Statement of cash flows

Cash and cash equivalents included in the statement of cash flows

A statement of cash flows shall explain changes during the period in the total of the following items:

• Cash
• Cash equivalents
• Restricted cash
• Restricted cash equivalents

If the cash flows pertain to more than one line in the statement of financial position, there should be an explanatory note of what accounts are covered in the cash flows. The Codification also directs companies to avoid ambiguous terms such as “funds” when describing cash and cash equivalents.

The cash flows cover movements of the four accounts above in total. This means that movement between the four items (for example, purchases and sales of cash equivalents, paid for in cash) are not considered as reportable cash flow movements under operating, investing, or financing activities, even when there is a transfer from the general cash account to a restricted cash account.

1. Cash

According to the Accounting Standards Codification, the term “cash” includes the following:

• Cash on hand
• Demand deposits with bank and other financial institutions
• Other kinds of accounts that have the general characteristics of demand deposits in that the customer may deposit additional funds at any time and also effectively may withdraw funds at any time without prior notice or penalty.

Movement in these accounts during the period should be analyzed into operating, investing, and financing activities for cash flow purposes, except when the movement is a receipt or payment related to cash equivalents or restricted cash balances.

2. Cash equivalents

This commonly includes the following items:

• Treasury bills
• Commercial paper
• Money market funds
• Federal funds sold (for an entity with banking operations).

According to the Accounting Standards Codification, the term “cash equivalents” refers to short-term, highly liquid investments that have both of the following characteristics:

1. Readily convertible to known amounts of cash
2. So near their maturity that they present insignificant risk of changes in value because of changes in interest rates.

In practice, an investment is a cash equivalent if its original maturity to the holder is three months or less.

The original maturity is determined with reference to the party holding the investment. For example, the following can be considered as cash equivalents:

• A three-month U.S. Treasury Bill
• A three-year U.S. Treasury note but purchased by a company three months from maturity

The following is not a cash equivalent:

• A three-year U.S. Treasury note purchased two years ago, even though only three months remain to maturity at the balance sheet date. Its original maturity to the holder was more than three months.

3. Restricted cash and restricted cash equivalents

The term “restricted cash” or “restricted cash equivalents” is not specifically defined in the Codification. In general, cash is considered restricted when it’s restricted as to withdrawal or use for other than current operations, or when it’s set aside for the acquisition or construction of noncurrent assets or for the liquidation of long-term debt. Restricted cash is often classified as a noncurrent asset, though it can be included in current assets if it’s considered to offset a related current liability - either way, it’s still part of the total that the statement of cash flows reconciles.

Cash flow classifications

Operating activities

Classification depends on the company’s normal business. For example, a real estate company’s purchases of property held for sale are operating, while for other companies they are investing.

Common cash inflows from operating activities include:

• Receipts of cash from customers from the sale of goods or services in line with the main business of the company
• Receipts of cash in the form of interest and dividends from loan, other debt instruments and equity securities
• All other cash receipts not included in the investing and financing activities (including amounts received from settlement of lawsuits and refunds from suppliers)
• All cash receipts of a lessor from leases

Common cash outflows from operating activities include:

• Payments of cash to acquire materials for the manufacture of goods or to acquire finished goods for resale. This includes the payments of the principal amounts of trade and notes payable related to goods originally acquired on credit
• Payments of cash to other suppliers and employees. This includes all cash payments paid by a lessee under an operating lease except to the extent that those payments represent costs to bring another asset to the condition and location necessary for its intended use (these are classified within investing activities)
• Payments of cash to governments for taxes, duties, fines, and other fees or penalties
• Payments of cash for interest to lenders and other creditors
• Payments of cash to settle an asset retirement obligation
• All other cash payments not included in the investing and financing activities (including payments to settle lawsuits, cash contributions to charities, and cash refunds to customers)

Financing activities

Common cash inflows from financing activities include:

• Receipts of cash from investors from issuing equity instruments such as the company’s own common stock
• Receipts of cash from issuing bonds, mortgages, notes, and from other short- or long-term borrowing

Common cash outflows from financing activities include:

• Payments of cash dividends or other distributions to owners
• Payments of cash to re-acquire the entity’s own equity instruments (this becomes treasury stock)
• Repayments of principal amounts borrowed from creditors
• Payments for debt issue costs
• Payments for debt prepayment or debt extinguishment costs
• Payments made by a lessee under a finance lease to reduce the lease liability (the principal portion only - the interest portion is operating, as shown in the table below)

For instance, dividends received from an investment in another company’s stock (say, $8,000) are an operating inflow, while dividends paid to the company’s own shareholders (say, $50,000) are a financing outflow.

Investing activities

Investing activities include making and collecting loans and acquiring and disposing of debt or equity instruments and property, plant, and equipment and other assets that are used to produce goods and services. Investing activity does not include transactions related to the acquisition and sale of inventory because these are included in the operating activities.

Cash flows from purchases, sales, and maturities of available-for-sale debt securities shall be classified as cash flows from investing activities.

Common cash inflows from investing activities include:

• Receipts from collections or sales of loans made by the entity and of other entities’ debt instruments (other than cash equivalents and debt instruments acquired specifically for resale, which are operating)
• Receipts from sales of equity instruments of other entities (other than equity instruments carried in a trading account) and from returns of investment in those instruments
• Receipts from the sale of property, plant, and equipment and other productive assets
• Receipts from sales of loans that were not specifically acquired for resale (e.g., loans originally acquired as investments)
• Receipts from proceeds of insurance settlements directly related to the transactions mentioned above such as proceeds of insurance on a building that is damaged or destroyed.

Common cash outflows from investing activities include:

• Disbursements for loans made by the company and payments to acquire debt instruments of other companies (other than cash equivalents and debt instruments that are acquired specifically for resale)
• Payments to acquire equity instruments of other entities (other than equity instruments carried in a trading account which are classified as operating activities)
• Payments for the purchase of property, plant, and equipment and other productive assets, including interest capitalized as part of the cost of those assets.
• Advance payments, down payments, or other amounts paid for the purchase of property, plant, and equipment acquired in a financing transaction (see the table below for how the remaining principal and interest payments are classified)

Non-cash investing and financing activities

Investing and financing activities of an entity do not always have cash impact (for example acquisition of property, plant and equipment on credit and remain unpaid at the end of the year).

Such transactions should be disclosed in either narrative or tabular format in the notes to the financial statements. Some transactions are part cash and part noncash. In this case, only the cash portion shall be reported in the statement of cash flows.

According to the codification, some examples of noncash investing and financing transactions are the following:

• Converting debt to equity
• Acquiring assets by assuming directly related liabilities, such as purchasing a building by incurring a mortgage to the seller
• Obtaining a right-of-use asset in exchange for a lease liability
• Obtaining a building or investment asset by receiving a gift
• Exchanging non-cash assets or liabilities for other non-cash assets or liabilities.