Accounting Business Reporting for Decision Making

266 Accounting: Business Reporting for Decision Making

Chapter 7 preview

Previous chapters presented the statement of profit or loss, statement of comprehensive income, state-

ment of changes in equity and the balance sheet; this chapter introduces the statement of cash flows.

The statement of cash flows is useful for users of financial statements as it provides information to help

assess an entity’s ability to generate cash flows, meet its obligations and appreciate why assets and lia-

bilities have changed. This chapter outlines the purpose of the statement of cash flows, its relationship to

the statement of profit or loss and the balance sheet, and its general format. Also discussed is the prep-

aration and interpretation of the statement of cash flows.

7.1 The purpose and usefulness of a statement

of cash flows

LEARNING OBJECTIVE 7.1 Assess the purpose and usefulness of a statement of cash flows.

Cash flows are the lifeblood of the business. Without cash flows a business will wither and die. We have

seen many companies and countries during the global financial crisis (GFC) and its aftermath stall or

come to a halt due to a cash shortage. Therefore, it makes sense to prepare a report that shows the cash

flows of a business. This is the purpose of a statement of cash flows.

The flows of cash are important for the working capital management of an entity. Working capital is

needed to fund inventory and accounts receivable while awaiting receipts from sales. The flow of cash

through purchases and payments of inventory and labour to the receipt of cash can be simply depicted

as shown in figure 7.1.

The number of times an entity can cycle through this process, generally the more profit it can make

(as long as prices are set appropriately). However, cash is very important through the cycle as there is

normally an outflow of funds for inventory and wages prior to the inflow from sales. The statement of

cash flows helps ascertain the cash generation from this cycle and whether or not the entity is collecting

its receipts in a timely manner.

The statement of profit or loss shows the income earned and expenses incurred through this cycle, while the

statement of cash flows shows the actual cash receipts and payments through this cycle. It is important that we

differentiate between a sale (revenue generated) and cash received; or between a purchase and a payment.

Purchase of

inventory

Sale of inventory

or service

Payment for

inventory and wages

Receipts from

sales

FIG U R E 7.1 Flow of cash in business cycle