11.3.4 Statement Of Cash Flows

Statement Of Cash Flows

As previously discussed, the statement of financial position shows a company’s financial status at a specific point in time, while the statement of comprehensive income summarizes the company’s operating activities for the year. However, neither offers insight into how the company’s financial position changed from one period to the next. This is where the statement of cash flows proves essential, detailing how the company generated and spent its cash during the year.

Importance of the Statement of Cash Flows

The statement of cash flows helps evaluate a company’s liquidity and solvency, offering insights into its financial quality. Key questions addressed include:

• Can the company pay its creditors, especially during downturns?
• Can it fund its needs internally if necessary?
• Can it reinvest while continuing to pay dividends to shareholders?

Analyzing the statement of cash flows over multiple years can expose trends that might otherwise go unnoticed. This statement often presents a clearer picture of a company’s viability than the statement of comprehensive income, as it measures actual cash generated from business operations.

Definitions and Key Terms

• Liquidity: A measure of how quickly a company can convert assets into cash to meet short-term obligations.
• Solvency: A measure of a company’s ability to meet its long-term debts and financial obligations.
• Operating Activities: Day-to-day business activities that generate or use cash, affecting income and expenses within the period.
• Financing Activities: Transactions made to finance the company, including debt issuance and dividend payments.
• Investing Activities: Investments made in the company, such as the purchase or sale of capital assets.

Structure of the Statement of Cash Flows

The statement categorizes cash flows into three sections:

• Operating Activities: Actions that require an inflow or outflow of cash, which generate sales and expenses during the year.
• Financing Activities: Transactions used to finance the company through cash inflows (issuing shares or debt) or outflows (repaying debt or paying dividends).
• Investing Activities: Investments in the company through the purchase or disposal of capital assets, or dividends received from associates.

The total cash flows from these activities determine the increase or decrease in cash during the fiscal year.

Operating Activities

Operating activities reflect accounts related to the company’s business operations and require an inflow or outflow of cash. Adjustments start from the profit, adding non-cash items such as depreciation and amortization, then adjust for changes in net working capital (trade receivables, inventories, trade payables, interest payable, and taxes payable).

Financing Activities

Financing activities involve transactions used to finance the company by raising funds or returning funds to investors. This includes issuing shares or debt (cash inflows) and repaying debt or paying dividends (cash outflows). These activities show how the company raises capital and returns value to shareholders.

Investing Activities

Investing activities include the purchase and sale of long-term investments and capital assets. Buying capital assets results in cash outflows, while selling them generates cash inflows. Additionally, dividends received from associates and investments in other companies are considered investing activities. These activities represent how the company allocates funds to grow its operational capacity and investment portfolio.

Net Cash Flows

The net cash flows from operating, financing, and investing activities are summed to determine the total increase or decrease in the company’s cash position over the fiscal year. This final net cash flow is essential for understanding the company’s liquidity and financial health.

Diagram: Structure of the Statement of Cash Flows

    graph LR;
	    A[Statement of Cash Flows]
	    A -->|Operating Activities| B[Inflow/Outflow of Cash<br>Adjustments for Profit<br>Non-Cash Items<br>Changes in Net Working Capital]
	    A -->|Financing Activities| C[Issuing Shares or Debt #40;Inflow#41;<br>Repaying Debt #40;Outflow#41;<br>Paying Dividends #40;Outflow#41;]
	    A -->|Investing Activities| D[Purchase of Capital Assets #40;Outflow#41;<br>Sale of Capital Assets #40;Inflow#41;<br>Dividends Received #40;Inflow#41;]
	    A --> O[Net Cash Flows]

Explanation:

• Operating Activities: Includes details on cash inflows/outflows, adjustments for profit, non-cash items, and changes in net working capital.
• Financing Activities: Covers issuing shares or debt (inflows), repaying debt (outflows), and paying dividends (outflows).
• Investing Activities: Describes cash outflows for purchasing capital assets and inflows from selling capital assets and receiving dividends.
• Net Cash Flows: Summarizes the overall impact on the company’s cash position.