What the statement answers; three activities; ASPE’s classification; cash equivalents
◈ 7 cardsSay what the cash flow statement answers that the income statement cannot, name the three activities, state ASPE’s classification of interest and dividends, and define cash equivalents.
Seventy-two thousand of profit, thirteen thousand of cash
Haliburton Paddle Works Ltd. builds canoes and paddles in a shop on the Drag River. Its year-2 income statement reports net income of 72,000. Its balance sheet shows cash of 28,000 at the start of the year and 41,000 at the end — an increase of only 13,000. The owner, reading both, asks the question every lender asks: where did the other 59,000 go?
The income statement cannot answer. It measures performance on the accrual basis — revenue when earned, expenses when incurred — and it says nothing about the 110,000 Haliburton paid for new equipment, the 20,000 instalment it repaid on the bank loan, or the 15,000 of dividends it actually paid. None of those is an expense. The cash flow statement exists to answer the question the other three statements leave open: where cash came from, where it went, and why the cash balance moved as it did. Under ASPE s.1400 it is one of the four statements a complete set requires, and it covers the same period as the income statement.
Three activities
Every cash movement is classified by what kind of activity produced it:
| Activity | What it covers | Haliburton, year 2 |
|---|---|---|
| Operating | the cash effects of the transactions that determine net income — collecting from customers, paying suppliers and staff, paying interest and income tax | 112,000 provided |
| Investing | buying and selling long-lived assets and investments | 84,000 used |
| Financing | borrowing and repaying debt, issuing shares, paying dividends | 15,000 used |
The three totals sum to the net change in cash, 13,000; add the opening balance and you must land on the closing balance the balance sheet shows. That final line is the statement’s own check.
Where interest and dividends go
ASPE s.1540 leaves no room to choose. Interest paid, interest received and dividends received are operating, because each one enters the determination of net income — Haliburton’s 6,000 of interest expense is an operating outflow, not a financing one, even though the loan itself is financing. Dividends paid are financing, because a dividend is a distribution charged to retained earnings and never enters net income. Income taxes paid are operating. A company reporting under IFRS may elect where interest and dividends go; that election is AFM 182’s, and on a 191 paper the answer is the fixed ASPE rule.
Cash and cash equivalents
The statement reconciles cash and cash equivalents. A cash equivalent is a short-term, highly liquid investment that is readily convertible to a known amount of cash and subject to an insignificant risk of change in value — normally one with three months or less to maturity from the date it was acquired. Haliburton’s 90-day treasury bill is a cash equivalent; buying it moves money from one pocket to another and is not an investing activity. Its 18-month term deposit is not: it fails the three-month test at acquisition, so buying it is an investing outflow and the deposit sits on the balance sheet as a short-term investment, outside cash.