Content area
Full text
In recent years, the statement of cash flows has received increasing attention from readers of financial statements. The cash flow statement gives vital information about a company's performance, as well as its major activities during the year; however, some of the rules for preparation make the cash flow statement less useful than it should be.
The weaknesses with the cash flow statement can be divided into five sections: 1) differences between commercial and industrial companies versus financial institutions; 2) problems with operating activities; 3) problems with investing activities; 4) problems with financing activities; and 5) the role of free cash flow. The authors offer potential solutions to these problems that could improve the cash flow statement
Financial Institutions Versus Commercial and Industrial Companies
In the case of financial institutions, the identification of the core operating activities is important, because they differ markedly from nonfinancial companies in this respect. Consider commercial banking institutions, where the core operations can be divided between on-balance sheet activities and off-balance sheet activities. The off-balance sheet activities consist primarily of fee-based activities for services rendered that do not create an asset or a liability. These create no problem for the cash flow presentation because they appear on the income statement and flow directly through the operating section of the cash flow statement.
The major problems are created by activities that have significant impact on the balance sheet. They are: 1) managing the accounts of depositors, which appears on the balance sheet as liabilities; 2) lending money to customers, which appears on the balance sheet as assets; and 3) trading in securities, which appears on the balance sheet as assets.
If these are a bank's core operations, one would expect them to be in the operating activities section of the cash flow statement. Instead, customer deposits are listed as financing activities, while loans to customers and securities activities appear in the investing activities section. As a result, the figure for "cash provided by operations" is meaningless. In other words, the breakdown of cash flows into operating, investing, and financing activities-as presently constituted for financial institutions-is not useful to readers of the financial statements. A totally new form of presentation is needed to provide useful cash flow information.
It is somewhat ironic that...