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  Measuring and Reporting Cash Flows

Introduction and Reporting Cash Flows

The Statement of Cash Flows

The statement of cash flows is a fairly current addition to the annual published financial statements. Companies were only needed to publish a statement of financial position (balance sheet) and an income statement. The current view appears to have been that all the financial information required through users would be contained under these two statements. This view might have been based partially on the supposition that it would also have plenty of cash if a business were profitable. Even though in the long run this is possible to be true, it is not essentially true in the short to medium term.

As we described, earlier that the income statement sets out the revenue and expenses, than the cash receipts and cash payments, for the period. The meaning of this is that the profit (or loss) that presents the variation among the revenue and expenses for the period, might have little or no relation to the cash generated for the period.

To demonstrate this point, let us take the instance of a business making a sale (producing a revenue). This might well lead to a raise in wealth which will be reflected in the income statement. Though, no cash changes hands - at least not at the time of sale if the sale is made on credit.

In its place, the raise in wealth is reflected in other asset: a raise in trade receivables. In addition, wealth is lost to the business by the decrease in inventories if an item of inventories is the subject of the sale. This means an expense is acquired in making the sale that will be depicted in the income statement.

Again, though, no cash has changed hands at the time of sale. For such types of causes, the profit and the cash produced for a period will seldom go hand in hand.

It is obvious from the above that if we are to gain insights concerning cash movements over time, the income statement is not the place to look. In its place we require a separate financial statement. This fact has become extensively familiar in recent years and in year 1991 a UK (United Kingdom) financial reporting standard, FRS 1, appeared that needed all but the smallest companies to produce and publish a statement of cash flows. This standard has been superseded for listed companies from year 2005 through the international standard IAS 7. The two standards have generally identical needs.

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