Companies are separate legal entities that can exist on their own. These entities are similar to other businesses since they operate similarly. However, they differ from other structures due to the separate legal entity feature. Through this, companies can transact without their owners’ involvement. Nevertheless, they may also face issues with being independent of their owners.
One advantage of being a separate legal entity is acquiring other companies. One company can purchase another to become the parent company. Consequently, the acquired company becomes a subsidiary or an associate. On top of that, companies can also buy other businesses and act like owners. Similarly, companies can sell those businesses for profit or loss.
Acquisitions and disposals of businesses are prevalent within most companies. Some companies make a substantial income from these transactions. On top of that, it allows them to expand their operations and cover more areas. Acquisitions and disposals of businesses can impact all the financial statements. However, this impact is not similar. The cash aspects of these transactions become a part of the cash flow statement.
Acquisitions and disposals can have a significant impact on the cash flow statement. Before discussing the effects of these transactions, it is crucial to understand the cash flow statement by itself.
What is the Cash Flow Statement?
The cash flow statement is one of the four crucial financial statements. This statement differs from the others as its reports on a company’s cash movements for a period. Usually, it categorizes that information under three headings. The cash flow statement is critical in helping investors understand the cash position. It is one of the reports that relates to liquidity.
The cash flow statement gets prepared along with the balance sheet and income statement. Usually, it goes last after companies report the other two statements. For companies, the cash flow statement may fall under two formats. These include indirect and direct methods. Companies mostly prefer to use the former as it has become a norm. It also promotes comparability with other companies.
Another name used for the cash flow statement is the statement of cash flows. It reports the cash spent and generated during a specific period. Like the income statement, the cash flow statement also covers a duration. Usually, companies use it to report their cash movements annually or quarterly. Some companies may also prepare the cash flow statement monthly. However, it usually occurs internally.
The cash flow statement focuses on cash movements. It differs from the other two primary financial statements as it does not follow the accrual concept. While this concept is crucial in accounting, reporting on cash flows is also substantial. On top of that, it also acts as a link between the income statement and the balance sheet. It details how money moves in and out of a company. Therefore, it can cover both of those statements.
Overall, the cash flow statement focuses on how cash moves in and out of a company. This movement is critical in allowing investors to understand how the company fares in its cash position. While the income statement focuses on profitability, the cash flow statement reports on the cash elements. For acquisitions and disposals, both statements cover different aspects of the transaction.
How do Acquisitions and Disposals of Business Affect the Cash Flow Statement?
Acquisitions and disposals of business affect the cash flow differently. The former occurs when a company invests in another company. Usually, these are a part of the plan to expand operations or increase profitability. Disposals, in contrast, are when a company sells a business. In essence, both transactions are the opposite of each other.
Both acquisitions and disposals fall under investing activities in the cash flow statement. When a company acquires a business, it is a part of its investment strategy. Similarly, disposals also fall under the same category. Usually, the decision to purchase or dispose of a business relates to how companies use their funds for investing. These transactions do not qualify as financing or operating activities.
A description of how acquisitions and disposals of business affect the cash flow statement is below.
Acquisitions of business
When a company acquire a business, it usually pays in cash. Therefore, acquisitions of a business affect the cash flow statement. However, this impact may not occur in some cases. Acquisition transactions don’t affect the income statement. These transactions do not carry a profit or loss during the initial period. Therefore, when a company purchases a business, it does not include it in the income statement.
As mentioned above, when a company acquire a business, it must pay compensation in exchange. Usually, this compensation is through cash or other monetary amounts. Since these amounts impact the cash and cash equivalent balances, they also affect the cash flow statement. The compensation paid to the sellers becomes a cash outflow in the cash flow statement. As stated above, it becomes a part of cash flows from investing activities.
Companies may also compensate the seller through other means. For example, some companies pay through stock issues. For those acquisitions, the amount won’t affect the cash flow statement. Instead, they will impact the balance sheet and the statement of changes in equity. Since these do not relate to cash and cash equivalent balances, they won’t fall under the cash flow statement.
Similarly, some companies may pay the seller in the future. These payments are also known as deferred payments. On top of that, these payments may have some criteria attached to them. For these payments, the cash flow statement won’t change at the transaction time. However, if the company pays the seller in cash in the future, it will affect the cash flow statement.
An example of how acquisitions of business affect the cash flow statement is below.
| Cash flows from investing activities | |
| Acquisition of business | (XXXX) |
| Other investing activities | XXXX / (XXXX) |
| Net cash flows from investing activities | XXXX / (XXXX) |
Disposal of business
A disposal is the opposite of an acquisition. These transactions involve a company receiving cash or other compensation from a buyer. Usually, it also results in profits or losses for the company. These items fall under the income statement. However, the cash flow statement does not consider them relevant for reporting. Since this statement covers cash items only, those aspects are irrelevant.
When a company disposes of a business, it receives compensation. Like acquisitions, this settlement may be in cash or through other means. Any cash receipt becomes a part of the cash flow statement. Other forms of compensation do not impact this statement. Similarly, any cash receipt falls under the cash flows from investing activities as an inflow.
Furthermore, companies may also receive deferred payments for disposals. The treatment for these transactions is similar to acquisitions. Companies can only record the cash receipt in the cash flow statement when it receives it. At the transaction time, any promises to pay in the future will not affect the cash flow statement. The same applies to contingent payments.
An example of how disposals of business affect the cash flow statement is below.
| Cash flows from investing activities | |
| Disposal of business | XXXX |
| Other investing activities | XXXX / (XXXX) |
| Net cash flows from investing activities | XXXX / (XXXX) |
Conclusion
Companies may acquire and dispose of other businesses as a part of their investment strategy. These transactions are prevalent for well-established companies. Acquisitions and disposals impact the cash flow statement. However, it only covers cash compensation. On top of that, any deferred payments affect the cash flow statement once received or paid.
