Aside from helping with adjusting accounting practices to IFRS, the Cash Flow Statement according to the indirect method is an accounting statement part of the annual Financial Statements, which has allowed non-accountants to more easily use the accounting records.
For instance, people often ask the reason for which a company has accounting profit, which has not translated into the same in the company’s cash, or if the company otherwise has any losses. However, when one looks at the bank account balance, there are more funds than before. The Cash Flow Statement is used to report on the financial transactions that distinguish the accounting profit from the company’s cash.
It is one way of recording all financial transactions, which did not affect result, into operating activities, investments and loans.
In addition to the accounting profit, operating activities include current assets and liabilities, such as clients, suppliers, inventory, payroll, taxes payable, advances to suppliers, and other rights and obligations that may be part of both the company’s current assets and liabilities.
For example, when we look at client accounts receivable, there may be a case of a sale performed on December 20, payable in January 10 of the next year. The sale price may have triggered profit for the company, but, if the amount was still not received, the cash has not increased. In this regard, it is arguable that on the date of the annual balance sheet, the sale caused a profit increase, as it is revenue, but there was no cash increase, as the sale price was not received.
Another similar example comes from inventory, which is also recorded under operating activities. A company may have increased its inventory with the purchase of goods, which will decrease cash; however, as long as the goods are still in stock, they represent an expense that was not considered in result, whereby the inventory increase will be represented by the decreased cash in the Cash Flow Statement, despite not having any impact on profit.
Investments, in turn, cover all expenses and receipts from purchases and sales of non-current assets, such as capital expenditures, tangible or intangible assets or purchase of equity interest. This is so because whenever a fixed asset is purchased or sold, a cash inflow or outflow is performed for the payment of the transaction. However, such activities are recorded as assets, and therefore do not affect the profit of the fiscal year. As such, the expense is recorded as cash outflow, and any receipts from non-current assets are recorded under cash, in the Cash Flow Statement.
Loans cover all transactions related to the loans and funding of current assets, as well as the non-current assets and the owners’ equity items. Loans may come from third parties, or in the form of capital contributions made by partners or shareholders. In general, there are two phases in the process of performing funding activities: first, there is a cash increase (loan obtained), followed by the cash decrease (payment of the debt). These phases are unrelated to accounting profit, as the loan is merely an engagement and payment of a debt, without any losses or gains, except for the interest that represent the financial expense, which are accounted for in determining result.
Based on the foregoing examples, profit does not mean cash increase, and the Cash Flow Statement by the indirect method may help understand the reasons for the differences between profit and cash increase.
Salatiel Dias Batista Filho