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Ind AS 7, also known as the Indian Accounting Standard 7, guides entities on how to prepare and present their cash flow statements (CFS). In this article, we will dive into the essentials of Ind AS 7, unraveling its key principles, and shedding light on its significance for businesses. So, let’s embark on this journey to demystify the world of cash flow statements under this standard.
scope and Objective:-
At its core, Ind AS 7 aims to enhance the usefulness of financial statements by requiring entities to present information about their historical cash flows. By analyzing cash flows, stakeholders gain a deeper understanding of how cash is generated and utilized within an organization. This information helps assess an entity’s ability to generate future cash flows, its liquidity position, and its overall financial performance.
Components of a Cash Flow Statement:-
Ind AS 7 outlines three main categories within a cash flow statement: operating activities, investing activities, and financing activities.
Operating Activities:-
This section focuses on the cash flows generated from the core operations of the business. It includes cash received from customers, cash paid to suppliers and employees, interest and dividends received, and interest paid. Operating cash flows are crucial as they indicate the entity’s ability to generate cash from its primary business activities. There are two methods for presenting cash flow from operating activities.
Direct Method of Cash Flow:-
The direct method of preparing the CFS under Ind AS 7 involves presenting the actual cash inflows and cash outflows from operating activities. This method provides a more straightforward and intuitive view of the cash flows generated by an organization’s core operations. While it is not the most commonly used method due to its detailed data requirements, it offers valuable insights into the sources and uses of cash.
Under the direct method, the cash flow statement starts with the total cash received from customers, which represents the cash collected from sales. It then deducts cash payments made to suppliers, employees, and other operating expenses to calculate the net cash provided by operating activities. This method provides a clear picture of how businesses generate cash from day-to-day business activities.
Indirect Method of Cash Flow:
The indirect method is the more commonly used way to prepare the cash flow statement. In this method, we with the net profit or loss as per the income statement and adjusts it for non-cash items and changes in working capital to get the net cash provided by operating activities.
To convert net profit or loss to net cash provided by operating activities, various adjustments are made. These adjustments include adding back non-cash expenses Like- depreciation, amortization, and impairment charges, which do not involve cash outflows. Additionally, changes in working capital items Like- accounts receivable, accounts payable, and inventory are taken into account. Increases in working capital items are subtracted, while decreases are added back to the net profit or loss.
The indirect method provides a more convenient way to prepare the cash flow statement as it relies on the existing financial statements, primarily the income statement and balance sheet. It offers a holistic view of the cash flows generated from operating activities, incorporating adjustments for non-cash items and changes in working capital.
Investing Activities:-
Investing activities cover the acquisition and disposal of long-term assets, Like- property, plant, and equipment, as well as investments in other entities. Cash flows related to buying or selling these assets are recorded in this section. Monitoring investing activities helps stakeholders understand how an entity is allocating its resources and whether it is making sound investment decisions.
Financing Activities:-
Financing activities encompass transactions that involve raising capital or repaying debts. Cash flows from issuing or repurchasing shares, obtaining or repaying loans, and paying dividends are categorized under financing activities. Understanding the financing activities of an entity provides insights into its capital structure, leverage, and dividend policy.
Importance of Cash Flow Statements:-
CFSs provide valuable information that complements the balance sheet and income statement. They reveal the cash-generating capabilities of an entity, its liquidity position, and its ability to meet financial obligations. Investors, creditors, and other stakeholders use CFS to evaluate the financial viability and sustainability of a business. Furthermore, they aid in identifying potential cash flow issues, such as a high reliance on financing activities or a decline in operating cash flows.
Preparation and Presentation:-
Ind AS 7 provides guidance on the format and presentation of cash flow statements. Entities are required to present cash flows from operating, investing, and financing activities using either the direct method or the indirect method. The direct method reports major classes of gross cash receipts and payments, while the indirect method adjusts net profit or loss for non-cash items to derive cash flows.
Additionally, the standard encourages entities to provide supplementary information that enhances the understanding of the cash flow statement. This can include additional disclosures about significant non-cash investing and financing activities or changes in financial liabilities.
Conclusion:-
Ind AS 7 plays a vital role in financial reporting by requiring entities to prepare and present cash flow statements. These statements provide a comprehensive view of an entity’s cash flows, allowing stakeholders to assess its liquidity, cash-generating capabilities, and financial stability. This standard ensures transparency and improves the overall quality and reliability of financial reporting in India.