Cash Flow Statements are the summary of inflows (receipts) and outflows (payments) of cash and cash equivalents during an accounting period.
- Cash comprises cash on hand and demand deposits with banks.
- Cash equivalents are short-term, highly liquid investments that are readily convertible into known amounts of cash and which are subject to an insignificant risk or changes in value. A short–term investment is one, which is due for maturity within three months from the date of acquisition. Investments in shares are not normally taken as a cash equivalent, because of uncertainties associated with them as to realisable value.
Cash flow is determined by looking at three components by which cash enters and leaves a company:
- Cash flow from Operating Activities
- Cash flow from Investing Activities
- Cash flow from Financing Activities
Cash Flow from Operating Activities
Operating activities are primarily derived from the principal revenue-producing activities of the enterprise. Therefore, they generally result from the transactions and other events that enter into the determination of net profit or loss.
Examples of cash flows from operating activities are:
- cash receipts from the sales of goods and the rendering of services
- cash receipts from royalties, fees, commissions and other revenue
- cash payments to suppliers for the goods and services
- cash payments to and on behalf of employees
- cash receipts and cash payments of an insurance enterprise for premiums and claims, annuities and other policy benefits
- cash payments or refunds of income taxes unless they can be specifically identified with financing and investing activities
- cash flows arising from the purchase and sale of dealing or trading securities and
- cash advances and loans made by financial enterprises.
Cash flow from Investing Activities
Investing activities are the acquisition and disposal of long-term assets and other investments not included in cash equivalents.
Examples of cash flow from investing activities are:
- Cash payments to acquire fixed assets (including intangibles)
- Cash receipts from disposal of fixed assets (including intangibles)
- cash payments/receipts to acquire/from the disposal of shares, warrants or debt instruments of other enterprises and interests in joint ventures (other than payments for those instruments considered to be cash equivalents and those held for dealing or trading purposes)
- cash advances and loans made to third parties (other than advances and loans made by a financial enterprise)
- cash receipts from the repayment of advances and loans made to third parties (other than advances and loans of a financial enterprise)
- cash payments/receipts for/from futures contracts, forward contracts, option contracts and swap contracts except when the contracts are held for dealing or trading purposes, or the payments/receipts are classified as financing activities.
Cash flow from Financing Activities
Financing activities are activities that result in changes in the size and composition of the owners’ capital and borrowing of the enterprises.
Examples of cash flows arising from financing activities are:
- cash proceeds from issuing shares or other similar instruments
- cash proceeds from issuing debentures, loans, notes, bonds, and other short or long-term borrowings and
- cash repayments of amounts borrowed.
Reporting Cash Flows from Operating Activities
An enterprise should report cash flows from operating activities using either:
- the direct method, whereby major classes of gross cash receipts and gross cash payments are disclosed or
- the indirect method, whereby net profit or loss is adjusted for the effects of transactions of a non-cash nature, any deferrals or accruals of past or future operating cash receipts or payments, and items of income or expense associated with investing or financing cash flows.
Format for direct and indirect methods are given below