Your Borrowers' Statement of Cash Flows: FASB Proposal Clarifies Its Guidance

A new proposal by the Financial Accounting Standards Board (FASB) would clarify several parts of its guidance on company cash flow statements. The move could take some of the guesswork out of your business customers’ financial statement preparation as well as reduce their number of restatements.

Accounting Standards Update (ASU) No. EITF-15F, Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments, issued January 29, 2016, is the first of two planned proposals regarding cash flow statements. A second proposal, also to be discussed this year, will clarify how to classify and present changes in restricted cash on the statement of cash flows.

According to the FASB, company reporting errors about cash flow reporting have been among the top causes of financial restatements. The standards board hasn’t said when they expect the new guidance, if finalized, to take effect. 

Lenders should be aware

As a lender, you should understand how the statement of cash flows works, where potential missteps are likely to take place, and how the proposal, if approved, would affect the picture of cash flows that your borrowers are painting. The statement can provide valuable insights into their ability to repay loans.

The statement comprises three sections 

The statement of cash flows customarily shows the sources and uses of cash and its equivalents. Under Generally Accepted Accounting Principles, it’s typically organized into three sections. 

The first section — cash flows from operations — starts with accrual-basis net income. Then it’s adjusted for items related to normal business operations, such as gains (or losses) on asset sales, depreciation and amortization, income taxes and net changes in accounts receivable, inventory, prepaid assets, accrued expenses and payables. The end result is cash-basis net income, which is the cash provided (or used) in the process of producing and delivering goods or providing services. Beware of borrowers with several successive years of negative operating cash flows.

If a company buys or sells property, equipment or marketable securities, the transaction shows up in the second section: cash flows from investing activities. It reveals whether a borrower is reinvesting in its future operations — or divesting assets for emergency funds.

The third section describes cash flows from financing activities. This section shows the company’s ability to obtain cash via either debt from lenders or equity from investors. It includes new loan proceeds, principal repayments, dividends paid, issuances of securities or bonds, and additional capital contributions by owners. 

Capital leases and noncash transactions are reported in a separate schedule at the bottom of the statement of cash flows or in a narrative footnote disclosure. 

Classification decisions can be confusing

Guidance on classification decisions is provided by Statement of Financial Accounting Standards No. 95, Statement of Cash Flows (Topic 230). Although this statement was issued in 1987, classification among operating, investing, and financing activities remains a gray area. 

Bank personnel have been especially confused about how to classify transactions that have aspects of more than one type of activity, such as taxes paid on investment gains, redemptions of employee stock options, sales of receivables, and dividends received from investments, installment sales and purchases. Sometimes it’s unclear from the guidance whether the cash flow should be split into two activities or allocated to one specific activity. External accounting advisors can provide guidance when borrowers are uncertain.

Gray areas addressed

The FASB proposal covers eight areas, including debt prepayment or debt extinguishment costs, the cash payment attributable to accreted interest on zero-coupon bonds and the proceeds businesses receive from corporate-owned life insurance. The proposal also addresses one of the most complicated parts of cash flow presentation, which is a concept that accountants call the “predominance principle.” To see the full proposal, click here.

Stay current

Lenders need to keep informed about requirements for preparing the statement of cash flows. Your being up to date on the matter will improve your due diligence efforts when you evaluate borrowers. 

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