Measuring cash flows Prepared by: Muhammad zubair Roll# 7170GOVERNMENT COLLEGE UNIVERSITY FAISALABAD BANKING & FINANCE
History & variation Prior to 1988, the financial statement showing the sources and uses liquid resources was called a “Statement of Changes in Financial Position”. Informally, this statement was often termed as “Funds Statement”. Some companies prepared funds statement showing the sources and uses of cash. Other companies however, prepared funds statements showing the sources and uses of working capital or some other type of “Liquid Resources”. As a result, “Funds Statement” or “Statement of changes in financial position” prepared by different companies varied greatly in content. This created difficulties for investors in comparing the Funds Statements of different companies. To solve this problem the Financial Accounting Standards Board (FASB) stated that beginning in 1988 al companies should discontinue the statement of changes in financial position and instead prepare a “Statement of Cash Flows”. The FASB provided considerably more guidance as to the form and content of the new statement of cash flows than it did for the old funds statement. To avoid confusion between the old “Funds Statement” and the new statement of cash flows, the FASB has asked companies to avoid the use of the word “Funds” in the new financial statement. In 1992 the “International Accounting Standards Board” (IASB) issued international accounting standard 7 (IAS 7) cash flows statements which became effective in 1994.  FASB. Statement No. 95, “Statement of Cash Flows” (Norwalk, Conn.: 1987), Para. 34.
Differences between FASB & ISA 7 rules The Financial Accounting Standards Board (FASB) defined rules that made it mandatory under Generally Accepted Accounting Principles (US GAAP) and (IAS 7) rules for cash flow statements are similar, but some of the differences are: IAS 7 requires that the cash flow statement include changes in both cash and cash equivalents. US GAAP permits using cash alone or cash and cash equivalents. IAS 7 permits bank borrowings (overdraft) in certain countries to be included in cash equivalents rather than being considered a part of financing activities. IAS 7 allows interest paid to be included in operating activities or financing activities. US GAAP requires that interest paid be included in operating activities US GAAP (FAS 95) requires that when the direct method is used to present the operating activities of the cash flow statement, a supplemental schedule must also present a cash flow statement using the indirect method. The IASC strongly recommends the direct method but allows either method. The IASC considers the indirect method less clear to users of financial statements. Cash flows statements are most commonly prepared using the indirect method, which is not especially useful in projecting future cash flows.
Importance: The official name of cash flows statement is “Statement of Cash Flows”. It’s the third major financial statement in accounting. It can be prepare monthly, quarterly, half yearly and yearly.
Cash flows? A term describing both the cash receipt and cash payments
Statement of Cash Flows? A statement in which cash receipts and cash payments of operating, investing and financing activities are mentioned.
PURPOSE OF THE STATEMENT: The basic purpose of a statement of cash flows is to provide information about the Cash Receipts and Cash Payments of a business entity during the accounting period. A statement of cash flows assists investors, creditors and others in assessing such factors as: The company’s ability to generate positive cash flows in future periods. The company’s ability to meet its obligations and to pay dividends. The company’s need for external financing. Both the cash and noncash aspects of the company’s investment and financing transactions for the period. Causes of the change in the amount of cash and cash equivalents between the beginning and at the end of the accounting period
Classification of Cash flows: Operating activities Investing Activities Financing Activities Effects of changes in exchange rates on cash
Operating activities Collection from customers for sales of goods and services Interest and dividends received Other receipts from operations Payments to suppliers of merchandise and services, including payments to employees Payments of interest Payments of income taxes Other expenditures relating to operations
Investing Activities Cash proceeds from selling investments or plant assets or fixed assets Cash proceeds from collecting principal amounts on loans Payments to acquire investments or plant assets or fixed assets Amounts advanced to borrowers
Financing Activities Proceeds from both short term and long term borrowing Cash received from owners e.g. issuing stocks and debentures Payments of amounts borrows excluding interest payments Payments to owners such as cash dividends
Supplementary schedule Companies using the direct method are required to provide a “supplementary schedule” illustrating the computation of net cash flow from operating activities by the indirect method. Therefore, supplementary schedule is also a compulsory part of statement of cash flows if the company is following Direct Method.
Cash and Cash Equivalents The “FASB” has defined “Cash” as including both “cash and cash equivalents”. “Cash Equivalents” are short term highly liquid Investments, such as money market funds, commercial paper and treasury bills
Adjustments (operating activities)• Cash received from customers• Interest and Dividend received• Payments for Purchases• Cash payments for expenses
Cash received from customers Net salesAdd Decrease in accounts receivableLess Increase in accounts receivable Net cash received from customers
Interest and Dividend received Interest revenue Add Decrease in interest receivableLess Increase in interest receivable Net interest received
Payments for Purchases Cost of goods soldAdd increase in inventoryLess decrease in inventoryAdd decrease in accounts payableLess increase in accounts payable Net cash payments for purchases
Cash payments for expenses ExpensesLess DepreciationAdd Increase in related expenseLess Decrease in related expenseLess Increase in related liabilityAdd decrease in related liability Net cash payments for expenses
Reporting Methods Direct Method Indirect Method
Direct Method A method of reporting net cash flows from operating activities by listing specific types of cash inflows and outflows. This is the method recommended by the FASB
Indirect Method A format of reporting net cash flows from operating activities that reconciles this figure with the amount of net income shown in the income statement. Both the methods almost same, the difference is only in calculating cash flows from operating activities
Format (indirect method) for operating activitiesNET INCOME Add depreciation, amortization of intangible and depletion Decrease in accounts receivable Decrease in inventories Decrease in prepaid expenses Increase in accounts payable Increase in accrued exp. Payable Increase in deferred income taxes payable Non operating loss deducted in computing net incomeDeduct Increase in accounts receivable, inventories Increase in prepaid expenses Decrease in accounts P/A, accrued expenses P/A Non cash gains included in net income Net cash flows from operating activitiesNOTE:Remaining format same like Direct Method, therefore that is not explained.