Ind AS 7 | Cash Flow Statement | Summary

Ind AS 7 describes the application of Indian Accounting Standard on the preparation of Cash Flow Statement

Before I show you a perfectly clean starting point for your cash flow preparations, I will take you to dive into Ind AS 7 Statement of Cash Flows and see how Ind AS wants us to present cash.

If you are ignoring an accrual principle of accounting, you are doing wrong. The basic rule of accounting we should always follow!!

The Statement of Cash Flow is an exception to the concept of accrual. That is the truth. Without ignoring the accrual concept of accounting you can not create a cash flow statement. Because of this reason, the statement of cash flows can be the only statement ignoring an accrual basis and totally based on a CASH basis.

Since we follow the accrual concept in accounting, it is quite possible that there is some non-cash transaction in the accounts that should be eliminated while preparing a cash flow statement.

The process of eliminating non-cash transactions may, no doubt, give you the headaches because the numbers do not match or balance always.

Why Ind AS 7??

The cash flow statement gives the entity the ability to understand the exact source of cash generation. It is really as simple as that.

In reality, many investors explore the statement of cash flows right after looking to profit figures, because they sometimes feel that the profit could be manipulated by some non-cash transactions, such as various provisions, fair value adjustments, etc.

However, all prefer cash whether it is the company itself or investor because it shows not only HOW MUCH CASH the company is going to generate over the year, but also where the cash was generated.

• Has the company increased its sales and generated cash by operating activities?
• Has the company sold some of its property and generated cash by investing activities?
• Or Has the company taken new loans and generated cash by financing activities?

This information is provided in the statement of cash flows which classifies cash flows during the period from operating activities, investing activities and financing activities.

Ind AS 7 | What comprises cash and cash equivalents?

As we know that the statement of cash flows shows you the movement in cash and cash equivalents. So we must be aware of what is cash and cash equivalents.

Cash comprises cash on hand (e.g. petty cash balance) and demand deposits (e.g. Saving or current bank accounts).

Cash equivalents are short-term and highly liquid investments that are easily convertible into cash and which are subject to an insignificant risk of changes in value.

Here, the investment which is of nature of short term maturity (from 1 to 3 months) would qualify for cash equivalent – for example, state treasury note, short term govt. bond. However, most shares and other equity instruments are excluded from cash equivalents.

Kindly note that the movements between cash and cash equivalents are a very important part of cash management and this is why these are not shown in the operating, financing or investing part of the statement of cash flows. So if your company buys an investment asset with a short maturity date, then this movement is not shown at all(it always appears in such a manner that the cash and cash equivalents have not moved at all).

Ind AS 7 | How the statement of cash flows shall be presented?

Ind AS 7 states that the statement of cash flows shall always report cash flows during the period classified by operating, investing and financing activities.

Before we’ll take a look at each part, let me also add that the statement of cash flows should also contain the final reconciliation in which you summarize the overall movement in cash and cash equivalents (corresponding with your balance sheet) as shown in this picture:

In the notes to the financial statements, an entity shall disclose the components of cash and cash equivalents.

Ind AS 7 | Operating activities

Operating activities are the principal revenue-generating activities of the entity which are done in the ordinary course of business and other activities which are neither investing nor financing activities.

This part is probably the most important because it shows the ability of the entity to generate cash by its own activities in the ordinary course of business, rather than by external financing or making investments.

Cash flows from operating activities result from the primary revenue-generating activities of each entity and therefore, there might be differences between different entities.

For example, the manufacturing company would report the receipt of interest income from the acquired company as a financing activity, but the bank or investment company would report similar interest income as an operating activity based on its specific purpose.

However, cash flow from operating activities generally result in those from those activities which are of the nature of  profit-making and the examples are of the operating activities are:

• Cash received from the sale of goods and the rendering of services in the ordinary course of business;
• Cash received of the nature royalties income, fees or commissions and other revenue ;
• Cash payments made to suppliers for goods and services received in the ordinary course of business;
• Cash payments to and on behalf of employees in the ordinary course of business;
• Cash received and cash payments made by an insurance entity for premiums and claims, annuities and other policy benefits in the ordinary course of business;
• Cash payments or refunds of income taxes unless they can be specifically identified with financing and investing activities; and
• cash receipts and payments from contracts held for dealing or trading purposes in the ordinary course of business.

The direct and indirect method

A company has two option to prepare the cash flow statement from operating activities:

• Direct method: In this case, you are required to show major classes of gross cash receipts and gross cash payments; or
• Indirect method: here, you can start with the profit or loss before tax and then you can adjust it for the effect of:

• changes in Working capital over the period (inventories, operating receivables, payables);
• Items which are of Non-cash nature (depreciation or amortization expenses of fixed assets, revaluation gain on revaluation of fixed assets, etc.);
• Items that are connected or linked with investing or financing activities.

The direct method can provide you more understandable information that is not disclosed under the indirect method. However, in reality, the indirect method is far more preferred in comparison to the direct method because it’s easy to get the information based on your accounting records.

IndAS 7 | Investing activities

Investing activities are those activities in which the long term assets are acquired and disposed of and other investments that don't come in definition of cash equivalents.

Examples of cash flows which are classified into investing activities are:

• Cash payments made to acquire tangible and long term assets (including capitalized development costs and self-constructed PPE);
• Cash received from the sales of tangible, intangibles and other long-term assets;
• Cash payments made to acquire and cash received from the sales of financial instrument which are of the nature of equity or debt of other entities and interests in joint ventures (but that is not for trading or dealing purposes);
• Cash advances and loans given to other parties, and cash received from their repayment (other than advances and loans made by a financial institution – these would go to operating activities);
• Cash payments for and cash received from various derivative contracts except when the contracts are held for dealing or trading purposes or the payments are classified as financing activities.

Ind AS 7 | Financing activities

Financing activities are those activities that result in changes in the composition and size of the contributed equity capital and borrowed capital of the entity.

Examples of cash flows which are arising from financing activities are:

• Cash received from issuing shares or other equity instruments;
• Cash payments made to owners to acquire or redeem the entity’s shares;
• Cash received from issuing debentures, loans, notes, bonds, mortgages and other short-term or long-term borrowings;
• Cash repayments of amounts borrowed from other entities; and
• Cash payments made by a lessee for the purpose of reduction of the outstanding liability relating to a finance lease.

Ind AS 7 | Reporting cash flows from investing and financing activities

Only GROSS cash flows are reported in the investing and financing activities, so no netting off is done.

So, It means that it is not possible to present the cash paid to acquire some tangible assets and cash received from the sale of some other fixed tangible assets in one line – instead, you must show these cash flows separately in 2 lines.

However, Ind AS 7 gives you two exceptions where you actually can present net:

• Cash receipts and payments on behalf of customers when the cash flows show off the activities of the customer rather than those of the entity. For example, some real estate companies can collect rents from tenants of the property and pay them over to the real property owners.
• Cash receipts and payments for those items in which the turnover is very quick, the amounts are very large, and the maturities are very short. For example, changes in principal amounts relating to credit card customers.
• Also, financial institutions can also report certain transactions on a net basis.

Ind AS 7 | Other issues

Foreign currency

When there are foreign currency cash flows of the entity, then you need to translate them to your functional currency by applying the exchange rate which is in force at the date of the cash flow.

However, you need to be careful at the closing, because unrealized year-end foreign exchange gains or losses are NOT cash flows at all. If they have any relation to your cash or cash equivalents, then you should present these amounts in a separate line in the final reconciliation.

Interest and dividends

Cash flows from interest income and dividends income received and paid shall be presented separately and consistently from one period to another period. But do remember that don't forget to understand the ordinary course of business

Taxes on income

Basically, cash flows that are arising from income taxes are also classified as cash flows from operating activities.

But if these taxes are specifically identifiable with financing or investing activities, then you should report your cash flows from taxes in these parts.

Investments

When you are holding some investments in subsidiaries, associates and joint ventures, then reporting cash flows to and from these investments really depends on the accounting method you are using.

When you apply equity or cost method in your accounting, then you should include only the cash flows between yourself and the investee into the cash flow statement (dividends or advances).

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