Cash Flows

Introduction to Cash Flows

What are the Statement of Cash Flows?

Cash flows are an essential financial report included in the general purpose financial report to be used by external users. Cash flows are alike a formal version of the cash budget that reports on a business's cash receipts and cash payments over a financial period categorised as 'Operating Activities', 'Investing Activities' and 'Financial Activities'. 

How do the Statement of Cash Flows differ from Cash Budgets?

Cash budgets are informal financial statements used by internal users. While both report on cash receipts and payments, the statement of cash flows has to follow strict AASB standards on the layout of the financial statement and the terminology of transactions.

Statement of Cash Flows requires transactions to be simplified and categorised unlike the cash budget where all cash receipts and cash payments are all listed and unsorted.

Why is Cash Important?

Cash flows are a sign of a business's ability to meet debt obligations. If the business is producting small or deficit amounts of cash, this could hinder the business's ability to repay its creditors. Businesses can still produce profits but have insufficient cash to meet its daily expenses and debt obligations, which could lead to insolvency - the inability to repay debts.

How can a Business Produce a Profit but Produce a Cash Deficit?

There's a variety of possible answers but mostly it comes down to businesses having a spending problem. Paying for assets in cash, such as inventory, will not impact on profits but will impact the underlying cash balance. 

Poor cash management could also lead to unnecessary use of credit. Over using bank overdrafts or taking too many loans to finance cash spending could lead to unmanagable increases in finance costs and debt obligations. 

Structure of Statement of Cash Flows

Operating Activities

Operating activities details the cash transactions directly involved with the management and operation of the business. 

Investing Activities

Investing activities details the cash transactions relating directly to the sale or purchases of non-current assets. 

Financing Activities

Financing activities details the cash transactions relating directly to the financing of a business. 

Cash and Cash Equivalents

Cash refers to money held on business premises (cash on hand) and cash held in business accounts in financial institutions.

Cash equivalents refers to short term investments with no significant risk in change in value and can be easily and quickly converted into cash, such as a term deposit.