Cash flow statement Study Guide

📖 Core Concepts Cash Flow Statement – Shows how balance‑sheet changes and income affect cash & cash equivalents; separates cash into Operating, Investing, Financing activities. Operating Activities – Core business cash flows (sales, collections, payments to suppliers & employees). Investing Activities – Cash from buying/selling long‑term assets, loans to others, M&A‑related cash. Financing Activities – Cash between the firm and its owners/creditors (debt issuance/repayment, equity issues, dividends). IAS 7 vs. U.S. GAAP – Both require a cash‑flow statement, but differ on classification of cash equivalents, interest paid, and presentation of non‑cash items. Direct vs. Indirect Method – Two ways to compute operating cash flow: Direct: list cash receipts/payments. Indirect: start with net income, adjust for non‑cash items & working‑capital changes. --- 📌 Must Remember Purpose – Reveal cash‑generated profit vs. accounting profit; assess liquidity, solvency, and flexibility. Users – Management, lenders, investors, directors, shareholders. IAS 7 Requirement – Must disclose cash and cash equivalents; bank overdrafts may be included as equivalents in some jurisdictions. Interest Paid Classification – IAS 7: optional (operating or financing); U.S. GAAP: always operating. Indirect‑Method Rule – Add back non‑cash expenses (depreciation, amortization). Subtract non‑cash gains (sale of assets). Add increases in liabilities; subtract increases in assets (working‑capital adjustments). Direct‑Method Caveat – If used under U.S. GAAP, a supplemental indirect statement is mandatory. --- 🔄 Key Processes Indirect Method – Operating Cash Flow Start with Net Income. + Depreciation, amortization, deferred tax, loss on asset sale. – Gains on asset sale, increases in current assets, decreases in current liabilities. + Increases in current liabilities, decreases in current assets. Classifying Cash Flows Operating → core revenue & expense cash movements. Investing → purchase/sale of PP&E, intangibles, loans made/collected, M&A cash. Financing → equity issuance/redemption, debt issuance/repayment, dividends paid/received. Preparing Footnote Disclosure (Non‑Cash Activities) List any investing/financing activities that did not involve cash (e.g., conversion of debt to equity, acquisition of assets by issuing shares). --- 🔍 Key Comparisons IAS 7 vs. U.S. GAAP – Cash Equivalents IAS 7: Includes bank overdraft borrowings (when they are repayable on demand). U.S. GAAP: Excludes overdrafts; reports cash only or cash + equivalents. Interest Paid Classification IAS 7: Operating or Financing (choice). U.S. GAAP: Always Operating. Direct vs. Indirect Method Direct: Shows cash receipts/payments; clearer for forecasting. Indirect: Starts with net income; universally used; required supplemental statement under U.S. GAAP if direct is chosen. --- ⚠️ Common Misunderstandings “Depreciation is a cash outflow.” – It’s a non‑cash expense; added back in the indirect method. “All interest paid is operating cash flow.” – Under IAS 7 it can be financing; under U.S. GAAP it is always operating. “Dividends received are always operating cash flow.” – IAS 7 may place them in investing if they arise from investments. “Non‑cash investing activities affect cash flow.” – They are disclosed only in footnotes; they do not change cash. --- 🧠 Mental Models / Intuition Cash Flow = “What actually moved in/out of the bank.” Treat the statement like a bank ledger: every line shows a real cash movement, not an accounting entry. Operating = “Day‑to‑day business,” Investing = “Future‑making,” Financing = “Capital‑structure changes.” Indirect method = “Net Income + (non‑cash & working‑capital adjustments).” Think of it as “undoing” accrual accounting to get back to cash. --- 🚩 Exceptions & Edge Cases Bank overdraft as cash equivalent – Only under IAS 7 and when overdraft is repayable on demand. Interest paid classification – Optional under IAS 7; mandatory operating under U.S. GAAP. Dividends received – May be classified in operating (U.S. GAAP) or investing (IAS 7) depending on source. --- 📍 When to Use Which Choose Direct Method when the exam asks for cash receipts/payments or when you have detailed cash‑transaction data. Use Indirect Method for most U.S. GAAP questions (default) and when only income‑statement and balance‑sheet figures are provided. Classify interest paid as operating unless the question explicitly follows IAS 7 and permits financing classification. Treat bank overdrafts as cash equivalents only if the question references IAS 7 and specifies “overdraft borrowings are repayable on demand.” --- 👀 Patterns to Recognize Working‑capital adjustments always follow the “asset ↑ = cash ↓, liability ↑ = cash ↑” rule. Non‑cash gains (e.g., sale of equipment profit) → subtract from net income. Non‑cash losses (e.g., asset impairment) → add to net income. Investing cash outflows are usually large, infrequent, and negative (capex). Financing cash inflows often involve debt/equity issuance; outflows involve repayments & dividends. --- 🗂️ Exam Traps Mistaking depreciation for cash outflow – leads to under‑stating operating cash flow. Classifying interest paid as financing under U.S. GAAP – will be marked wrong. Omitting the supplemental indirect statement when the direct method is used in a U.S. GAAP context. Counting non‑cash footnote items as cash – e.g., stock‑for‑stock acquisitions. Mis‑labeling dividends received – check whether the question follows IAS 7 (possible investing classification). ---