Financing activities section is the third and last section of the statement of cash flows that reports cash flows resulting from financing activities of a business. It generally involves flow of cash between the company and its sources of finance i.e., owners and creditors. Here, the creditors mean the creditors for non-trading liabilities such as bonds payable and long term loans etc. The payment made to creditors for purchase of raw materials or merchandise inventory is not reported in financing activities section. Such creditors are known as trade creditors and cash paid to them is included in the operating activities section of the statement of cash flows.
- Examples of financing activities
- Understanding cash and non-cash financing activities
- Treatment of interest on debt and dividend on stock
Examples of financing activities:
Some examples of cash flows from financing activities are listed below:
- Obtaining cash from common stockholders by issuing them the entity’s common stock,
- Obtaining cash from preferred stockholders by issuing them the preferred stock,
- Sale of treasury stock, if available,
- Issuance of bonds long term bonds payable,
- Payment of cash dividend to common stockholders,
- Payment of cash dividend to preferred stockholders,
- Purchase of treasury stock,
- Redemption of preferred stock,
- Redemption (repurchase) of bonds payable.
Understanding cash and non-cash financing activities:
Financing activities may or may not involve the use of cash; examples of financing activities that affect cash include issuing common or preferred stock for cash, issuing bonds for cash and obtaining loan from a financial institution etc. We only report those activities on the statement of cash flows that affect cash.
Those financing activities that have no impact on cash are known as ‘non-cash financing activities’ and these activities are disclosed in the foot notes under the caption ‘non-cash investing and financing activities’. Examples of non-cash financing activities include converting a debt to common stock, converting preferred stock to common stock and discharging a liability by issuing a note or a bond payable to the creditor.
Treatment of interest on debt and dividend on stock:
Companies pay interest on debt and dividend on common and preferred stock. Both the payments affect cash and therefore must be disclosed in the statement of cash flows. Under US GAAPs, any interest paid by the entity must be treated as cash outflow from operating activities and any dividend paid on both common and preferred stock must be treated as cash outflow from financing activities. Under IFRS, companies can, however, treat both the cash flows as either operating or financing cash flows. GAAPs, therefore, have more stringent guidelines in this regard.
Where a company chooses itself or is enforced to prepare its financial statements in accordance with IFRSs by a jurisdictional law, these cash flows must be disclosed on consistent basis from period to period. For example, if an entity, reporting under IFRSs, lists both dividend and interest paid in financing activities section, it should continue adopting this presentation in all subsequent years unless a change results in a better presentation or it is suggested by IFRSs itself or by some applicable law etc.
The format of financing activities section is usually much simpler and shorter than operating activities section. It is illustrated below:
The following information belongs to James and Peter Company:
- James and Peter earned a net income of $250,000 for the year 2013 and paid a cash dividend of $110,000 during the year.
- The decrease in bonds payable represents their redemption during the year 2013.
- Company issued all shares of common stock for cash.
Required: Calculate net cash flows from financing activities of James and Peter Company during the year 2013.
- 300,000 – 220,000
- 440,000 – 120,000
- 272,000 + 250,000 – 412,000