Ind AS 7: Statement of Cash Flows Explained

Introduction: Ind AS 7, known as the Statement of Cash Flows, stands as a cornerstone in financial reporting, providing a structured view of an entity’s cash movements. This standard is instrumental for stakeholders to gauge an entity’s financial performance and liquidity over a reporting period. By classifying cash flows into operating, investing, and financing activities, it offers a clear picture of how an entity manages its cash and cash equivalents.

Objective and Principles: Ind AS 7 establishes principles and guidance for the preparation and presentation of an entity’s cash flows. The standard is designed to provide a clear understanding of how cash and cash equivalents change over time due to an entity’s operating, investing, and financing activities during a reporting period.

Cash Flows Definition:

• Operating, Investing, and Financing Activities: Ind AS 7 categorizes cash flows into three main activities: operating, investing, and financing. Operating activities involve the core business operations, investing activities pertain to the acquisition and disposal of long-term assets and investments, while financing activities involve changes in equity and borrowings.

Example: An operating activity would be the cash received from customers for goods sold, an investing activity might involve purchasing new machinery, and a financing activity could be obtaining a bank loan.

• Cash and Cash Equivalents Definition: Cash flows are defined as inflows and outflows of cash and cash equivalents. Cash includes cash on hand and demand deposits. Cash equivalents are short-term, highly liquid investments that are easily convertible to known amounts of cash and have an insignificant risk of changes in value.

Example: Cash equivalents might include short-term government bonds or money market funds, which can be quickly converted into cash with minimal risk.

Objectives of Ind AS 7:

• Historical Changes in Cash and Cash Equivalents: The primary objective of Ind AS 7 is to provide information about the historical changes in cash and cash equivalents during a reporting period, specifically deriving from operating, investing, and financing activities.

Example: If a company acquires a new piece of equipment (investing activity), the cash outflow for this acquisition will be reflected in the statement of cash flows.

• Assessment of Financial Health: Users of financial statements, such as investors and creditors, utilize information about cash flows to assess an entity’s ability to generate cash and cash equivalents. Understanding the timing and certainty of cash generation is crucial for making informed economic decisions.

Example: Investors might analyze the operating cash flow to assess if a company is generating enough cash to cover its day-to-day operations and obligations.

• Timing and Certainty of Cash Generation: The economic decisions made by users depend on evaluating not only the ability of an entity to generate cash but also the timing and certainty of that generation.

Example: A company with consistent and predictable cash flows may be viewed more favorably by investors compared to a company with erratic or uncertain cash flows.

Key Requirements of Ind AS 7 – Statement of Cash Flows:

1. Classification of Cash Flows: Ind AS 7 mandates that the statement of cash flows must report cash flows categorized into three main activities: operating, investing, and financing. This classification provides users with insights into the different sources and uses of cash within the entity.

2. Components of Cash and Cash Equivalents: The statement must include the components of cash and cash equivalents at the beginning and end of the reporting period. Exceptions exist in limited circumstances where cash flows are offset and reported on a net basis.

3. Operating Activities:

• Definition: Operating activities are the principal revenue-producing activities and other activities that are not investing or financing activities.
• Importance: Cash flows from operating activities are crucial indicators of the entity’s ability to generate cash to repay loans, maintain operations, pay dividends, and make new investments without external financing.
• Methods: The entity can choose between the direct method (presentation of major classes of gross cash receipts and payments) or the indirect method (adjusting profit or loss for non-cash transactions, deferrals, accruals, and items associated with investing or financing).

Example: A manufacturing company using the direct method would separately list cash received from customers and cash paid to suppliers. Meanwhile, a company using the indirect method adjusts net income for non-cash items like depreciation and changes in working capital.

4. Investing Activities:

• Definition: Investing activities involve the acquisition and disposal of long-term assets and other investments not considered cash equivalents.
• Importance: Separate disclosure of investing activities is essential to reflect the extent to which expenditures have been made for resources intended to generate future income and cash flows.

Example: If a company purchases machinery or sells an investment property, these transactions would be categorized as investing activities.

5. Financing Activities:

• Definition: Financing activities result in changes in the size and composition of contributed equity and borrowings.
• Importance: The separate disclosure of cash flows from financing activities aids in predicting claims on future cash flows by providers of capital to the entity.

Example: If a company issues bonds or repurchases its own shares, these transactions fall under financing activities.

6. Reporting of Major Classes:

• Ind AS 7 requires the separate reporting of major classes of gross cash receipts and payments arising from investing and financing activities.

Example: Major classes could include proceeds from issuing bonds, repayment of loans, or dividends paid.

7. Non-Cash Transactions:

• Ind AS 7 specifies that investing and financing transactions not involving the use of cash or cash equivalents should be excluded from the statement of cash flows.
• Such transactions should be disclosed elsewhere in the financial statements to provide comprehensive information about these activities.

Example: If a company acquires an asset through the issuance of common stock rather than cash, this non-cash investing activity is disclosed in a separate section of the financial statements.

8. Foreign Currency Cash Flows:

• Cash flows from transactions in foreign currency are recorded in the entity’s functional currency using the exchange rate at the date of the cash flow.
• Unrealized gains and losses from changes in foreign currency exchange rates are not considered cash flows. However, the impact of exchange rate changes on cash and cash equivalents held or due in a foreign currency is reported in the statement of cash flows for reconciliation purposes.

Example: If a company conducts a sale in a foreign currency, the cash flow is recorded using the exchange rate on the date of the transaction, while unrealized gains or losses from changes in exchange rates are not treated as cash flows.

9. Cash and Cash Equivalents:

• An entity is required to disclose the components of cash and cash equivalents, providing a reconciliation of amounts in the statement of cash flows with equivalent items in the balance sheet.
• If significant cash and cash equivalents are restricted for specific purposes, this information, along with management commentary, must be disclosed.

Example: If a portion of an entity’s cash is set aside for a specific project or debt repayment, the restricted amount is disclosed separately in the financial statements.

10. Changes in Liabilities from Financing Activities:

• Ind AS 7 mandates disclosures to enable users to assess changes in liabilities arising from financing activities, covering both cash flow and non-cash changes.
• The disclosure includes changes from financing cash flows, transactions involving obtaining or losing control of subsidiaries or businesses, effects of changes in foreign exchange rates, changes in fair values, and other changes.

Example: If a company issues bonds, the disclosure would encompass the cash received from the issuance, any changes in fair value, and the impact of foreign exchange rates if the bonds are denominated in a foreign currency.

11. Reconciliation of Balances:

• Entities may provide a reconciliation between the opening and closing balances of liabilities arising from financing activities, incorporating the changes outlined above.

Example: The reconciliation may show how the initial balance of long-term debt has changed over the reporting period due to various financing activities, providing transparency for stakeholders.

Conclusion: Ind AS 7 – Statement of Cash Flows serves as a vital tool for financial analysis, enabling stakeholders to delve deeper into an entity’s financial activities and their impact on cash positions. By adhering to its principles, entities can provide a comprehensive view of their financial health, supporting informed decision-making by investors, creditors, and other users of financial statements.