Subject 1. Classification of Cash Flows and Non-Cash Activities

The cash flow statement provides important information about a company's cash receipts and cash payments during an accounting period as well as information about a company's operating, investing and financing activities. Although the income statement provides a measure of a company's success, cash and cash flow are also vital to a company's long-term success. Information on the sources and uses of cash helps creditors, investors, and other statement users evaluate the company's liquidity, solvency, and financial flexibility.

Cash receipts and cash payments during a period are classified in the statement of cash flows into three different activities:

Operating Activities

These involve the cash effects of transactions that enter into the determination of net income and changes in the working capital accounts (accounts receivable, inventory, and accounts payable). Cash flows from operating activities (CFOs) reflect the company's ability to generate sufficient cash from its continuing operations. CFOs are derived by converting the income statement from an accrual basis to a cash basis. For most companies, positive operating cash flows are essential for long-run survival.

The major operating cash flows are (1) cash received from customers, (2) cash paid to suppliers and employees, (3) interest and dividends received, (4) interest paid, and (5) income taxes paid.

Special items to note:

  • Interest and dividend revenue, and interest expenses, are considered operating activities, but dividends paid are considered financing activities. Note that interest expense is reported on the income statement while dividends flow through the retained earnings statement.

    Remember that an interest/dividend item is an operating activity if it appears on the income statement. For example, payments of dividends do not appear on the income statement, and thus are not classified as operating activities.

  • All income taxes are considered operating activities, even if some arise from financing or investing.

  • Indirect borrowing using accounts payable is not considered a financing activity - such borrowing would be classified as an operating activity.

Investing Activities

These include making and collecting loans and acquiring and disposing of investments (both debt and equity) and property, plants, and equipment. In general, these items relate to the long-term asset items on the balance sheet. Investing cash flows reflect how a company plans its expansions.

Examples are:

  • Sale or purchase of property, plant and equipment.
  • Investments in joint ventures and affiliates and long-term investments in securities.
  • Loans to other entities or collection of loans from other entities.

Financing Activities

These involve liability and owner's equity items, and include:

  • Obtaining capital from owners and providing them with a return on (and a return of) their investments.
  • Borrowing money from creditors and repaying the amounts borrowed.

In general, the items in this section relate to the debt and the equity items on the balance sheet. Financing cash flows reflect how the company plans to finance its expansion and reward its owners.

Examples:

  • Dividends paid to stockholders (not interest paid to creditors!). Note that the cash outflow caused by dividends is determined by dividends paid, not dividends declared. Dividends paid are not reflected in the retained earnings account. The amount is provided in the supplementary information.
  • Issue or repurchase of the company's stocks.
  • Issue or retirement of long-term debt (including the current portion of long-term debt).

Purchase of debt and equity securities from other entities (sale of debt or equity securities of other entities) and loans to other entities (collection of loans to other entities) are considered investing activities. However, issuance of debt (bonds and notes) and equity securities is a financing cash inflow, and payment of dividend, redemption of debt, and reacquisition of capital stock are financing cash outflows.

Non-cash Activities

Some investing and financing activities do not flow through the statement of cash flows because they don't require the use of cash:

  • Retiring debt securities by issuing equity securities to the lender.
  • Converting preferred stock to common stock.
  • Acquiring assets through a capital lease.
  • Obtaining long-term assets by issuing notes payable to the seller.
  • Exchanging one non-cash asset for another non-cash asset.
  • The purchase of non-cash assets by issuing equity or debt securities.

For example, if a company purchases $200,000 of land by issuing a long-term bond, this transaction is a non-cash one, as it does not involve direct outlays of cash. Therefore, it is excluded from the statement of cash flows. These types of transactions should be disclosed in a separate schedule as part of the statement of cash flows or in the footnotes to the financial statements.

Differences between IFRS and U.S. GAAP

The above discussions are based on the U.S. GAAP. Under IFRS there is some flexibility in reporting some items of cash flow, particularly interest and dividends.

  • Interest and dividends received:

    • Under U.S. GAAP, interest income and dividends received from investment in other companies are classified as CFO.
    • Under IFRS, interest and dividends received may be classified as either CFO or CFI.

  • Interest paid:

    • Under U.S. GAAP, interest paid is classified as CFO.
    • Under IFRS, interest paid may be classified as either CFO or CFF.

  • Dividends paid:

    • Under U.S. GAAP, dividends paid are classified as CFF.
    • Under IFRS, dividends paid may be classified as either CFO or CFF.

User Contributed Comments 13

You need to log in first to add your comment.
Creg: CFO,CFI,CFF R6
Creg: Change in most CA and Cl
cahiz84: yes you need to know this for the exam.
rethan: Do we have to know the difference betweem how IFRS and GAAP treat various activities? ex. dividends paid in US GAAP is a financing activity, while IFRS allows for it to be stated in either CFO or CFI
synergy13: we dont have to know! They test our conceptual skilks and not compliance!
JimA: so is cash flows from operating activities just NI-COGS?
Mgtw: retiring debt is CFI or CFF?
The notes say 'disposing of investments (debt/equity)' is CFI
but retiring long term debt is CFF. What's the difference?
HTale: Mgtw, the part that refers to 'disposing of investments' is the part regarding when a company invests in another companies balance sheet (that is, acquires its debt or equity). Disposing it (selling it off, in the main) is considered a CFI activity. However, disposing of your own debt (redemption) or equity (stock buy back) is a CFF activity. That is the main difference!
omya: US GAAP: Dividend payment is Financing activity (Here amount is given by dividend paid n not dividend declared) + Interest payment/receipt + Dividend receipt is operating activities.
IFRS: Interest or dividend earned can be CFO or CFI activity.
Interest/Dividend paid can be CFO or CFF activity.
All income tax payments are Operating activities even if they arise from non operating activities.
johntan1979: synergy13 must either be one of the examiners setting questions for the CFA exam or one of those who most likely will be retaking the exam.
Dalydaly: There is no concern about the gain or loss from sale a fixed asset , and how may I differentiate between dividends from net income and that from retained earnings - thanks
Shaan23: Synergy -- seriously? If you pass I'll be impressed.
jfermin315: lol this to funny