11/25/2014

CAclubindiaNews:Cashflowstatementanditsusefulness

Cashflowstatementanditsusefulness
MANU

VINU

CONVERSATIONBETWEEN
MANUANDVINUABOUT
CASHFLOWSTATMENTANDITS
USEFULNESS

Manu
Vinu
Manu
Vinu
Manu

HiVinu!Howareyou?
FineManu!
HowisyourFinancialAnalysisJobgoingon?
Manu,nowIamintheprocessofanalysingFinancialStatementsofaparticular
customer.HisFinancialsvisavizrealityistakingmeforaride!
Why?Whatstheproblem?
HeisshowinggoodprogressinhisbusinesswithGrowthinSalesandProfits.But
thatsonpapers.
Inreality,

Hedoesnthavesufficientfundstomeethisexpenses.

Vinu

HecouldntserviceBankLoansontime.
Manyofhischequesissuedtosuppliersgetbounced.
Hepayssalarytohisemployeeswithgreatdelay.

Manu
Vinu
Manu
Vinu
Manu
Vinu

Howallthesecanhappenifheismakingsomuchprofit?Ihaveadoubtwhether
heisgivingbogusfinancialreport?
Vinu!Idontknowwhattheexactbackgroundofyourcustomeris.ButonethingI
cantellyou!Itisnotnecessarythatheshouldhavecashtomeethisexpenses/
requirements,sincebecauseheismakingprofit.
Thatsoundsstrange!!!!
Butthatsthereality!Profitisnotcash!
Comeonyaar!Whatareyoutalking?
TrueVinu!Profitsarenotcashandregisteritinyourmindstrongly!
Ok!Iunderstandthatifyousaysomething,itwouldbewithlogic.Buttellmethat
logic!

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CAclubindiaNews:Cashflowstatementanditsusefulness

Ok.Answerthissimplequestion:
LetssayyouhavethefollowingProfitandLossStatement:

Manu

Rs.InCrs
Sales
Less:
RawMaterialConsumed
LabourCost
PowerandFuel
Depreciation

100.00

(60.00)
(10.00)
(5.00)
(5.00)

Whatshouldbeprofit?
Salesis100.00Crs

Vinu

expensesare80.00Crs

Manu

Vinu

Soprofitsshouldbe20.00Crs.
Fine!Withthislimitedinformation,tellmewhatcouldbethecashbalance?
Sales100.00Crs
Expenses80.00Crs

SoCashBalanceshouldalsobe20.00Crs
Thisisyourmistake!
DontyourememberFinancialsarepreparedfollowingaccrualconceptwherein

Manu

Expenseswillbeaccountedwhenaccrued,whetheritispaidornot

Vinu
Manu
Vinu
Manu

Incomewillberecognisedwhetheritisreceivedornot.
Yes.Agreed.Butherewedonthaveanysuchitemoryouhavenottoldme
anythingaboutthat!
True!Butyoualsodidntnoticetheeffectofdepreciation.Whetherdepreciation
hascashoutflow?
No!Itisonlybookentrytoaccountforfixedassetsbychargingagainstprofits
overtheperiodofitslife.
Sowhatcouldbetheprofitbeforedepreciation?
Itmaybe

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Vinu

Manu
Vinu
Manu
Vinu
Manu
Vinu
Manu
Vinu
Manu

Vinu

Manu
Vinu
Manu
Vinu
Manu
Vinu
Manu

Vinu
Manu

Vinu

Manu

CAclubindiaNews:Cashflowstatementanditsusefulness

Profit
Add:Depreciation
Profitbefore
Depreciation

20.00
5.00
25.00

Ya!ThatscorrectandthatprofitcanbecalledasCashProfit!
Oh!Isthisthecashbalance?
Dontjumpforconclusion.AgainIamrepeating!Profitisnotcash!
Ok!Ok!
Doyouthinkallthesalescanbemadeforcash?
No!Inordertobecompetitiveandattractnewcustomers,creditshouldbegiven!
Correct!Letssay,75%ofsalesareoncredit!
Theninthatcase,100Crsx75%=75Crsshouldbecreditsales.
So,whatisyourCashSales?
TotalSales
100.00
Less:CreditSales
75.00
CashSales
25.00

Whenyougivecredit,youcanalsogetcredit!Isitnot?
Sure!
Butithappensinmarketthatyougivemorecredittoattractcustomersbutyou
receiveonlylesscreditfromyoursuppliers!Because,supplierswouldbegenerally
bigplayersandtheygobyfixednorms!Yourotherexpenseswouldbebasically
power,labour,andotheroperatingexpenseswhereyoucannothavemuchcredit.
True!
Soletusassume,50%ofyourexpensesareoncredit.
MytotalexpensesareRs.80Crs.So50%ofitis................
Stop!Dontconsiderallexpenses.Itincludesdepreciationalsowhichisanoncash
item.
Correct!TotalexpensesareRs.75Cr(excludingdepreciationof5Crs).

50%of75CrsisRs.37.50Crs
So,whatisyourCashPayments?
TotalExpenses
Less:Creditavailableforexpenses
(50%)
CashExpenses

75.00
37.50
37.50

NowyouhavebothyourCashExpensesandCashSales.Canyoupreparea
Comparisontable?
Ya!Icandothat.

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CAclubindiaNews:Cashflowstatementanditsusefulness

Particulars

Vinu

AsperP&L
Account
Sales
100.00
Less:

RawMaterialConsumed (60.00)
LabourCost
(10.00)
PowerandFuel
(5.00)
Depreciation
(5.00)

ActualCashFlow
+25.00

37.50
NoCashFlow

Lookatthetable!

YoumadesalesofRs.100CrswhereasyoureceivedonlyRs.25Crs.
Manu

Youhaveincurredexpensesof75Crs(excludingdepreciation)whereasyoupaid
only37.50Crs.

Sowhatisyourcashbalance?
Cashbalance?

Vinu

a)CashSales
b)Less:CashExpenses
c)Shortage(ab)

25.00
(37.50)
12.50

Manu
Vinu

Manu

Vinu

Idonthavecashbalance!!!!!!
ButyouhadprofitofRs.20Crs!
Haha!Iamcaught!NowIunderstandprofithasnorelevancetocashbalanceor
cashgeneration!!!
No!Modifythatstatement!

Profithasrelevancebutitalonedoesnotdecidecashbalanceorsaycash
generation!
Ok!Inthiscase,howcomecashbalancecanbenegative?
ItisNegative12.50Cr.
DontsayNegative12.50Cr.

Cashcanneverbenegativefigure.

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11/25/2014

Manu

CAclubindiaNews:Cashflowstatementanditsusefulness

WhathappenedtoyouisyourealisedRs.25CrsfromcashsalesandPAIDcash
expensesofRs.37.50Crs.

Vinu

Youcannotpay37.50Crswithoutcashwithyou.YesorNo?
Yes!Icannotpay37.50Crswithoutcashwithme.ButhowIgot37.50?
Yougenerated25Crs.

Manu

YouhadshortageofRs.12.50Cr

Vinu
Manu

Youshouldhavemanagedthatshortagewithsomeothersources!
Someothersources??Howcome?
Commonyaar!Doyouthink,cashisgeneratedorbroughtintothebusinessonly
throughsales?Therearevariousotherwaysformobilisingcashforthebusiness.
Correct!
Cashcanbebroughtintothebusinessthrough

Vinu

a.RaisingCapital
b.RaisingLongTermLoans
c.RaisingShortTermLoans
d.SellingAssets

Manu
Vinu
Manu
Vinu
Manu

Vinu

e.SellingInvestments.
Good!
WhatwasyourShortagefromOperations?
ItwasRs.12.50Cr
Nowletusassume,youhavefundedthisshortagebybringingincapitalofRs.25
Crs
Rs.25Crs???
Yes!Nowarriveatyourcashposition
Itis
a)CashSales
b)Less:CashExpenses
c)Shortage(ab)
d)Add:FreshCapital
e)Surplus

25.00
37.50
12.50
25.00
12.50

IhavesurplusofRs.12.50.
Correct!NowalsoassumeyoupurchasePlantandMachineryforRs.20Crsand
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Manu

CAclubindiaNews:Cashflowstatementanditsusefulness

workoutyourcashposition.
Itshouldbe

Vinu

Manu

Vinu

Manu

a)CashSales
b)Less:CashExpenses
c)Shortage(ab)
d)Add:FreshCapital
e)Surplus
f)Less:Purchaseof
P&M
g)Shortage

25.00
37.50
12.50
25.00
12.50
20.00
7.50

AgainIamlandinginshortage.
Dontworry!RaiseloanforRs.7.50Crsandworkoutyourcashposition.
a)CashSales
25.00
b)Less:CashExpenses 37.50
c)Shortage(ab)
12.50
d)Add:FreshCapital
25.00
e)Surplus
12.50
f)Less:PurchaseofP&M 20.00
g)Shortage
7.50
h)BankLoan
7.50
i)CashBalance

Didyounoticed,yourbalanceisNilnow.
Yes!Nowiunderstand.

Ihadshortageof12.50CrfromOperations.

Butthatwassupportedoutoffreshcapitalof25Crs.

Vinu

Withthebalancemoneyavailable(2512.50=12.50),IwentforpurchasingPlant
andMachinery20Crs.

AgainIfacedshortageofRs.7.50Crs.

So,IhadtofinancetheshortagethroughBankLoanofRs.7.50Crs
Correct!

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CAclubindiaNews:Cashflowstatementanditsusefulness

Manu

ThecashyougeneratedfromrunningoroperatingyourbusinessiscalledasCash
GeneratedfromOperatingActivity.Inyourcase,itisdeficitofRs.12.50Cr.

Vinu

True!
ToSupportcashdeficitinoperationsandalsotosupportpurchaseofplantand
machinery,youraisedfinancefromtwosources

Manu

Capital25Crs
Loan7.50Crs

Vinu
Manu
Vinu
Manu

Vinu

Manu

TheyareCashGeneratedfromFinancingActivity
Correct!
YouhaveinvestedRs.20CrsinpurchaseofP&M.
SoyouhavenotgeneratedanycashfromInvestmentActivitybutratherconsumed
cash.
Correct!
Canyoucaptureallthesecashflowsasperactivities
CashFlowfromOperatingActivity
12.50
CashFlowfromInvestingActivity
20.00
CashFlowfromFinancingActivity
32.50

Good!ThisisyouabridgedCashFlowStatement.Ittellsthat,youhavemobilised
32.50Crsandhaveused20CrsforInvestingActivityand12.50CrsforOperating
Activity.

Vinu

Nowyouwillappreciatewhythecompaniescansufferdespitemakingprofits.
Yes!Inthiscase,thoughIhavemadeprofitbuthavenotgeneratedcash.Iwas
functioningonlywiththesupportofcapitalfundsprovidedbyfinancingactivity.
ApartfromthatIalsousedallthebalancecapitalfundsforacquiringPlantand
MachineryalongwithBankLoan.
Correct!Nowyouaregettingthepulseofit.

Manu

Vinu
Manu

Vinu

ThisisthepurposeofpreparingCashFlowStatement.Itwouldgivemuch
informationwhichP&LandBalanceSheetwillnotgiveonthefaceofreading.
ThatswhyCashFlowStatementanditsAnalysisaregivenhighimportanceby
Investorsandallstakeholders.
So,howidealCashFlowshouldbe?
Intheinitialperiod,cashcanbeprovidedbyFinancingActivitytoOperating
ActivityandInvestmentActivity.Butgradually,thecashflowfromOperating
Activityshouldbecomepositiveanditshouldprovideforrepayingfinancingcash
flowsandalsosupportInvestmentactivities.
Ya!Cashflowfromoperatingactivityshouldbepositiveanditindicatesthevery
purposeofrunninganybusiness.Ifthiscashflowispositive,wewillhavesource

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Manu
Vinu
Manu
Vinu

CAclubindiaNews:Cashflowstatementanditsusefulness

forfundinginvestmentandfinancingactivities.
Correct!
ButManu,thecashflowstatementswhichIhaveseenarelengthyinnature.It
wouldnotbeliketheonewhichwehavediscussed.
Wehavediscussedthecashflowwhichcanbepreparedunderdirectmethod.But
whatweseeinIndustrywouldbecashflowpreparedinIndirectMethod.
Whatwasthat?
ThosecashflowstatementsarepreparedfromtheinformationavailableinProfit
andLossStatementandBalanceSheetinIndirectWay.

Manu

ProfitandLossStatementwillbeperusedtofindoutthecashprofits.

Vinu

ProfitsreportedinP&LStatementarecomputedusingaccrualandmatching
concept.So,thatprofitisafterprovidingforvariousnoncashitems.
NonCashitemslike?
NonCashItemslike

Manu

a.CreditSales
b.CreditPurchases
c.OutstandingExpenses

Vinu
Manu

d.AccruedIncomes
Correct!
TheseitemswillalsohavepresenceinBalanceSheetintheformofcurrentassets
andcurrentliabilitiesinvariousnames.Somovementofthoseitemswillalsobe
providedinCashFlowStatementtoknowtheexactcashgeneratedfromoperating
activity.
Ya!Inourexample

SaleswereRs.100Crs.whereasDebtorscreatedoutofSalesis75Crs.

Vinu

Ourprofitis20Crs,NoNo...Cashprofitis25Crsbutitiscalculatedbasedon
TotalSales(cash&credit)andsoitwillnotreflectcashgeneration.

SowehavetodeductnoncashsalesfromCashProfitswhichisintheformof
Debtors75Crs.Isthatright?
Youareright!

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CAclubindiaNews:Cashflowstatementanditsusefulness

Manu

Bydeductingincreaseincurrentasset(inourcase,debtors)fromcashprofits,we
arecommunicatingtothereaders,thatthoughourcompanyhasearnedcashprofit
ofRs.25CrsfromSalesofRs.100Crs,pleasebearinmindwehavenotrealised75
CrsworthofDebtors.Sowearedeductingit!!!

Vinu

Verytrue!
Inthesameway,ifwecarrycreditors,orsay,creditorsincreases,thentothat
extentthereisnocashoutflow.So,thatwillbeaddedwithcashprofitsto
communicatetothereaders,cashpositionismorethanthecashprofits!
Correct!Inourcase,cashprofitisRs.25Crs.Wealsohaveunpaidexpenses
(creditors)ofRs.37.50Crs.Sothisshouldbeaddedtocashprofits!
Youareright!Canyoutabulatecashgeneratedfromyouroperatingactivitybased
onourdiscussion?
Ya!

Manu
Vinu
Manu

Vinu

Profit
Add:Depreciation
Less:IncreaseinCurrentAssets(Debtors)
Add:IncreaseinCurrentLiabilities
(Creditors)
NetCashfromOperatingActivities

20.00
5.00
(75.00)
37.50
(12.50)

Isitcorrect?
VeryMuch!
Manu

Vinu

Alsorememberyouwillseesomemoreadditionsandsubtractionsinrealcash
flowstatements.
Like?
Additionsfor

InterestExpenses
LossonSaleofAsset

Manu

Deductionsfor

InterestIncome
DividendIncome

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CAclubindiaNews:Cashflowstatementanditsusefulness

ProfitonSaleofAsset
Vinu

Whentheseitemsobviouslydecidetheprofits,wheytheseshouldbeaddedbackor
deducted?
Iagreethattheydecidedprofits!

Buttheyarenotoutofoperationalactivitiesofthebusiness.

Manu

Incashflowfromoperatingactivity,focusisonfindingcashgeneratedfrom
operatingactivity.

Soanyactivity,whichisnotpartofoperatingactivity,butalreadyincludedin
profitswillberemovedbyeitheraddingbackordeducting!
Ok!
Letmeunderstandthat!

Vinu

InterestispaidonFinancingSourceSoitisaFinancingActivity.Butitis
alreadyconsideredasexpenseforarrivingatprofit.So,weremovethisinterestby
addingback!Isthatright?
Correct!

Manu

Vinu

Manu

Vinu

Manu
Vinu

Loss/ProfitonSaleofAssetareresultofInvestingActivity!Soweremovethem
fromprofitseitherbyadding/deductingunderCashFlowfromOperating
Activities.
True!
Dividend/InterestincomearealsopartofInvestingActivity!Soweshould
removethemfromprofitsbydeductingunderCashFlowfromOperating
Activities.
Soremember,whenyoudothisadjustment(adding/deducting)underOperating
Activity,youaredoingit,becauseyouwanttoshowthemunderrespective
activity!
Ya!
InterestaddedbackinOperatingActivityshouldbeshownasdeductionin
FinancingActivity.

Dividend/InterestIncomedeductedinOperatingActivityshouldbeshownas
additioninInvestingActivity.
VeryGood!SonowyouknowhowtoprepareCashFlowStatementtoo!
HowabouttheotheractivitiesManu?

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CAclubindiaNews:Cashflowstatementanditsusefulness

Otheractivitiesdontinvolvemuchcomplication!Youhavetoensureonlycash
flowsarecapturedandnoncashitemsareignored.
Manu

Sometimesassetscanbepurchasedbyissueofsharesinsteadofcash.Thenin
thosecases,purchaseofassetwillnotfigureunderInvestmentactivity.
Understood!

Vinu

Whatwouldbetheeffect,ifacompanyissuesbonusshares?
Inthatcasealso,thereisnocashflow.

Manu

Vinu

BecauseofBonusIssue,theremaybeincreaseinShareCapitalbuttherewillnot
beanycashinflow.SothatwillnotfindplaceinCashFlowStatement!
Understood!Sothefocusisoncashinflowsandoutflowsandallnoncashitems
areknockedoff!
Exactly!

Manu

CashflowstatementisagreattoolforInvestors,Bankersandotherstakeholders!
Itwouldcommunicate,whetheryougeneratefundsfrombusinessoryouare
dependentonInvestmentandFinancingActivitiesforrunningyouroperations!
True!

Vinu

IfbusinessisrunwithsupportofcashinflowsfromInvestmentactivitiesit
indicatescompanyissellingitsassetstofunditsoperations!Soitwouldraise
seriousquestiononGoingConcernright?
Yes!

Manu

Similarly,ifcashflowsfromFinancingActivitiescontinuouslyincreasesto
supportoperatingactivity,itisalsonotahealthysignbecausecompanyis
dependentonotherfundstosupportitsoperationsanditwouldbecomedangerous
ifthecompanyistoodependentonborrowedfunds.
Ya!IthinksinglereadingofCashFlowStatementwouldgivecompletecashflow
movementofbusiness.
Absolutelyanditisveryimportantforanystakeholdertoreadcashflowstatement
beforeinvestingorlending,because

CASHISKING.

Manu

Vinu

Author:
CANRaja,B.Com.,PGDBA,ACA
CharteredAccountant
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CAclubindiaNews:Cashflowstatementanditsusefulness

EMail:nrajca@gmail.com
Web:www.concells.in/elearning

ToViewmyOnlinecourseonFinancialManagementforCAIPCC/CMAInterhostedin
CACLUBINDIA,usethefollowinglink:
http://www.caclubindia.com/coaching/232fmcrashcourseenglish.asp

Source:

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