Hedge of a net investment in a foreign operation

Chapter 21 – Statement of Cash Flows Page 303 Chapter 21 STATEMENT OF CASH FLOWS 1 Business Context Cash is essential if a business is to continue its operations. Cash, or access to cash, is needed to pay for an entity’s outlays on a continuing basis and is a fundamental part of its operating cycle. An entity’s operating cycle is the period of time that a normal operating transaction takes to complete within a business, for example the time between the receipt of the order to final payment being made by the customer. If an entity is unable to pay its debts as they fall due, then it risks insolvency. Cash and liquidity are different concepts to profit. It is possible for a highly profitable entity to have liquidity problems if it does not manage the flow of cash within its business effectively. Cash is about the liquidity of a business, and hence cash flows concern the change in that liquidity. Cash management is not just about surviving; it is about the process of utilising cash resources to their optimal effect. For an investor to be able to assess the effectiveness of a business, it is important that information is included in the financial statements not only on the entity’s performance and financial position but also on its cash flows. When used alongside a statement of financial position, for example, a statement of cash flows provides users with information on the changes in net assets of the entity. An entity may have a strong financial position and good performance during the period, but may also have suffered significant cash outflows. The financial information is therefore not complete without the cash flow information, which may tell a different story to the original assessment of an entity’s performance. 2 Chapter Objectives This chapter covers the preparation and presentation of a statement of cash flows as part of an entity’s financial statements. IAS 1 Presentation of financial statements sets out the content of an entity’s financial statements. It includes the requirement for a statement of cash flows to be presented. On completion of this chapter you should be able to:  understand the objectives and scope of IAS 7 Statement of cash flows;  identify the important terminology and definitions which relate to the presentation of the statement of cash flows in the financial statements;  distinguish between cash and cash equivalents, and other assets and liabilities;  identify the main sections of a statement of cash flows and the cash flows relating to each of them; and  apply knowledge and understanding of IAS 7 through basic calculations. Chapter 21 - Statement of Cash Flows Page 304 3 Objectives, Scope and Definitions of IAS 7

3.1 Objective and scope

The objective of IAS 7 is to provide information about the historical changes in cash, and cash equivalents, of an entity. This information is presented via a statement of cash flows that classifies cash flows under the headings of: [IAS 7.10]  operating activities;  investing activities; and  financing activities. The preparation of a statement of cash flows as part of an entity’s financial statements is required of all entities, with no exceptions. [IAS 7.1] 3.2 What is cash? The nature of cash may, at first, seem obvious, but cash may be held in many forms. Some forms of cash can be accessed immediately while there is a delay in accessing others. As defined by IAS 7, cash includes not only cash itself but also any instrument that can be converted into cash so quickly that it is in effect equivalent to cash. In IAS 7, the statement of cash flows seeks to identify changes in: Classification Amounts included Cash “Cash in hand and demand deposits”. [IAS 7.6] Cash equivalents “Short-term, highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value”. [IAS 7.6] An essential element of a cash equivalent is that it is held for the purpose of meeting short- term cash commitments as they fall due and not for long-term investment purposes. To meet the definition of a cash equivalent, the item should be “readily convertible” which suggests that it has a short maturity of, say, three months or less from the date of acquisition. Cash equivalents may therefore include:  short term deposits;  loan notes;  bank deposit accounts; and  government securities. Equity investments should normally be excluded, because, unlike government securities, they are subject to a significant risk of changes in value. Bank borrowings normally form part of an entity’s financing activities, which are discussed below. A bank overdraft, however, is often used as a key element of an entity’s daily cash management; for example a positive cash balance may be held at the end of one day with an overdraft the next. In such circumstances the overdraft should be included as a component of cash and cash equivalents.