The cash flow statement provides important information about a company’s cash receipts and payments during an accounting period. It is a vital information source that assists users to evaluate a company’s liquidity, solvency, and financial flexibility.
Under both IFRS and US GAAP, cash flows are categorized as operating, investing, or financing activities on the cash flow statement.
Operating activities: These are activities related to the normal operations of a company. Examples include:
Investing activities: These are activities associated with acquisition and disposal of long-term assets. Examples include:
Financing activities: These are activities related to obtaining or repaying capital. Examples include:
Example
JFK Enterprises recorded the following for the year 2015:
Purchase of equipment $70,000
Gain from sale of van $8,000
Receipts from sale of van $18,000
Dividends paid on ordinary share capital $10,000
Interest and preference dividend paid $12,000
Salaries paid $40,000
What is the net cash flow from investing activities?
Solution:
We first need to identify cash flows associated with investing activities. These are the purchase of equipment and the receipts from the sale of van. The gain from sale of van is not a cash flow item. The remaining items pertain to either operating or financing cash flows. Therefore, the net cash flow from investing activities is:
Net cash flow from investing activities = Purchase of equipment + Receipt from sale of van
Net cash flow from investing activities = -$70,000 + $18,000 = $52,000
Non-cash transactions
A non-cash transaction is any transaction that does not involve an outflow or inflow of cash. Significant non-cash transactions must be disclosed in either a footnote or a supplemental schedule to the cash flow statement. Analysts should incorporate non-cash transactions into the analysis of past and current performance and include their effects in estimating future cash flows. An example of a non-cash transaction is the conversion of face value $1,000,000 convertible bonds to common stock.
The reporting of interest paid/received and dividends paid/received is different between IFRS and US GAAP. The differences between the two standards are summarized in the table below.
| Cash flow | IFRS | US GAAP |
| Interest received | Operating or investing | Operating |
| Interest paid | Operating or financing | Operating |
| Dividends received | Operating or investing | Operating |
| Dividends paid | Operating or financing | Financing |
In addition to the points made above, IFRS and US GAAP also have some differences with respect to bank overdrafts, taxes paid, and the format of the cash flow statement. These are outlined in the table below.
| Cash Flow | IFRS | US GAAP |
| Bank overdrafts | Considered part of cash equivalents. | Not considered part of cash equivalents and classified as financing. |
| Taxes paid | Generally categorized as operating, but a portion can be allocated to investing or financing if it can be specifically identified with these categories. | Operating. |
| Format of statement | Both direct and indirect formats are allowed but the direct format is encouraged. | Both direct and indirect formats are allowed but the direct format is encouraged. A reconciliation of net income to cash flow from operating activities must be provided regardless of method used. |
Under IFRS and US GAAP, there are two acceptable formats for reporting cash flow from operating activities: indirect and direct.
Indirect Format Sample
With the indirect method, we start with net income and make several adjustments for non-cash, non-operating items to arrive at the cash flow from operations. Shown below is a sample of the indirect format for a fictitious company called K2 Corp.
| Net income | 2,775 |
| Depreciation | 1,000 |
| Gain on sale of equipment | (200) |
| Increase in accounts receivable | (150) |
| Increase in inventory | (600) |
| Increase in pre-paid expenses | (30) |
| Increase in accounts payable | 300 |
| Increase in wages payable | 10 |
| Increase in tax payable | 5 |
| Increase in other accrued liabilities | 100 |
| Decrease in interest payable | (10) |
| Cash flow from operations | 3,200 |
Direct Format Sample
In the direct format, we look at the specific cash inflows and outflows that resulted in cash flow from operating activities. This method is encouraged by both IFRS and US GAAP.
| Cash from customers | 24,850 |
| Cash paid to suppliers | (10,300) |
| Cash paid to employees | (7,990) |
| Cash paid for other operating expenses | (1,930) |
| Cash paid for interest | (510) |
| Cash paid for taxes | (920) |
| Cash flow from operations | 3,200 |
Notice that while the presentation formats are different, the cash flow from operations number is the same under both methods.
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