The creation of cash flow statement was done by the FASB so that the stakeholders of the business including creditors, owners, and managers can receive a higher amount of information about the receipts and expenditures of cash. Though there is the provision of showing the cash balances in the balance sheet at the end of every period, there is no further information given on the balance sheet, statement of owner’s equity or income statement. The creation of a cash flow statement solves this problem without fail.
The basic purpose of a cash flow statement is the provision of summary about the receipts and payments of cash so that adequate information is disseminated for a given period. Additionally, there can be a reconciliation of the differences between the start and end of cash balances that are presented on the balance sheet. The use and misuse of cash flows in varied areas of expenses for a specified period are correctly represented in the cash flow statement.
The bottom line of the reason cash flow is created is that information regarding the gross receipts and payments of the cash flows are provided for any given time of period.
The gross form of receipts and payments are reported in the statement of cash flows in the form of three distinct classifications. These are the operating activities, financing activities, and the investing activities. These classifications provide a value of net change, which should tally with the changes in the cash and cash equivalents of a Company for a given period of reporting. For example, if we take the year of 2013 as the calendar year, the cash flow statement will be able to explain the reasons why there was a change in the cash equivalents and cash value of the Company for the balance sheet values of the period between December 31 in 2012 and the same in 2013.
The statement of cash flows should report cash amounts in the form of operating, financing and investing activities. Additionally, there should be disclosure of other relevant information, which also includes a number of interest payments, payment of income taxes and other types of important financing and investing activities, which were devoid of cash uses.
The distribution of cash flows for a Company occurs within the range of the income statement and balance sheet of the company.
The International Accounting Standards Board or IASB did the establishment of the international accounting standards, with the aim of giving a globally recognized framework for financial reporting. These standards have been adopted at the global level and accepted on a larger scale. The financial reporting of most of the countries in the United States domestic companies requires acceptance and use of GAAP or Generally Accepted Accounting Principles by the Securities and Exchange Commission. However, private companies may not follow the standards of GAAP as SEC does not necessarily regulate the private entities. This is why these companies take the liberty of using the international accounting standards as per the suitability of their requirements and needs.
There are some advantages of using International Accounting Standards for a Company, which can be listed as follows:
- Enhanced capital flow:
The standards of international financial reporting or IFRS help in the facilitation of transparency and convergence of practices of accounting. There is thus a boost in the capital flow in the international and foreign markets. There is a convenience on the side of stakeholders including all the investors for comparison of the performance of the business with their international counterparts. Thus, there is ease and inexpensiveness for the companies when it comes to raising capital for business from all the global investors.
- Worldwide orientation:
The use of IFRS creates freedom for businesses from obstructive scope at the national level for all standards of accounting. In countries with IFRS-compliance, there will be easy and automatic acceptance of the financial reports. In these areas, there is no need for preparation of alternative financial statement sets when there is pursuance of interest of business in these nations. The costs of business are thus reduced when it comes to preparation of financial statement preparation for the global audience.
- Standard setting at general level:
There is high flexibility in the IFRS stipulations for the changes that are expected as well as changes that are not accepted in the global scene of business as the reliance is on broader principles. The stipulations that are generalized have a design which becomes applicable and accommodative for the variance in circumstances and values related to jurisdictions. This has a minimum level of IASB interventions. For instance, there are no recommendations of precise formats from the side of IASB for the preparation of required financial statements. The business then gets discretion for the choice of format presentation so that the best can be selected and the financial report users can be optimally benefitted.
- Higher level of financial reporting:
There is the minimal undermining of objectives that are set the standard in the case of IFRS. Thus, the financial reports quality is enhanced. This is in contrast to the specific accounting sets of each country where the susceptibility is high when it comes to circumventions. The confidence of the investors towards business is also enhanced when the quality of financial reports is high.
There is a classification of receipts and payments of cash form in the cash flow statement as operating, financing and investing activities. The followings are the transactions and specific event features of every type:
- Operating activities
- Investing activities
- Financing activities
These can be briefly explained in the following ways:
Operating Activities:
The elements of operating activities include the cash type effects of those transactions that involve determining aspects like net income (cash receipts from sales of goods and services), and cash payments (paid to employees and suppliers for acquiring expenses and inventory).
Investing Activities: The purview of investing activities involve non-current or long term assets which include the following:
- Creation and collection of loans
- Acquisition and disposal of the assets of long-term nature that are productive and investments.
Financing Activities:
The inclusion of financing activities involves stockholders, liability, items of equity and includes the following two items:
- A collection of cash from all creditors and repayment of the borrowed amounts.
- A collection of capital from owners so that they can be provided with sufficient return on the investments that they have made.
There are two methods for the calculation of cash flows from operating activities. The direct method does not require the net income value and has other adjustments for arriving at the final amount. However, when we see the indirect method, the net income amount in the Company’s income statement is utilized so that amount of cash flow from operating activities can be calculated.
The preparation of the income statements follows the accrual basis of accounting. This method requires the revenue to be recognized only when there is an earning and not in a situation where a receipt has been mad. This means that the net income is devoid of representation of the net cash flow from operating activities. It is thus mandatory that the earnings before interest and tax, also known as the EBIT are adjusted for such items which have an effect on the net income. This may be the case even when there is no actual payment of cash or receipt against the same.
The indirect method for the calculation of cash flow operating activities can be mentioned by the following formula:
Cash Flows from Operating Activities
Net Income
+ Non-Cash Expenses:
(Depreciation, Depletion, and Amortization Expenses)
+ Non-Operating Losses:
(Loss on Non-Current Assets Sale)
− Non-Operating Gains:
(Gains on Non-Current Assets Sales)
+ Decrease in Current Assets:
(Accounts Receivable, Prepaid Expenses, and Inventory, etc.)
− Rise in Current Assets
+ Rise in Current Liabilities:
(Accounts Payable, Income Tax Payable, Accrued Liabilities, etc.)
− Reduction in Current Liabilities
= Net Cash Flow from Operating Activities (Accountingexplained.com).
The other method of calculating cash flow from operating activities is the direct method. This is the method in which there is a presentation of cash flow statements so that there is a presentation of precise cash flow that has an association with items, which affect the cash flow (Accountingtools.com). The items that have typical inclusion in this are:
- Cash collection from customers
- Interest and dividends received
- Cash paid to employees
- Cash paid to suppliers
- Interest paid at different points
- Income taxes paid to the Government
The advantage of the use of the direct method of cash flow calculation when compared to the indirect one is the revelation of operating receipts and payments in cash terms.
In the case of Hope International, it is necessary that the cash flow statement is prepared. The following information on cash flow can be the benefits that the Company can take from cash flow statement maintenance.
- There is no effect of accounting accruals or policies on cash flow information. Thus, there are minimal chances of manipulation.
- There is information about all the inflows and outflows of cash when all sources are taken.
- The quality of the revenue of the entity can be correctly assessed with the cash flow information.
- The cash flow statement is very easy to understand and can be a reliable source of company information for non-accountants as well (Chartered Education).
Despite these advantages, there are a few drawbacks that a Company should consider before getting into cash flow statement preparation. There can be a situation where the management is taking voluntary steps of delaying the supplier payments so that the net cash inflows can be increased. There can be a situation where the buying of goods can be done based on leasing provisions.
There is no guarantee that statement of cash flows reflects the entity earnings. However, it is also true that if the Company has a positive cash trade trend given the period of short term, and sales are being expensed, there will be no future of the Company.
Works Cited
"Benefits And Limitations Of Cash Flow Statements Under IAS 7 | Chartered Education". Chartered Education. N.p., 2015. Web. 6 Apr. 2016.
"Cash Flows Direct Method - Accountingtools". Accountingtools.com. N.p., 2016. Web. 6 Apr. 2016.
"Managerial Accounting 1.0 | Flat World Education". Flat World Knowledge. N.p., 2016. Web. 6 Apr. 2016.
"Operating Activities Cashflow Indirect Method | Formula | Example". Accountingexplained.com. N.p., 2016. Web. 6 Apr. 2016.
"Operating, Investing And Financing Activities - Classification Of Cash Flows - Accountingexplanation.Com".Accountingexplanation.com. N.p., 2016. Web. 6 Apr. 2016.
"What Are The Benefits Of International Accounting Standards?". Smallbusiness.chron.com. N.p., 2016. Web. 6 Apr. 2016.
"What Is The Purpose Of The Cash Flow Statement? | Accountingcoach". AccountingCoach.com. N.p., 2016. Web. 6 Apr. 2016.
