Browse Corporation

11.3.4 Statement Of Cash Flows

Comprehensive overview and guide on the Statement of Cash Flows, highlighting its importance in evaluating a company's liquidity, solvency, and overall quality, along with its structure and components.

Statement Of Cash Flows

As previously discussed, the statement of financial position shows a company’s financial status at a specific point in time, while the statement of comprehensive income summarizes the company’s operating activities for the year. However, neither offers insight into how the company’s financial position changed from one period to the next. This is where the statement of cash flows proves essential, detailing how the company generated and spent its cash during the year.

Importance of the Statement of Cash Flows

The statement of cash flows helps evaluate a company’s liquidity and solvency, offering insights into its financial quality. Key questions addressed include:

  • Can the company pay its creditors, especially during downturns?
  • Can it fund its needs internally if necessary?
  • Can it reinvest while continuing to pay dividends to shareholders?

Analyzing the statement of cash flows over multiple years can expose trends that might otherwise go unnoticed. This statement often presents a clearer picture of a company’s viability than the statement of comprehensive income, as it measures actual cash generated from business operations.

Definitions and Key Terms

  • Liquidity: A measure of how quickly a company can convert assets into cash to meet short-term obligations.
  • Solvency: A measure of a company’s ability to meet its long-term debts and financial obligations.
  • Operating Activities: Day-to-day business activities that generate or use cash, affecting income and expenses within the period.
  • Financing Activities: Transactions made to finance the company, including debt issuance and dividend payments.
  • Investing Activities: Investments made in the company, such as the purchase or sale of capital assets.

Structure of the Statement of Cash Flows

The statement categorizes cash flows into three sections:

  • Operating Activities: Actions that require an inflow or outflow of cash, which generate sales and expenses during the year.
  • Financing Activities: Transactions used to finance the company through cash inflows (issuing shares or debt) or outflows (repaying debt or paying dividends).
  • Investing Activities: Investments in the company through the purchase or disposal of capital assets, or dividends received from associates.

The total cash flows from these activities determine the increase or decrease in cash during the fiscal year.

Operating Activities

Operating activities reflect accounts related to the company’s business operations and require an inflow or outflow of cash. Adjustments start from the profit, adding non-cash items such as depreciation and amortization, then adjust for changes in net working capital (trade receivables, inventories, trade payables, interest payable, and taxes payable).

Financing Activities

Financing activities involve transactions used to finance the company by raising funds or returning funds to investors. This includes issuing shares or debt (cash inflows) and repaying debt or paying dividends (cash outflows). These activities show how the company raises capital and returns value to shareholders.

Investing Activities

Investing activities include the purchase and sale of long-term investments and capital assets. Buying capital assets results in cash outflows, while selling them generates cash inflows. Additionally, dividends received from associates and investments in other companies are considered investing activities. These activities represent how the company allocates funds to grow its operational capacity and investment portfolio.

Net Cash Flows

The net cash flows from operating, financing, and investing activities are summed to determine the total increase or decrease in the company’s cash position over the fiscal year. This final net cash flow is essential for understanding the company’s liquidity and financial health.

Diagram: Structure of the Statement of Cash Flows

    graph LR;
	    A[Statement of Cash Flows]
	    A -->|Operating Activities| B[Inflow/Outflow of Cash<br>Adjustments for Profit<br>Non-Cash Items<br>Changes in Net Working Capital]
	    A -->|Financing Activities| C[Issuing Shares or Debt #40;Inflow#41;<br>Repaying Debt #40;Outflow#41;<br>Paying Dividends #40;Outflow#41;]
	    A -->|Investing Activities| D[Purchase of Capital Assets #40;Outflow#41;<br>Sale of Capital Assets #40;Inflow#41;<br>Dividends Received #40;Inflow#41;]
	    A --> O[Net Cash Flows]


  • Operating Activities: Includes details on cash inflows/outflows, adjustments for profit, non-cash items, and changes in net working capital.
  • Financing Activities: Covers issuing shares or debt (inflows), repaying debt (outflows), and paying dividends (outflows).
  • Investing Activities: Describes cash outflows for purchasing capital assets and inflows from selling capital assets and receiving dividends.
  • Net Cash Flows: Summarizes the overall impact on the company’s cash position.

📚✨ Quiz Time! ✨📚

🧐 Assess and Solidify Your Understanding

Welcome to the Knowledge Checkpoint! You’ll find 10 carefully curated quizzes designed to reinforce the key concepts covered. These questions will help you gauge your grasp of the material, identify areas that need further review, and ensure you’re on the right track towards mastering the content for the Canadian Securities certification exams. Take your time, think critically, and use these quizzes as a tool to enhance your learning journey. 📘✨

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## Which financial statement shows how a company generated and spent its cash during the year? - [ ] Statement of financial position - [ ] Statement of comprehensive income - [x] Statement of cash flows - [ ] Statement of equity changes > **Explanation:** The statement of cash flows details how a company generated and spent its cash over a period, unlike the statement of financial position or the statement of comprehensive income. ## What is included in the item 'cash and cash equivalents' in the statement of cash flows? - [ ] Only cash in the company’s bank accounts - [ ] Only short-term investments - [x] Cash on hand, cash in bank accounts, and short-term, highly liquid investments - [ ] Long-term investments such as bonds > **Explanation:** Cash and cash equivalents include cash on hand, in bank accounts, and short-term, highly liquid investments that are readily convertible to cash. ## Which of the following is NOT assessed using the statement of cash flows? - [ ] Liquidity of the company - [ ] Solvency of the company - [ ] Quality of the company's earnings - [x] Company’s market share > **Explanation:** The statement of cash flows is used to evaluate the liquidity, solvency, and overall quality of the company’s earnings, not its market share. ## What are the three main categories of cash flows in the statement of cash flows? - [ ] Operating, Trading, and Financing Activities - [x] Operating, Financing, and Investing Activities - [ ] Trading, Financing, and Investing Activities - [ ] Operating, Marketing, and Research Activities > **Explanation:** The statement of cash flows categorizes cash flows into Operating, Financing, and Investing Activities. ## In the statement of cash flows, what does the 'Operating Activities' section include? - [ ] Cash flows from issuing new shares and repaying debt - [ ] Cash flows from purchasing and selling company investments - [ ] Cash flows that relate to the operations of the business but exclude expenses - [x] Cash flows that reflect the activities that generate sales and expenses > **Explanation:** Operating Activities include cash flows related to generating sales and incurring expenses. ## What does item 37, 'change in net working capital', represent in the statement of cash flows? - [ ] Changes in long-term debt and equity - [x] Changes in assets and liability accounts such as trade receivables and inventories - [ ] Changes in the value of capital assets - [ ] It shows dividends received from associates > **Explanation:** Changes in net working capital include changes in current asset and liability accounts like trade receivables, inventories, trade payables, etc. ## What does a substantial increase in trade receivables indicate? - [ ] Improved cash flow due to immediate sales - [ ] Reduced need for external financing - [x] Possible credit management issues or extending credit to non-paying customers - [ ] Increased liquidity and solvency > **Explanation:** A substantial increase in trade receivables could indicate credit management issues or extending credit to customers who may struggle to pay. ## Which activity involves issuing new shares or repaying debt in the statement of cash flows? - [ ] Operating Activities - [x] Financing Activities - [ ] Investing Activities - [ ] Transition Activities > **Explanation:** Financing Activities include cash flows from issuing new shares and repaying debt. ## What does the Investing Activities section of the statement of cash flows NOT include? - [ ] Purchase of new capital assets - [ ] Sale of capital assets - [x] Payment of dividends to shareholders - [ ] Dividends received from associates > **Explanation:** Investing Activities include purchases and sales of capital assets and dividends received, but dividends paid to shareholders are typically in the Financing Activities section. ## What does the final section of the statement of cash flows show? - [ ] Net income for the year - [ ] Changes in long-term investments - [x] Increase or decrease in cash for the current fiscal year - [ ] Total liabilities and equity > **Explanation:** The final section summarizes cash flows from Operating, Investing, and Financing Activities to show the net increase or decrease in cash for the year.

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Saturday, July 13, 2024