Understanding IAS 7: Statement of Cash Flows

IAS 7, "Statement of Cash Flows," provides guidelines on preparing and presenting the statement of cash flows, a crucial part of financial reporting. The statement shows how changes in balance sheet accounts and income affect cash and cash equivalents. This standard provides users of financial statements with a view of the company’s liquidity and solvency by breaking down cash inflows and outflows into three categories: operating, investing, and financing activities.

In this article, we will explore IAS 7, explain how the statement of cash flows is prepared, and offer a real-time case study with an Excel table example for beginners to understand the standard.

1. Key Principles of IAS 7

The main objective of IAS 7 is to provide information about the historical changes in cash and cash equivalents of an entity, classified into three main activities:

a. Operating Activities These include cash flows directly related to the company's principal revenue-generating activities. This section adjusts for non-cash items such as depreciation and changes in working capital.

b. Investing Activities This section includes cash flows from purchasing and selling long-term assets, such as property, plant, equipment, and investments.

c. Financing Activities These are cash flows related to changes in the entity's capital structure, such as issuing shares, obtaining loans, repaying debt, and paying dividends.

2. Structure of the Statement of Cash Flows

IAS 7 allows entities to prepare the cash flow statement using either:

• The?Direct Method?shows actual cash receipts and payments.
• The Indirect Method adjusts net profit or loss for the effects of non-cash transactions, such as depreciation, changes in working capital, and non-operating items.

Most companies use the indirect method?due to its ease of preparation.

3. Real-time Case Study: Preparing a Cash Flow Statement under IAS 7

Let’s consider a hypothetical company, ABC Trading Ltd., that prepares its financial statements for the year ending December 31, 2023.

The company provided the following information for the year:

• Net income: $100,000
• Depreciation: $10,000
• Increase in Accounts Receivable: $5,000
• Decrease in Inventory: $8,000
• Decrease in Accounts Payable: $7,000
• Purchase of equipment: $20,000
• Issuance of new shares: $50,000
• Loan repayment: $15,000
• Dividends paid: $10,000
• Cash and cash equivalents at the beginning of the year: $20,000

Step 1: Prepare the Cash Flow Statement Using the Indirect Method

a. Cash Flows from Operating Activities

To calculate cash flows from operating activities, we start with the net income and adjust it for non-cash items like depreciation and changes in working capital.

b. Cash Flows from Investing Activities

Cash flows from investing activities are primarily related to purchasing and selling long-term assets, such as equipment.

c. Cash Flows from Financing Activities

Financing involves issuing shares, obtaining or repaying loans, and paying dividends.

Step 2: Calculate Net Increase (Decrease) in Cash and Cash Equivalents

The total cash inflows and outflows are summarized as follows:

Step 3: Reconcile with the Opening Cash Balance

To calculate the cash balance at the end of the year, we add the net increase to the opening cash balance:

4. Disclosure Requirements under IAS 7

IAS 7 requires entities to disclose the following information:

1. Cash and Cash Equivalents: The components of cash and cash equivalents at the end of the reporting period.
2. Reconciliation of Net Cash Flows to Net Profit or Loss: If the indirect method is used, entities must provide a reconciliation between cash flows from operating activities and net profit or loss.
3. Non-cash Transactions: Significant non-cash transactions, such as acquiring assets through finance leases, must be disclosed.

5. Implementation Date and Key Considerations

IAS 7 has been effective since January 1, 1994, and is a critical financial reporting component.

Key Considerations:

• Direct vs. Indirect Method: While IAS 7 allows both methods, the indirect method is more commonly used due to its simplicity and alignment with accrual-based financial statements.
• Cash Equivalents: It’s important to note that cash equivalents include short-term investments with three months or less maturity.
• Disclosure of Non-Cash Transactions: Companies must be transparent about significant non-cash transactions, which can impact financial performance without affecting cash flow.

6. Conclusion

IAS 7 ensures that companies provide comprehensive information about their cash inflows and outflows, offering users of financial statements a clear picture of the entity’s liquidity and cash management. Following this standard, companies like ABC Trading Ltd. can present transparent and accurate financial statements highlighting their cash flow activities.

The following article will explore IAS 16: Property, Plant, and Equipment, a standard that focuses on accounting for tangible fixed assets. Stay tuned as we continue our journey through the IAS standards, helping you navigate the complexities of financial reporting.