Module III - Cash Flow Statement

Meaning of Cash Flow Statement:

Cash Flow Statement deals with flow of cash which includes cash
equivalents as well as cash. This statement is additional
information to the users of Financial Statements. The statement
shows the incoming and outgoing of cash. The statement
assesses the capability of the enterprise to generate cash and
utilize it. Thus a Cash-Flow statement may be defined as a
summary of receipts and disbursements of cash for a particular
period of time.
It also explains reasons for the changes in cash position of the
firm. Cash flows are cash inflows and outflows. Transactions
which increase the cash position of the entity are called as inflows
of cash and those which decrease the cash position as outflows
of cash. Cash flow Statement traces the various sources which
bring in cash such as cash from operating activities, sale of
current and fixed assets, issue of share capital and debentures
etc. and applications which cause outflow of cash such as loss
from operations, purchase of current and fixed assets, redemption
of debentures, preference shares and other long-term debt for
cash. In short, a cash flow statement shows the cash receipts and
disbursements during a certain period.
It shows the various sources (i.e., inflows) and applications (i.e.,
outflows) of cash during a particular period and their net impact
on the cash balance.
According to Khan and Jain:“Cash Flow statements are
statements of changes in financial position prepared on the basis
of funds defined as cash or cash equivalents.”
The Institute of Cost and Works Accountants of India defines
Cash Flow statement as “a statement setting out the flow of cash
under distinct heads of sources of funds and their utilisation to
determine the requirements of cash during the given period and to
prepare for its adequate provision.”
Thus, a cash flow statement is a statement which provides a
detailed explanation for the changes in a firm’s cash balance
during a particular period by indicating the firm’s sources and
uses of cash and, ultimately, net impact on cash balance during
that period.
Cash and relevant terms
(a)Cash fund :Cash Fund includes Cash in hand, Demand
deposits with banks, and
cash equivalents.
(b) Cash equivalents: It includes short-term, highly liquid
investments, readily convertible into cash within three months and
which are subject to insignificant risk of changes in values. Some
examples of cash equivalents include Treasury Bills, Short-term Government
Bonds, Marketable Securities, Commercial Paper, Money Market Funds.

Features of Cash Flow Statement:

The features or characteristics of Cash Flow Statement may be
summarised in the following way:
i. It is a periodical statement as it covers a particular period of
time, say, month or year.
ii. It shows movement of cash in between two balance sheet
dates.
iii. It establishes the relationship between net profit and
changes in cash position of the firm.
iv. It does not involve matching of cost against revenue.
v. It is an indicator of cash earning capacity of the firm.
vi. It reflects clearly how financial position of a firm changes
over a period of time due to its operating activities, investing
activities and financing activities.
Objectives of Cash Flow Statement:
Cash Flow Statement is prepared to fulfill some objectives.Some
of the main objectives of Cash Flow Statement are:
i. It shows the cash earning capacity of the firm.
ii. It indicates different sources from which cash been collected
and various purposes for which cash has been utilised
during the year.
iii. It classifies cash flows during the period from operating,
investing and financing activities.
iv. It gives answers to various perplexing questions often
encountered by management, such as why the firm is unable
to pay dividend instead of making enough profit ? Why is
there huge idle cash balance in spite of loss suffered?
Where have the proceeds of sale of fixed assets gone? etc.
v. It helps the management in cash planning and control so
that there are no shortage or surplus of cash at any point of
time.
vi. It evaluates the ability of the firm to meet obligations such as
loan repayment, dividends, taxes etc.
Purpose & Importance of Cash Flow Statements
i. Statement of cash flows provides important insights about
the liquidity and solvency of a company which are vital for
survival and growth of any organization.
ii. It enables analysts to use the information about historic cash
flows for projections of future cash flows of an entity on
which to base their economic decisions.
iii. By summarizing key changes in financial position during a
period, cash flow statement serves to highlight priorities of
management.
iv. Comparison of cash flows of different entities helps reveal
the relative quality of their earnings since cash flow
information is more objective as opposed to the financial
performance reflected in income statement.

Advantages of Cash Flow Statement

i. Cash Flow Statements help in knowing the liquidity / actual
cash position of the company which funds flow and P&L are
unable to specify.
ii. As the liquidity position is known, any shortfalls can be
arranged for or excess can be used for the growth of the
business
iii. Any discrepancy in the financial reporting can be gauged
through the cash flow statement by comparing the cash
position of both.
iv. Cash is the basis of all financial operations. Therefore, a
projected cash flow statement will enable the management
to plan and control the financial operations properly.
v. Cash Flow analysis together with the ratio analysis helps
measure the profitability and financial position of business.
vi. Cash flow statement helps in internal financial management
as it is useful in formulation of financial plans.
Limitations of Cash Flow Statement:
Cash Flow Statement is, no doubt, an important tool of financial
analysis which discloses the complete story of cash management.
The increase in—or decrease of—cash and reasons thereof, can
be known, However, it has its own limitation.
These limitations are:
i. Since cash flow statement does not consider non-cash
items, it cannot reveal the actual net income of the business.
ii. Cash flow statement cannot replace fund flow statement or
income statement. Each of them has a separate function to
perform which cannot be done by the cash flow statement.
iii. The cash balance as disclosed by the projected cash flow
statement may not represent the real liquid position of the
 business since it can be easily influenced by the managerial
decisions, by making certain payments in advance or by
postponing payments.
iv. It is not helpful in measuring the economic efficiency in
certain cases e.g., public utility service where generally
heavy capital expenditure is involved.
v. Since it shows only cash position, it is not possible to know
actual profit and loss of the company by just looking at this
statement.
vi. In isolation this is of no use as it requires other financial
statements like balance sheet, profit and loss etc.,
CLASSIFICATION OF ACTIVITIES:
Cash flow activities are to be classified into three categories.
This is done to show separately the cash flows generated / used
by these activities, thereby helping to assess the impact of these
activities on the financial position and cash and cash equivalents
of an enterprise.
I. Operating activities
II. Investing activities
III. Financing activities
Cash from Operating Activities:
Operating activities are the activities that comprise of the primary /
main activities of an enterprise during an accounting period. For
example, for a garment manufacturing company, operating
activities include procurement of raw material, sale of garments,
incurrence of manufacturing expenses, etc. These are the
principal revenue generating activities of the enterprise.
Profit before tax as presented in the income statement could be
used as a starting point to calculate the cash flows from operating
activities.
Cash Inflows from operating activities:

 Cash receipts from sale of goods and rendering services.

 Cash receipts from fees, royalties, commissions and other

revenues.
Cash Outflows from operating activities:

 Cash payments to suppliers for goods and services.

 Cash payments of income taxes unless they can be

specifically identified with financing and investing activities.
Following adjustments are required to be made to the profit
before tax to arrive at the cash flow from operations:

 Elimination of non cash expenses (e.g. depreciation,

amortization, impairment losses, bad debts written off, etc)

 Removal of expenses to be classified elsewhere in the cash

flow statement (e.g. interest expense should be classified
under financing activities)

 Removal of income to be presented elsewhere in the cash

flow statement (e.g. dividend income and interest income
should be classified under investing activities unless in case
of for example an investment bank)
  Elimination of non cash income (e.g. gain on revaluation of
investments)
The amount of cash from operations indicates the internal
solvency level of the company. It is a key indicator of the extent to
which the operations of the enterprise have generated sufficient
cash flows to maintain its operating potential.
Cash from Investing Activities:
Cash flow from investing activities includes the movement in cash
flows owing to the purchase and sale of assets. It relates to
purchase and sale of long-term assets or fixed assets such as
machinery, furniture, land and building, etc.
Cash Outflows from investing activities

 Cash payments to acquire fixed assets including intangibles

and capitalized R&D.

 Cash advances and loans made to third party (other than

advances and loans made by a financial enterprise wherein
it is operating activities).

 Cash payments to acquire shares, warrants or debt

instruments of other enterprises other than the instruments
those held for trading purposes.
Cash Inflows from investing activities

 Cash receipt from disposal of fixed assets including

intangibles.

 Cash receipt from the repayment of advances or loans made

to third parties (except in case of financial enterprise).
  Dividend received from investments in other enterprises.

 Cash receipt from disposal of shares, warrants or debt

instruments of other enterprises except those held for trading
purposes.
Cash from Financing Activities:
It includes financing activities related to long-term funds or capital
of an enterprise. Financing activities are activities that result in
changes in the size and composition of the owners’ capital and
borrowings of the enterprise.
e.g., cash proceeds from issue of equity shares, debentures,
raising long-term loans, repayment of bank loans, etc.
Cash Inflows from financing activities

 Cash proceeds from issuing shares (equity / preference).

 Cash proceeds from issuing debentures, loans, bonds and

other short/ long-term borrowings.
Cash Outflows from financing activities:

 Cash repayments of amounts borrowed.

 Interest paid on debentures and long-term loans and

advances.

 Dividends paid on equity and preference capital.

Main heads of Cash Flow statement:

Cash Flow Statement (Main heads only)
(A) Cash flows from operating activities xxx
(B) Cash flows from investing activities xxx
(C) Cash flows from financing activities xxx
Net increase (decrease) in cash and cash equivalents (A + B + C)
xxx
Cash and cash equivalents at the beginning xxx
Cash and cash equivalents at the end xxxx

Difference between Funds Flow Statement and Cash Flow

Statement

Basis of Funds Flow Statement Cash Flow Statement

Difference

1. Basis of Funds flow statement is Cash flow statement is

Analysis based on broader based on narrow concept
concept i.e. working i.e. cash, which is only one
capital. of the elements of working
capital.

2. Source Funds flow statement Cash flow statement stars

tells about the various with the opening balance of
sources from where the cash and reaches to the
funds generated with closing balance of cash by
various uses to which proceeding through
they are put. sources and uses.

3. Usage Funds flow statement is Cash flow statement is

more useful in useful in understanding the
assessing the long- short-term phenomena
 range financial strategy. affecting the liquidity of the
business.

4. Schedule In funds flow statement In cash flow statement

of changes in current changes in current assets
Changes assets and current and current liabilities are
in Working liabilities are shown shown in the cash flow
Capital through the schedule of statement itself.
changes in working
capital.

5. End Result Funds flow statement Cash flow statement shows

shows the causes of the causes the changes in
changes in net working cash.
capital.

6. Principal of Funds flow statement is In cash flow statement data

Accounting in alignment with the obtained on accrual basis
accrual basis of are converted into cash
accounting. basis.

CASH FLOW STATEMENT

for the year ended …..

Particulars Amount
(A)Cash From Operating Activities

Net Profit Before Tax (Note 1)

Add: Non Operating and Non Cash Expenses

Depreciation

Goodwill, patents, trademarks etc written off

Discount on issue of shares, debentures or loss on issue of debentures written off

Preliminary expenses written off

Interest on debentures or other borrowings

Loss on sale of fixed assets

Less: Non Operating and Non Cash Income

Dividend earned during the year

Interest earned during the year

Rent earned during the year

Profit on sale of Fixed Assets

=Operating Profit before Working Capital Changes

Add: Decrease in Current Assets & Increase In Current Liabilities

Less: Increase in Current Assets & Decrease in Current Liabilities

=Cash Generated from Operations

Less: Income Tax paid (Less refund if any)

=Cash Flow before Extraordinary Items

Add/Less: Extraordinary Items

=Net Cash from/used in Operating activities (A)

(B) Cash Flow From Investing Activities

Add:

Proceeds from sale of Fixed Assets

Proceeds from sale of long term investments

Proceeds from sale of Goodwill/Patents/Trademarks etc

Rent received

Interest/Dividend received (in case of non financial companies)

Less:

Purchase of Fixed Assets

Purchase of Long Term Investments

Purchase of Goodwill/Patents/Trademarks etc

=Net Cash From/used in Investing Activities (B)

(C) Cash Flow from Financing Activities

Add:

Proceeds from Issue of Shares and Debentures

Proceeds from Long term loans and other

borrowings

Less:

Repayment of Long term Loans and Borrowing

Redemption of Debentures/Preference Shares

Interest On Debentures and Loans Paid

Final Dividend Paid

Interim Dividend Paid

=Net Cash from/used in Financing Activities (C)

Net Increase/Decrease in Cash and Cash Equivalents(A+B+C)

Add: Cash and cash equivalents in the beginning of the year

-Cash in hand/at bank

-Marketable Investments

-Short term deposits

=Cash and Cash Equivalents at the end of the Year

Note 1. Calculation of Net Profit before tax
Net profit as per Profit and Loss account

Add:

Transfer to Reserves

Interim dividend paid during the year

Proposed dividend for the current year

Provision for tax made during the year

Extra ordinary items debited to profit and loss account (if any)

Less:

Tax refund

Extraordinary items credited to profit and loss account (if any)

=Net Profit Before Tax