policy for identifying what is cash and what it isn’t.

This policy should be applied consistently each reporting period and should be disclosed to help users understand the entity’s statement of cash flows.

If there’s a change in this policy for cash identification, this should be accounted for as a change in accounting policy under IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors.