Investing and financing activities

Cash flows from investing activities

Investing activities are always reported at their gross cash receipts and payments - there’s no indirect method option here; the direct-versus-indirect choice applies only to the operating activities section, which we cover in a later chapter. To prepare the cash flows from investing activities, it is best to be familiar with the movements in the entity’s non-current assets. Examples of items included in investing activities under the codification are listed in the previous chapter.

You need to remember that we only need to include the gross amount of cash received or paid in the transaction in the cash flows from investing activities, however most of the time this will not be directly provided in the examination and you will need to determine it from a variety of inputs similar to the direct method T-accounts discussed prior.

The most common item would be the purchase and sale of long-term fixed assets such as PPE. With this we recommend going back into the basics and knowing the debit and credit impacts of transactions.

Sample problem: Assuming a company sold some property, plant and equipment during the year. The loss on the sale in the income statement is $10,000. At the time of sale, the equipment had accumulated depreciation of $75,000. It was originally bought for $87,000. How will the transaction appear in the statement of cash flows?

Solution: Since this transaction impacted non-current assets, this is clearly a cash flow from investing activity. We note that the proceeds from the sale were not provided directly. However since all the details of the transactions were provided, we can determine the proceeds by laying out the inputs into a journal entry:

In numeric terms, the cash proceeds of $2,000 plus the accumulated depreciation of $75,000 plus the $10,000 loss equal the equipment’s original cost of $87,000, confirming the debits equal the credits.

The journal entry method will help you in so many cases and not just in computing cash flows. Alternatively, it can be analyzed as follows:

In other words, proceeds equal net book value minus loss: $(87,000-75,000)-10,000=2,000$.

The above means that we had a loss of $10,000 because we only sold a PPE with a net book value of $12,000 for $2,000. The $2,000 will appear as a gross cash flow from investing activities. In addition, if the entity is preparing cash flows from operating activities using the indirect method, the loss on sale of $10,000 will appear as a reconciling item in the operating activities.

The template of the cash flows from investing activities is as follows:

A net cash inflow (positive) from investing activities often signals that the company is selling off their assets. This may indicate a shift in strategy in terms of long-term growth or might even indicate that the company is undergoing liquidation.

While a net cash outflow (negative) from investing activities means that the company is investing in its long-term growth. Keep in mind that the sign alone doesn’t tell you whether this is good or bad news - you need to look at the context alongside the rest of the financial statements before drawing a conclusion.

Cash flows from financing activities

Same with the investing activity, cash flows from financing activities are presented at gross cash receipts and payments with no alternative option. To prepare this, it is best to be familiar with the movements in the entity’s non-current liabilities (such as bonds, borrowings and other non-current liabilities) and equity (such as share capital, APIC and Treasury Stocks).

When determining the amount to disclose in the cash flows from financing activities, you need to remember that we only need to include the gross amount of cash received or paid in the transaction. In particular, any gain or loss from the transaction is not presented in the cash flows from financing activities although it may be presented as a reconciling item in the cash flows from operating activities when using the indirect method. An example of the above is any gain or loss on extinguishment of debt when a debt item has been repaid early.

Under US GAAP, dividends paid to shareholders are classified as a financing outflow, while interest paid, interest received, and dividends received are all classified as operating activities - a frequently tested distinction. IFRS allows more flexibility here, permitting these items to be classified as either operating or financing/investing, as long as the classification is applied consistently.

The template of the cash flows from financing activities is as follows:

A net cash inflow (positive) from financing activities may indicate that the company’s capital has been funded by either additional investments from shareholders or through long-term debt. This could indicate future growth as the capital will be expected to be invested into revenue-producing activities of the company.

A net cash outflow (negative) from financing activities generally indicates that capital is being repaid to shareholders through dividends or stock repurchases, or long-term loans are being repaid.

Non-cash investing and financing activities

Investing activities typically affect non-current assets and financing activities typically affect non-current liabilities and equity. It can normally happen that transactions impact a mixture of these accounts but they do not have cash impacts. These are considered by the Codification as non-cash investing and financing activities.

In addition, some transactions are part cash and part non-cash. In this case, only the cash portion is reported in the statement of cash flows.

These transactions should be disclosed as additional information in the statement of cash flows. The disclosures can either be a narrative of the transaction or summarized in a schedule. In particular, according to the Codification, if there are only a few such noncash transactions, it may be convenient to include them on the same page as the statement of cash flows. Otherwise, the transactions may be reported elsewhere in the financial statements, clearly referenced to the statement of cash flows.

For purposes of the exams, when being asked to prepare a statement of cash flows, we recommend to include them within the statement for a complete presentation. See the next section for the recommended format.