Cash Flow Statement

Contents : 
  1. Meaning & Definitions of Cash Flow Statement.
  2. Objectives of Cash Flow Statement.
  3. Advantages and Disadvantages of Cash Flow Statement.
  4. Differences Between Cash Flow & Fund Flow Statement.
  5. Cash Flow Statement under Accounting Standard -3 (AS-3).
  6. Preparation and Format of Cash Flow Statement.
  7. Adjustments of Cash Flow Statement.
  8. Example with Solution of Cash Flow Statement.

What is Cash Flow Statement ?


"Cash" is a vital element of any business entity, as it plays a crucial role throughout the entire lifetime of a business enterprise. 'Cash' for a 'Business' has been aptly compared with the 'Blood' for a 'Human Body'. 'Cash' is required to meet day-to-day requirements for running the business and for making payments to 'Suppliers', 'Wages/Salaries to the Employees', 'Interest', 'Dividends', etc. Maintenance of an optimum level of cash is, therefore, of paramount importance for a business entity.

Definition of Cash Flow Statement :


According to Indian Accounting Standard (AS-3) :
Cash flow means inflows and outflows of cash and cash equivalents. Cash comprises of cash in hand and demand deposits with banks. Cash equivalents are short-term, highly liquid investments which are readily convertible into cash.

Cash Flow Statement' may be defined as a statement, which depicts the changes in financial position of a business organisation due to 'Inflows' and 'Outflows' of cash. Analysis of such 'Inflows' and 'Outflows' is necessitated for short-range business activities.

Objectives of Cash Flow Statement :


The fundamental objective behind the preparation of the 'Cash Flow Statement' is to underline and emphasis the changes that have taken place in the 'Cash Position' during a specific period. The sources from where the cash was procured by an organisation and the uses, to which it (the cash) was put, are elaborated in the cash flow statement.

Other objectives for preparing cash flow statement are discussed in the following points :

1) Showing the Inflows and Outflows (sources and applications) of cash into/out of the business during a specific period.

2) Disclosing the 'Positive' and 'Negative features of 'Cash Management' undertaken by the organisation.

3) Facilitating the policy formulation by the management in respect of certain financial matters such as Dividend Policy.

4) Ascertaining the Liquidity Position of the business organisation.

5) Finding out the net changes having taken place in respect of 'Cash' and 'Cash Equivalents'.

6) Studying the trend regarding 'Cash Receipts' and 'Cash Payments'.

7) Finding out the 'Deviation of Cash' from 'Earnings'.

8) Assessing the Financial Position of the business enterprise in a more realistic manner and forecasting the 'Cash Position'.


Advantages of Cash Flow Statement :


Preparation and analysis of cash flow statement have the following advantages :

1) It facilitates measurement of the business enterprise's ability to meet its fixed charges.

2) It is useful in bringing to the forefront the business enterprise's status with regard to its ‘Liquidity' and 'Solvency' during adverse conditions.

3) It is helpful in assessing the changes in 'Cash Position' between 'Profit & Loss Account' and 'Balance Sheet' items of two consecutive accounting periods.

4) Disclosures made by the 'Cash Flow Statement enables the management of a business enterprise to initiate preventive measures in financially difficult situations.

5) Identification of 'Discretionary Cash Flows' from business transactions becomes possible through 'Cash Flow Analysis'.

6) It facilitates listing out the 'Potential Financial Flows', which may be put to use during crisis conditions.

7) Cash Flow Statement reveals the information with regard to the availability of 'Cash'. Such information is very useful in deciding the quantum of 'Dividend' to be distributed to the shareholders or in extreme cases whether or not to skip a dividend payment altogether.

Disadvantages of Cash Flow Statement :


Cash flow statement is deficient in certain respects, some of which are as follows :

1) Non-Cash Transactions are Overlooked :
The entire focus of Cash Flow Statement is exclusively on the 'Inflows' and 'Outflows of cash. Non-Cash Transactions' like purchase of buildings by issuing shares/debentures to the vendors or issue of bonus shares are out of its purview.

2) Not a Substitute for an Income Statement : 
An 'Income Statement' of a business organisation covers both 'Cash' and 'Non-Cash' items and reveals the 'Net Income'. 'Cash Flow Statement, on the other hand, takes into consideration only 'Cash Flows' and as such can show only 'Net Cash Flows' inflows or outflows. It cannot disclose the 'Net Profit/Loss' of the organisation.

3) Limited Use : 
'Cash Flow Statement' has very limited use in isolation. Only when it is accompanied by other 'Financial Statements' like 'Balance Sheet' and 'Profit & Loss Account', it provides some meaningful and useful results.

4) Historical in Nature : 
Preparation of 'Cash Flow Statement' involves rearranging other Financial Statements, viz. 'Balance Sheet' and 'Profit & Loss Account, which contain past data and are historical in nature. It would have been more useful and prospective in nature, when accompanied with 'Projected Cash Flow Statement'.

5) Ignoring the Accrual Concept :
Accrual concept, one of the basic accounting concepts, is totally ignored while preparing cash flow statement.

Difference Between Cash Flow and Fund Flow Statement :

Basis of Difference

Fund Flow Statement

Cash Flow Statement

Nature of Statement

It states the changes in working capital.

It states the changes in cash position.

Object

 

The objective of preparing fund Flow Statement is to gather information with regard to an enterprise ability to meet its long term liabilities.

The objective of preparing cash flow statement is to gather information with regard to an enterprise ability to meet its short term liabilities.

Opening Balance

 

There is opening balance of cash in hand in the preparation of fund flow statement.

It is prepared with opening balance of cash in hand.

Period

 

Preparation of fund flow statement is for a longer period.

Preparation of cash flow statement is for a shorter period.

Planning

 

Fund flow statement facilitates long term planning of an enterprise.

Cash flow statement facilitates short term planning of the enterprise.

Dependence 

 

Funds Flow Statement can be prepared with the help of cash flow statement.

 

 

Cash flow statement can't be prepared with the help of fund flow statement only. In addition to the funds flow statement the schedule of changes in working capital is also required for the preparation of cash flow statement.

Additional Statement 

Preparation of fund flow statement is necessary followed by the preparation of an additional statement, viz. schedule of changes in working capital.

Preparation of cash flow statement is not followed by the preparation of any additional statement.

 

Difference of Sides

Difference between both the sides of fund flow statement is either in increase or decrease in working capital.

Difference between both the sides of cash flow statement is the closing balance of cash.

 

Cash Flow Statement (AS-3) :


The Accounting Standard-3 (AS-3), relating to the 'Cash Flow Analysis', issued by the 'Institute of Chartered Accountants of India' (ICAI) earlier was revised in the year 1997. Further, in terms of the instructions issued by the Securities and Exchange Board of India (SEBI), listed companies are required to furnish a copy of 'Cash Flow Analysis' prepared by it, along with a copy of its 'Final Accounts'.

Before undertaking 'Cash Flow Analysis', a business organisation may categorise its activities into following three groups :
1) Operating activities.
2) Investing activities.
3) Financing activities.

Cash is generated from the operations of a business enterprise through ‘any one' or a 'combination of more than one of the above activities, depending upon the nature of its core business. Categorisation of activities enables an analyst to have more precise information with regard to the impact of those activities on the position of 'Cash/Cash Equivalent of the enterprise. Such classified information may also be useful during the evaluation of inter-relationship between different categories of activities. Sometimes a single transaction may involve 'Cash Flows' from different activities. For example, when a fixed asset is purchased on 'Deferred Payment Basis', the installment payment includes both the ‘Principal amount and the amount of Interest Accrued' on that principal amount. While the interest payment is categorised as 'Financing Activity', the payment of principal is categorised as 'Investing Activity'.

1) Operating Activities :

'Cash Flow' from the Operating Activities' forms the major position of the 'Total Cash Flows' and its source is from the core Income Generating Activity of the enterprise. The amount of 'Cash Flows' generated out of the 'Operating Activities' is also an important indicator of the enterprise's 'Operational Efficiency and its ability to pay dividends, repay loans, and make investments in new projects without looking for to any external resource of finance. Information with regard to the level of 'Cash Flows' from a specific category may be very useful, along with certain other information, in predicting future 'Operating Cash Flows'.

Examples of Cash Flows Arising from Operating Activities :
  1. Cast received from the sale of goods and services.
  2. Cash receive as 'Fees', Commission' and 'Royalties' etc.
  3. Cash paid to the suppliers for goods and services.
  4. Cash paid to and receive from an Insurance company in connection with premium, claims, annuities and other policy benefits.
  5. Cash paid to and on behalf of employees.
  6. Cash relating to the refund of 'Income Tax' (provided they are classified either as 'Investing Activities' or 'Financing Activities').
  7. Cash transactions of the contracts pertaining to the Futures, Forwards, Options and Swaps provided such contracts/derivatives are kept in the books for trading purposes.

2) Investing Activities :

The details of 'Cash Flows' generated out of 'Investing Activities' need to be revealed separately. This is significant in view of the fact that such 'Cash Flows' symbolise the degree of the expenditure incurred for resources meant to generate income and cash flows in the future.

Examples of Cash Flows Arising from Investing Activities :
  1. Cash payments made for the acquisition of 'Fixed Assets' (including those which are intangible in nature). Further cash payments made in connection with the 'Capitalised Research and Development Costs' and 'Self-Constructed Fixed Assets' are also considered as Cash Flows' arising from 'Investing Activities.
  2. Cash proceeds received from disposal of fixed asset (including those which are intangible in nature).
  3. Cash paid for the purchase of shares, Debentures, Warrants and other such instruments of other companies and interest in joint venture. However, cash payment for the purpose of instrument which are : i) Cash and cash equivalents. ii) Held for trading purpose, are excluded.
  4. Cash received from the sale of Shares, Debentures, Warrants and other such instruments of other companies and interest in joint venture. However, cash received for the purpose of instrument which are : i) Cash and cash equivalents. ii) Held for trading purpose, are excluded.
  5. Cash loans and advances extended to third parties (other than cash loans and advances extended by a financing company).
  6. Cash received as the repayment of loans and advances extended to third parties (other than cash received as the repayment of loans and advances extended by a financing company).
  7. Cash paid for the contracts relating to 'Futures', 'Forwards', 'Options', and 'Swaps', except when such contracts are held for trading purposes, or the transaction is categorised as 'Financing Activities'.
  8. Cash received for the contracts relating to 'Futures', 'Forwards', 'Options', and 'Swaps', except when such contracts are held for trading purposes, or the transaction is categorised as 'Financing Activities'.
Note : When a contract is accounted for as 'Hedge', the 'Cash Flows' of the contract are categorised in the same way as the 'Cash Flows' of the position being hedged.


3) Financing Activities :

'Cash Flows' generated out of 'Financing Activities' are required to be shown separately, as it facilitates forecasting of claims on future 'Cash Flows' by the fund providers (both 'Long Term as well as 'Short Term') to the enterprise.

Examples of Cash Flows Arising from Financing Activities :
  1. Cash proceeds of "Share Issue" and other such instruments.
  2. Cash proceeds of 'Debenture Issue' and other debt instruments like 'Bonds', 'Loans', 'Notes' and other borrowings (both 'Short Term' and 'Long Term').
  3. Repayment of the borrowed funds in cash.

Preparation of Cash Flow Statements :


Cash flow statement may be prepared by either of the two methods mentioned below :

1) Preparation of 'Cash Flow Statement' under "Traditional Method" :
The 'Traditional Method' is a simple and basic procedure of preparing Cash Flow Statement. This method does not have any standard format to be adopted and 'Inflows' and 'Outflows' are not categorised as 'Operating Activities', 'Investment Activities', and 'Financing Activities' separately.

2) Preparation of "Cash Flow Statement' under AS-3 :
The fundamental difference between preparation of "Cash Flow Statement' under AS-3 and the one under "Traditional Method' is the reporting and presentation of the statement. There are two methods of reporting 'Cash Flows' from the operating activities point of view :
i) Direct Method.
ii) Indirect Method.

Indirect Method :

Under the indirect method, instead of taking individual items of 'Profit & Loss Account' as the basis for calculating 'Cash from Operations', "Net Profit' is taken as the base, which is subject to various adjustments as follows :

1) Transactions relating to 'Non-cash Items such as Depreciation, Goodwill, Preliminary Expenses etc.

2) Changes having taken place in Inventories, Operating Receivables and Payables during the period.

3) Other remaining transactions, which have an impact on cash and are included in "Financing and Investing' activities'. For example, Loss or Gain on Sale of Fixed Assets', Loss or Gain on Sale of Investments', etc.

Listed companies have, however, no choice of preparing Cash Flow Statement under Indirect Method. 
As prescribed under AS-3, they are required to prepare and report Cash Flow Statement under the "Direct Method" only.

Format of Cash Flow Statement Preparation (Indirect Method) :


Cash Flow Statement
(for the period ended 31st March.....)

Particulars

Rs.

Cash Flows from Operating Activities

Net Profit as per P&L A/c

Add: Non-Operating Items:

Depreciation on Building

Depreciation on Machinery

Depreciation on Machinery sold

Increase in Provision for doubtful debts

Dividend paid

Transfer to Reserves

Goodwill written off

Preliminary Expenses written-off

Other tangible assets written-off

Loss on sale or disposable of fixed

assets

Less: Profit on sale of investment

Profit on sale of machinery

Operating Profit before Working Capital

Changes

Add: Increase in Current liabilities

Decrease in Current assets

Less: Increase in Current assets

Decrease in Current liabilities

Cash Generated from Operating Activities

Less: Income tax Paid

Net Cash Flows from Operating Activities

(A)

Cash Flows from Investing Activities:

Add: Sale of Investments

Sale of Machine

Less: Purchase of Buildings

Less: Purchase of Machinery

Net Cash Flows from Investing Activities (B)

Cash Flows from Financing Activities:

Add: Issue of Share

Add: Issue of Debenture

Less: Redemption of Debentures

Less: Interim Dividend Paid

Less: Dividend Paid

Net Cash Flows from Financing Activities (C)

Net Increase/Decrease in Cash & Cash

Equivalents (A + B+C)

Cash& Cash Equivalents at the Beginning of the Year

Cash &Cash Equivalents at End of the Year

 

Note : In order to judge the accuracy of cash flow statement (indirect method) one  has to examine that net increase/decrease in cash & cash equivalents (A+B+C) and cash & cash equivalents at the beginning of the year must be equal to cash & cash equivalents at end of the year. This can be written as,

Cash & Cash Equivalents at the, end of the year = Net Increase/Decrease in Cash & Cash Equivalents + Cash & Cash Equivalents at the beginning of the year.

Adjustment of Typical Items :


Various adjustments of typical items are as follows :

1) During the preparation of Cash Flow Statement, the items like Depreciation, Dividends, Gain on Sale of Assets etc. are treated in the same way as they are suggested to be treated while preparing the Funds Flow Statement.

2) Provision for Taxation is considered as a 'Non-current Item'.

3) The actual amount of "Tax Paid' during a year is reflected as 'Cash Outflow' in the Cash Flow Statement.

With a view to ascertain the amount of "Cash from Operations" the current amount held as 'Provision for Tax' is added back to the amount of Net Profit.

Example :

From the following balance sheets of Tarun Ltd., prepare the cash flow statement.


Liabilities

Rs.

Rs.

Assets

Rs.

Rs.

Equity Share Capital

12% Preference Share Capital

General Reserve

P & L A/C

Creditors

2,00,000

 

50,000

 

35,000

15,000

23,000

2,50,000

 

40,000

 

55,000

17,000

5000

Goodwill

Building

Plant

Debtors

Stock

Cash

30,000

1,00,000

40,000

1,20,000

18,000

15,000

20,000

80,000

70,000

1,60,000

20,000

17,000

3,23,000

3,67,000

3,23,000

3,67,000

Adjustments :
i) Depreciation charged on Plant was Rs.30,000.
ii) Depreciation charged on building was Rs.250,000.

Solution :

                 Cash Flow Statement

                   (for the period ended 2016)

Particulars

Rs.

Cash Flows from Operating Activities:

Net Profit as per P&L AC 17,000 - 15,000)

Add: Non-Operating Items:

Depreciation on Plant                                      30,000    

Depreciation on Building                                50,000

Goodwill written-off                                       10,000

Transfer to General Reserve                           20,000

Operating Profit before Working Capital Changes

Less: Decrease in Creditors (18,000)

Increase in Debtors (40,000)

Increase in Stock (2,000)

Net Cash Flows from Operating Activities (A)

Cash Flows from Investing Activities:

Less: Purchase of Building (30,000)

Purchase of Plant (60,000)

Net Cash Flows from Investing activities (B)

Cash Flows from Financing Activities:

Add: Issue of shares (equity)                          50,000

Less: Redemption of preference shares        (10,000)

Net Cash Flows from Financing Activities (C)

Net increase in Cash & Cash Equivalents (A+B+C)

Cash & Cash Equivalents at the Beginning of the Year

Cash & Cash Equivalents at End of the Year

 

2,000

 

 

 

 

1,10,000

1,12,000

 

 

(60,000)

52,000

 

 

(90,000)

(38,000)

 

 

40,000

2,000

15,000

17,000