Information about the cash flows of an entity is useful in providing users of financial statements with a basis to assess the ability of the entity to generate cash and cash equivalents and the needs of the entity to utilise those cash flows. The economic decisions that are taken by users require an evaluation of the ability of an entity to generate cash and cash equivalents and the timing and certainty of their generation.
The objective of this Standard (IAS 7 - Statement of Cash Flows) is to require the provision of information about the historical changes in cash and cash equivalents of an entity by means of a statement of cash flows which classifies cash flows during the period from operating, investing and financing activities.
IAS 7 requires that a cash flow statement should be classified into four components : (1) operating activities, (2) investing activities, (3) financing activities, and (4) cash and cash equivalents.
Due care must be taken to include transactions under the appropriate category. Whatever classification chosen has to be applied in a consistent manner from year to year. Example : if "interest received" is presented as cash flow from investing activities in year 1, the same classification should be followed from year to year, even though IAS 7 allows "interest received" to be presented either as a cash flow from operating activities or a cash flow from investing activities.
A single transaction may include cash flows that are classified partly as one type of activity and partly as another category. Example : cash payment made toward repayment of a bank loan has two components : the repayment of principal portion of the loan, which is classified as a financing activity, and repayment of the interest which is classified as an operating activity.
Cash flows from operating activities are mainly derived from principle revenue-generating activities of the entity. This is a critical indicator of the financial strength of an entity because it is an important source of internal finance. Financial statement users usually look at cash flows from operating activities as a gauge of an entity's ability to maintain its operating capability and support other activities, such as servicing debt and repaying of borrowings, paying dividends to shareholders, and making investments without recourse to external funding.
Investing activities include the purchase and disposal of property, plant and equipment and other long-term assets, such as investment property. They also include purchase and sale of debt and equity and debt instruments of other entities that are not considered cash equivalents or held for dealing or trading purposes.
Investing activities also include cash advances and collections on loans made to other entities. This however, does not include loans and advances made by banks and other financial institutions to their customers that would be classified as "operating activities" as they are cash flows from these entities' principal revenue-producing activities.
Financing activities include obtaining resources from and returning resources to the owners. Also included in this category is obtaining resources through borrowings (short term or long term) and repayments of the amounts borrowed.
Non Cash Transactions
IAS 7 requires that noncash investing and financing activities should be excluded from the cash flow statement and reported "elsewhere" in the financial statements, where all relevant information about these activities is disclosed. This requirement is interpreted as the necessity to disclose noncash activities in the footnotes to financial statements instead of including them in the cash flow statement.
Investing and financing transactions that do not require the use of cash or cash equivalents shall be excluded from a statement of cash flows. Such transactions shall be disclosed elsewhere in the financial statements in a way that provides all the relevant information about these investing and financing activities (IAS 7 Par. 43).
Many investing and financing activities do not have a direct impact on current cash flows although they do affect the capital and asset structure of an entity. The exclusion of non-cash transactions from the statement of cash flows is consistent with the objective of a statement of cash flows as these items do not involve cash flows in the current period. Examples of non-cash transactions are : (a) the acquisition of assets either by assuming directly related liabilities or by means of a finance lease, (b) the acquisition of an entity by means of an equity issue, and (c) the conversion of debt to equity (IAS 7 Par. 44).
(Source : IFRS Practical Implementation Guide and Workbook - 2nd Edition, Abbas Ali Mirza, Magnus Orrell, Graham J. Holt and IFRS 2009 Bound Volume)