The statement of cash flows is one of the core financial statements, along with the income statement and balance sheet, that provides important information about a company's financial health and performance. In Canada, the statement of cash flows is governed by accounting standards issued by the Accounting Standards Board (AcSB). Here is an overview of the key things to know about the purpose and use of the statement of cash flows in the Canadian context:
What is the Statement of Cash Flows?
The statement of cash flows shows the sources and uses of a company's cash and cash equivalents during a specified period, usually quarterly or annually. It breaks down cash flows into three main categories:
- Operating activities - This includes cash generated or spent on day-to-day business operations and activities like producing and selling goods/services, paying employees and suppliers, etc. It provides insight into the company's ability to generate cash from core operations.
- Investing activities - These include cash used for investments like purchasing fixed assets or other long-term investments, or cash earned from selling them. This helps assess how much the company is investing in its future growth potential.
- Financing activities - This covers the cash flow related to raising money from lenders and investors or returning money to them via dividends, share repurchases, loan repayments etc. It shows how the company funds its operations and investments.
The net change in cash across these three categories equals the net increase or decrease in cash for that period.
Why is the Statement of Cash Flows Important?
The statement of cash flows serves several important purposes:
Assessing liquidity and solvency: The statement helps determine if the company is generating enough cash from operations to pay its expenses, or if it is relying too much on outside financing. This helps assess short and long-term liquidity and solvency risks.
Evaluating financial flexibility: Analyzing trends in cash flow from operations, investments and financing shows how well the company is managing cash and its ability to respond to opportunities or adverse events.
Assessing quality of earnings: It helps determine if net income is backed by actual cash flow or non-cash accounting maneuvers. Comparing earnings and cash flow can signal potential issues.
Forecasting future cash needs: Historical cash flow patterns provide a basis for projecting future cash requirements and sources.
In summary, the statement of cash flows provides unique insights, not apparent from other statements, into the financial health, flexibility and performance of a company over time. This is vital for financial analysis and decision making by management, investors and lenders.
Key Principles for Preparing the Statement of Cash Flows
Certain key accounting principles govern the preparation of statement of cash flows in Canada:
- Consistency: The same presentation format and classification of cash activities should be used from period to period. Changes must be clearly disclosed.
- Transparency: Important analysis-impacting events and arrangements must be clearly highlighted and disclosed.
- Conservatism: Uncertainty should be reflected through careful consideration and cautious judgment.
- Materiality: Only material items - those that can influence analysis - should be separately reported. Immaterial items can be aggregated.
Companies can choose between the direct or indirect method to present operating cash flows. Under the more commonly used indirect method, net income is adjusted for non-cash items to derive cash flow from operations. Cash flows from investing and financing are usually presented under the direct method.
In summary, the statement of cash flows is a vital report outlining the sources and uses of cash by a company over a period. It provides unique insights into liquidity, financial health, flexibility and performance - key aspects that influence investment and lending decisions. Following standard principles, companies in Canada prepare the statement of cash flows as per accounting rules laid out by the AcSB.