The income statement and the balance sheet of an enterprise show important aspects of its performance and position. However, users of financial statements are also interested in how the enterprise generates and uses its cash resources. In particular, users are concerned about the overall solvency and liquidity of the enterprise.
IAS 7 is designed to aid users in that regard, and requires a cash flow statement to be drawn up summarising the cash flows during a period classified into three separate sections:
Operating activities
Investing
Financing.
It is recognised that, although an enterprise may have generated a profit during the year and increased its assets, it may not necessarily create readily accessible cash, as the money could be tied up in stocks, debtors etc. Also, in arriving at profit a number of non-cash deductions and additions have been included e.g. depreciation. These need to be taken into account when calculating the actual cash generated.
IAS 7 permits two methods of calculating operating cash flows the direct and the indirect methods. The indirect method requires the profit to be reconciled to the cash flow being generated by operations. This is carried out as in the previous paragraph. The direct method, on the other hand, identifies the actual cash receipts from customers and the actual cash payments to suppliers and employees. Both methods lead to the same figure. The direct method is illustrated in Example 6.1, and the...
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