FinancialReporting
FRC
Cash flow statements
Preparing a cash flow statement is complex. Here, Steve Collings explains what should be included, and how to do it
FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland deals with the cash flow statement in Section 7 Statement of Cash Flows.
At the outset, it is worth noting that small entities are not required to include a cash flow statement in their complete set of financial statements and the vast majority do not produce one. FRS 102, Section 7 does not contain any exemption from the preparation of a cash flow statement for a parent entity, but qualifying entities can take advantage of a reduced disclosure framework, including an exemption from producing a cash flow statement.
Cash flow classification
FRS 102 prescribes three cash flow classifications being operating activities, investing activities and financing activities. The standard does not mandate the order in which these cash flow classifications are presented, but they generally follow the order in which they appear in the standard. Under FRS 102, the reconciliation of operating profit to net cash flow from operating activities can be shown as part of the primary statement itself.
• Operating activities
Operating activities are the day-to-day revenue-producing activities of the business. Examples of operating activities include cash receipts from the sale of goods and rendering of services, cash payments to suppliers for goods and services and cash receipts from customers.
The operating activities classification can be seen as the ‘default’ classification. In other words, if the cash flow is not an investing or financing cash flow, it will be included in operating cash flows. It is important, however, to ensure that cash flows are correctly allocated according to their nature as regulators such as the Financial Reporting Council and professional bodies do review entities’ financial statements to ensure compliance with the applicable financial reporting framework.
• Investing activities
Cash flows from investing activities arise from the acquisition and disposal of an entity’s long-term assets and other investments that are not included in cash equivalents. Examples of investing activities include the disposal proceeds from the sale of property, plant and equipment, the cost of plant and machinery and cash receipts from sales of equity or debt instruments of other entities.
• Financing activities
Financing activities are those activities that result in a change in size and composition of the contributed borrowings and equity structure of the business.
REVENUE
Method of preparing the cash flow statement
There are two permissible methods of preparing the cash flow statement:
The five-step model approach works as follows:
• the indirect method; and
• the direct method.
Indirect method
Under the indirect method, the net cash flow from operating activities figure is arrived at by adjusting profit or loss for the effects of non-cash items reported in profit or loss. Profit or loss is also adjusted for the fluctuations in working capital.
Direct method
The direct method of preparing the cash flow statement is useful for the users because it reports the major classes of gross operating cash receipts and gross operating cash payments. However, the reality is that the indirect method is the method which is most common (and is equally acceptable). Under the direct method, information is disclosed about the major classes of gross receipts and gross cash payments. An example is shown in these tables, right.
Components of cash and cash equivalents
FRS 102, para 7.20 requires the entity to present the components of cash and cash equivalents as well as presenting a reconciliation of the amounts presented in the cash flow statement to the equivalent items presented in the balance sheet. FRS 102, para 7.20 does not require the entity to present this reconciliation if the amount of cash and cash equivalents presented in the cash flow statement is the same as the amount in the balance sheet.
Cash and cash equivalents not available for use by the entity
Where the entity holds significant cash and cash equivalent balances, which are not available for use by the entity, FRS 102, para 7.21 requires this to be disclosed.
Net debt reconciliation
FRS 102, para 7.22 requires the entity to disclose an analysis of changes in net debt from the beginning of the reporting period to the end, showing changes arising from:
(a) the cash flows of the entity;
(b) the acquisition and disposal of subsidiaries;
(c) new finance leases;
(d) other non-cash changes; and
(e) the recognition of changes in market value and exchange rate.
FRS 102, para 7.22 states that when several balances from the balance sheet have been combined to form the components of opening and closing net debt, sufficient detail must be shown to enable the users to identify these balances. The analysis of net debt need not be presented for prior periods.
DISCLOSURES
Non-cash transactions
The cash flow statement is prepared, by its very nature, using a cash-based rather than an accruals-based method to show the user how the entity has generated and spent cash during the period.
On this basis, FRS 102, Section 7 requires the entity to exclude operating, investing and financing transactions that do not require the use of cash or cash equivalents. For such transactions, the standard requires disclosure of these transactions elsewhere in the financial statements in a way that provides all the relevant information.
EXAMPLE
Disclosure of non-cash transactions:
Ratchford Ltd has a year end of 31 August 2023. On 17 July 2023, it issued 100 new shares to convertible loan note holders in settlement of £50,000 capital and interest outstanding on loan notes. The remaining capital and interest liabilities were satisfied through a rights issue comprising of £5,000 in cash and the remainder in exchange of shares. The non-cash transactions would be disclosed within the notes to the cash flow statement. Other examples of non-cash transactions, in addition to the conversion of debt to equity, include the acquisition of assets by assuming directly related liabilities or by means of a finance lease and issuing equity as consideration during a business combination.
FRC