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As part of its Disclosure Initiative, the IASB is proposing amendments to IAS 7 Statement of Cash Flows that will provide users with information to help them better understand how companies generate and deploy resources. Although the additional disclosure requirements are modest, the proposed changes represent a significant enhancement to financial reporting that many users have championed for a number of years.
The health of a business, small or large, is vitally dependent on cash flow. Ultimately, it is cash that pays the operating costs such as wages and suppliers as well as the debt and equity that funds investment for growth and provides returns to shareholders in the form or dividends. Investors often focus on the cash dynamics of individual businesses. Is the company consuming or generating cash and is it able to meet its obligations from this cash flow? How is free cash being deployed and what is the cash return on cash invested? These are key considerations for many users of financial statements.
While the cash flow statement is the obvious place to start the analysis of cash flows, it is important to recognise that not all of the investments that a company may make are reflected here.
Many preparers recognise that current cash flow disclosures paint an incomplete picture. They appreciate the need for investors and analysts to have a better understanding of the economics of their business and thus voluntarily supplement the customary summary cash flow information. They also provide a reconciliation of net debt from the end of one accounting period to the end of the subsequent period. The net debt reconciliation captures items such as acquired debt and the inception of finance leases, as well as any fair value adjustments made to debt and the impact of foreign exchange movements. With this information, investors are presented with a more comprehensive and ‘true and fair’ view of the performance and financial position, and hence risk, of their business.
For a number of years, investors and analysts have been asking standard-setters to include a requirement for all companies to provide a net debt reconciliation. While the proposed amendment to IAS 7 does not include a net debt reconciliation, it will ensure that users have the necessary information to undertake a net debt reconciliation themselves. One of the challenges that the IASB has faced is that there is no definition of net debt in IFRS. Instead, the proposed changes will require companies to reconcile the movement in debt from one period to another. Combining this with the existing information from the cash flow statement will facilitate a net debt reconciliation.