8.5 Preparing the investing and financing activities sections of the statement of cash flows
Rina Dhillon; Mitchell Franklin; Patty Graybeal; and Dixon Cooper
Preparation of the investing and financing sections of the statement of cash flows is an identical process for both the direct and indirect methods, since only the technique used to arrive at net cash flow from operating activities is affected by the choice of the direct or indirect method. The following section discusses specifics regarding preparation of these two non-operating sections. Changes in the various non-current assets, non-current liabilities, and equity can be determined from analysis of the company’s comparative balance sheet, which lists the current period and previous period balances for all assets and liabilities.
Investing Activities
Cash flows from investing activities always relate to non-current asset transactions and may involve increases or decreases in cash relating to these transactions. The most common of these activities involve purchase or sale of property, plant, and equipment, but other activities, such as those involving investment assets and lending of loans as investments, also represent cash flows from investing. Changes in non-current assets for the period can be identified in the Non-Current Assets section of the business’ comparative balance sheet, combined with any related gain or loss that is included on the income statement and notes to the financial statements.
To calculate cash flows from investing activities, all changes in non-current assets must be examined. An increase in a non-current asset suggests a purchase and therefore a cash outflow. Examples of cash outflows include cash payments for:
In the example used in Section 8.3 and 8.4, the investing section includes one transaction involving the sale of non-current assets, which increased cash for a total net cash flow from investing of $150000. Analysis of the notes to the financial statements revealed that on 1 July, equipment and machinery was sold for a total $150000. Details relating to the treatment of this transaction in the investing activities section of the cash flow statement are provided below.
After preparing the investing activities section of the cash flow statement, the financing activities section is prepared. We now turn our attention to the calculation of cash flows from financing activities.
Financing Activities
Cash flows from financing activities always relate to either long-term debt (non-current liabilities) or cash inflows and outflows from/to shareholders/investors (equity) transactions and may involve increases or decreases in cash relating to these transactions. Shareholders’ equity transactions, like issuing of shares, payment of dividends, and share buybacks are very common financing activities. Debt transactions, such as issuance of debt, and the related repayment of debt, are also frequent financing events. It is important to note that although dividend payments to shareholders are considered as a financing activity, payments of interest to creditors are not. The reason for this is interest is an expense that is reported on the income statement, and are considered to be part of a business’s daily operations, therefore payments for interest are reported as operating instead of financing activities. Changes in non-current liabilities and equity for the period can be identified in the Non-Current Liabilities section and the Shareholders’ Equity section of the company’s comparative balance sheet, and in the financial statement notes.
To calculate cash flows from financing activities, the balances for non-current liabilities, equity accounts and dividends must be examined. An increase in a liability or an equity account suggests a cash inflow. Examples of cash inflows include cash receipts from:
In the example used in Section 8.3 and 8.4, the financing section included one transaction related to equity, and which decreased cash, for a total net cash flow from financing of $50000.
Analysis of the notes to the financial statements revealed shares were repurchased for cash on 15 January and changes in shareholders’ equity (share capital) in the comparative balance sheet from $150000 to $100000 would mean that the business repurchased (bought back) shares for $50000 ($150000-100000) cash. Details relating to the treatment of this transaction in the financing activities section of the cash flow statement are provided below.
Summary of Investing and Financing Transactions on the Cash Flow Statement
Investing and financing transactions are critical activities of business, and they often represent significant amounts of company equity, either as sources or uses of cash. Common activities that must be reported as investing activities are purchases of property, plant and equipment, shares, and bonds, while financing activities normally relate to the business’ funding sources, namely, creditors (debt) and investors (equity). These financing activities could include transactions such as borrowing or repaying loans, or issuing shares or share buybacks, to name a few examples.
The next section, Section 8.6, brings together the complete statement of cash flows, using the direct method.
