Companies (excluding ‘small companies’) preparing financial statements using International Accounting Standards must prepare a statement of cash flows. The objective of IAS 7 is to require the presentation of information about the historical changes in cash and cash equivalents of an entity by means of a statement of cash flows, which classifies cash flows during the period according to operating, investing and financing activities.
What is the statement of cash flows?
The idea of the Statement of Cash Flows is to clarify an area not covered by the Income Statement or Statement of Financial Position, that is: the cash position of the business and how it was reached. More companies go into liquidation as a result of cash flow problems than lack of sales or profits. The Statement of Cash Flows, therefore, is vital for assessing the financial stability of a company.
There are many transactions in both the Income statement and Statement of Financial Position which do not reflect movements of cash, such as:
- Sales and purchases when the company trades on a credit basis
Other items reflect movements of cash but do not affect profit, such as:
- Purchase of non-current assets
- Issue of Shares
The Statement of Cash Flows concentrates on the sources and uses of cash, so is a useful indicator of a company’s liquidity and solvency.
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The advantages of cash flow accounting
- Survival in business depends on the ability to generate cash. Many businessmen quote ‘Cash is King’ and it is hard to disagree. Cash flow accounting directs attention towards this critical issue.
- Cash flow is more comprehensive than ‘profit’ which is dependent on accounting conventions and concepts.
- Creditors (long and short-term) are more interested in an entity’s ability to repay them than in its profitability. Whereas ‘profits’ might indicate that cash is likely to be available, cash flow accounting is more direct with its message.
- Cash flow reporting can provide a better means of comparing the results of different companies than traditional profit reporting.
- Cash flow reporting satisfies the needs of all users better;
- For management, it provides the sort of information on which decisions should be taken: (in management accounting, ‘relevant costs’ to a decision are future cash flows); traditional profit accounting does not help with this type of decision-making.
- For shareholders, and auditors, cash flow accounting can provide a satisfactory basis for stewardship accounting.
- As described previously, the information needs of creditors and employees will be better serviced by cash flow accounting.
- Cash flow forecasts are easier to prepare, as well as more useful, than profit forecasts.
- They can in some respects be audited more easily than accounts based on the accruals concept.
- The accruals concept is confusing and cash flows are more easily understood by non-accountants.
- Cash flow accounting should be both retrospective and include a forecast for the future. This is of great informational value to all users of accounting information.
- Forecasts can subsequently be monitored by the publication of various statements which compare actual cash flows against the forecast.