Nowadays, bankers/investers are interested to read a cash flow statement of a company when making investment decision in addition to reading the conventional profit and loss account and Balance Sheet which are prepared in accordance with accruals accounting. This is because stock valuation, depreciation policy and provision of bad and doubtful debts on the profit and loss account and Balance Sheet are judgemental. This make it difficult for the users of financial statements to ascertian a company's result with confidence.
A cash flow statement presents only cash transactions undertaken by a company during the financial year. Thus, it reflects a company liquidity position.
Why a company's liquidity is important?
A company can be profitable and yet having cash flow problems. There are various reasons for this. For examples, customers take a long time to settle their debts due to poor credit control system in place, and substantial cash being invested in stock and yet the stock turnover is not efficient.
All these will have effect on the company creditors payments days which will result in creditors stop supplying. In addition, If the company is heavily relied on bank overdraft to fund its operations, the bank may stop renewing its facility if monthly minimum repayments fall due are not being repaid on timely basis and may demand full loans repayment and failure to do so may resulted assets of the company secured against the bank facility being re-possessed. The company may subject to liquidation or administration and subsequently being dissolved. Shareholders and directors' reputation may be in jeopardy if personal guarantees were given on those borrowings.
All businesses are encouraged to take control of their customers payments days from day one by introducing credit terms, carry out credit check on new customers before granting credit terms to avoid potential bad debts, minimise stock holding period, request credit terms from suppliers.
Profitability and liquidity are equally important in ensuring businesses short term as well as long term survival.
How to apply FRS1 ?
Small Company
Small companies preparing its financial statements in accordance with Financial Reporting Standards for Smaller Entities (FRSSE) are exempted from the requirement to prepare cash flow statement.
A company is classified as small when its meet two out of three of the following criterias:
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Its turnover is less than £5.6 million.
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Its gross assets is less than £ 2.8 million.
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Its employees is less than 50.
Medium/Large Companies
Companies that classified as not small are required to include cash flow statements in its financial statements.
Group Account
A subsiadiary of a group is exempted to prepare cash flow statement under FRS1 if its parent company is preparing the consolidated cash flow statement. This fact has to be disclosed in the notes to the financial statements of the subsidiary accounts with the ultimate controlling parent company also disclosed in the notes together with address of where the investors could obtain the consolidated accounts.
