Common mistakes in preparing the cash flow statement

The cash flow statement is an integral part of the financial statements. This statement informs users about the actual cash received by the entity during a particular reporting period, and how these funds were spent to meet service delivery objectives. The cash flow statement:

• can be used as a comparison with budgeted amounts when the budget is prepared on the cash basis;
• can assist management in making decisions on how changes in funding will impact the scope and nature of the entity’s activities;
• is valuable in predicting an entity’s future cash requirements; and
• is useful to assess the entity’s ability to generate cash flows in the future.

Some entities may have given the preparation of the cash flow statement less prominence in comparison to other statements in the financial statements. The cash flow statement remains an important part of the financial statements.

Practice has shown that a number of common mistakes are made by preparers when preparing the cash flow statements.

Adjusting for non-cash flow items

A mistake that is often made in preparing the cash flow statement, is not adjusting for all the non-cash flow items. Very often, the software programs that are used to prepare financial statements do not adjust for non-cash flow items such as good and/or services in-kind or adjusting for the straight lining of operating lease expenses.

Goods in-kind comprise tangible assets that are received by the entity in a non-exchange transaction and are measured at fair value on date of acquisition. Similarly, when services in- kind are significant to the entity’s operations and a value can reliably be determined, these services are recognised in the statement of financial performance at fair value. Goods and/or recognised services in-kind, including donations other than cash, are not cash transactions and should therefore be adjusted as non-cash items in the cash flow statement.

GRAP 13 on Leases requires lease payments under operating leases to be recognised as an expense on a straight-line basis over the lease term. Straight lining the lease expense does not represent an actual cash payment. An adjustment for the non-cash portion of the operating lease payment should therefore be made when preparing the cash flow statement.

Presenting cash flow items at net amounts

Most cash flow items are reported separately in the cash flow statement. GRAP 2 on Cash Flow Statements only allows the presentation of cash flows on a net basis in the following instances:

1. the cash receipts and payments are made on behalf of third parties – thus where the reporting entity acts as an agent in accordance with GRAP 109 on Accounting by Principals and Agents; and
2. cash receipts and payments are made for items in which the turnover is quick, the amounts are large, and the maturities are short. This will be, for example, the purchase and sale of an investment.

Items such as interest received and finance costs, and dividends received and paid, should therefore be presented separately in the cash flow statement rather than presented as net amounts.
 
Classification of bank borrowings and investments as cash and cash equivalents

Entities are sometimes unsure which items are “cash and cash equivalents” in the cash flow statement. An item is part of “cash and cash equivalents” if it is held to meet short-term commitments, rather than for investment or other purposes.

Bank borrowings, that are generally considered to be financing activities, are not cash equivalents. The exception is, however, if the bank overdraft is repayable on demand and forms an integral part of the entity’s cash management activities. This will typically be evident where the bank balance often fluctuates between positive and negative.

Management’s intention for having or holding an investment plays an important consideration in determining whether the investment qualifies as a cash equivalent. An investment is a cash equivalent if it is:

• Short term and highly liquid – GRAP 2 explains that an investment may have a maturity date of three months or less from the acquisition date. This does, however, not automatically excludes investments from being cash equivalents if they have a maturity date of more than three months.
• Readily convertible to know amounts of cash – for an investment to be a cash equivalent, it must be convertible into cash without an undue period of notice, and without the entity incurring significant penalties on withdrawal. The amount of cash to be received on withdrawal must be known to the entity when the investment is made. 
• Insignificant risk of changes in values – this means that the investment is similar to cash and any changes in its value are insignificant.

The Secretariat of the ASB has issued a Frequently Asked Question that explains what items should be included in “cash and cash equivalents”. The FAQ can be accessed by following this link.

Reconciliation of net cash flows from operating activities to surplus/(deficit)

In preparing the cash flow statement, a reconciliation is prepared to reconcile the surplus/(deficit) in the statement of financial performance, with the net cash flows from operating activities. A common mistake is to not adjust for items that are shown separately on the face of the cash flow statement.

Depending on the nature of the entity’s activities, interest received is disclosed separately in the cash flow statement as either operating or investing activities. Likewise, finance costs are separately disclosed as either operating or financing activities. As these elements are included in the surplus/(deficit) for the period, they should be adjusted in calculating the net cash flows from operating or investing activities. Interest received is deducted from the surplus/(deficit), while the finance costs are added back.

ASB projects on GRAP 2

The ASB is currently undertaking a project to review entities’ compliance with the presentation requirements in GRAP 2. This project also involves identifying and understanding practices that entities apply in the compilation and preparation of the cash flow statement. The results of the review will be presented to the ASB Board in March 2021.