At the beginning, it is always necessary to define what the explanatory variable in the cash flow statement is – i.e. to decide which items on the balance sheet can be considered as cash and cash equivalents whose movements over the reporting period are explained by the statement. For example, escrow accounts typically do not meet the definition of cash/cash equivalents due to the impossibility of using the funds from such account in a short period of time (3 months). A receivable may sometimes qualify as cash/cash equivalents and would therefore be an explanatory variable. At other times, the cash pooling would represent a source of enhancing the value of idle funds (and would then be presented in the investment portion of the cash flow) or may be a component of working capital (tracked in the operating cash flow). Similarly, a liability in cash pooling may be a component of working capital or it may be a liability arising from the funding of the entity. Meeting the conditions of the cash/cash equivalents definition is critical to the overall statement and must be assessed with confidence.

The second major decision in the process of preparing the cash flow statement is the choice of the method of preparing the operating portion of the cash flow – direct or indirect. While the direct method, which separates individual payments received and made, is more accurate, in practice, the indirect method is more widely used due to its lower workload, which is based on the profit and loss account, or on the profit or loss before tax adjusted for non-cash transactions, changes in working capital, and taking into account the reclassification of cash flows to other parts of the cash flow (investment or financial activities) and to separately reported items (payment of corporate income tax, etc.). Because of its more frequent use in practice, we will focus on the indirect method in the operating area.

The third decision is the determination of liability items – liabilities which represent the financing of the company, the change (drawdown and repayment) of which is presented in financial activities. These are typically various loans and credits, both bank and non-bank, for example in a group, or the aforementioned cash pooling. Items not presented in financing activities will be part of the working capital. For long-term loan and credit items, the financial nature is usually unquestionable, whereas for short-term titles or revolving loans, further consideration may be necessary.

Similarly, it is necessary to assess how accruals in assets and liabilities will be reflected in cash flow, taking into account their materiality. For example, if we consider that there are comprehensive deferred expenses (CDE) in the assets, these will be items similar in nature to fixed assets: the expenditure on the CDE is in a different period than the expense (amortisation of the CDE in the profit and loss account). Similarly, depending on the nature of the entity’s activities, deferred income may be included in liabilities – will it always be working capital, or perhaps financing? The realisation cycle of deferred income may even take several years.

When an accounting professional sets out to prepare a cash flow statement, he or she often uses software solutions or various templates – tools available from auditing and consulting firms. In the case of a software-designed solution or the use of a semi-automated template, there may be a problematic moment when it is not clear what algorithm the software or tool uses to calculate cash flows and include individual items from the (trial) balance sheet. Nor can the software or tool be relied upon to produce cash flow without error or without the need for ‘fine tuning’. Thus, the proposed cash flow needs to be subjected to critical judgement, scrutiny and necessary additional adjustments.

The additional adjustments will most often be related to non-cash transactions in the profit and loss account, or their year-on-year change in balance, as well as to changes in liabilities related to acquired fixed assets (unpaid investment invoices) and also related to the follow-up to any adjustments made in the preparation of cash flow in the previous period. Certain items cannot be extracted directly from the statements or notes to the financial statements for cash flow purposes. While some non-cash transactions are relatively easy to identify and quantify for cash flow purposes (change in reserves and provisions), others necessitate more analysis and a detailed accounting approach (e.g. unrealised foreign exchange rate gains or losses, valuation of unrealised derivatives, etc.). Outstanding commitments from capital construction will typically be best identified from the balance account. These are also an example where the follow-up of an adjustment made in the previous year’s cash flow preparation is often forgotten (i.e. if unpaid capital expenditure invoices were excluded in the calculation of fixed asset acquisition expenditure last year, then if these were paid in the current period, I must include them in the cash flow expenditure this year).

Other specific issues arise when the cash flow is for a post-transformation period, particularly after a merger or, conversely, a spin-off in which cash/cash equivalents are acquired or spun-off at the beginning of or during the reporting period. The statement then contains separate lines at the beginning to capture the movement of such cash/cash equivalents.

A more complex task may be the preparation of a cash flow statement in the consolidated financial statements. It is not currently a mandatory statement, but the pending draft of a new accounting legislation introduces it as a mandatory statement within the consolidated financial statements. If the preparation of such a statement is not supported by the consolidation software itself and is rather handled through the data contained in the reporting package, it is often advisable to focus attention on external items when obtaining information from reporting entities included in the consolidation – i.e. on payments to external entities and collections from external entities (suppliers, customers, banks, financial institutions, etc.), as these then remain in the consolidation and form the core of the consolidated cash flow statement.

The theory is grey, green is the tree of life. So do not hesitate to contact us with questions about the cash flow statement.