Preparation and Analysis of Cash Flow Statements: The Net Profit Approach and Operating Profit Approach

A cash flow statement is required as part of a complete set of financial statements prepared in conformity with IFRS as well as US GAAP for all business enterprises. IAS 7 lays down a formal structure for the cash flow statement. Cash flows should be classified under the following three standard headings: ìOperating activitiesî, ìInvesting activitiesî, ìFinancing activitiesî. The classification of cash flows among operating, investing and financing activities is essential to the analysis of cash flow data. Net cash flow (the change in cash and equivalents during the period) has little informational content by itself; it is the classification and individual components that are informative. Although the classification of cash flows into the three main categories is important, it should be mentioned that classification guidelines are arbitrary. IAS 7 has not indicated how to classify certain items that might fit logically in more than one of the major categories of the statement of cash flows. Examples: 1) Interest and dividends received can be presented as an operating activity, despite their close association with other activities presented as investing activities. 2) Interest and dividends paid can be presented as an operating activity, despite their close association with other activities presented as financing activities. Additional troubles arise from case that there is no standard definition of operating activities and consequently, cash flows from operating activities. Both IASB and FASB have taken position that operating activities are activities that are not investing or financing activities. At the same time the opinion that the association of a cash flow with profit is the primary criterion for classifying the flow as operating, is expressed. The examples illustrate the influence of the differences in the classification of cash flow data on net cash from different kinds of activities.