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UNIT 1 INTRODUCTION TO MANAGEMENT ACCOUNTING

LESSON 1 LESSON 2 LESSON 3 INTRODUCTION TO MANAGEMENT ACCOUNTING-1 INTRODUCTION TO MANAGEMENT ACCOUNTING-2 INTRODUCTION TO MANAGEMENT ACCOUNTING-3

Context
This units deals with Definition, scope, function, importance and limitations of management accounting, distinction between management accounting, financial accounting and cost accounting, role and responsibilities of management accountants .

LESSON 1

INTRODUCTION ACCOUNTING-I

TO

MANAGEMENT

TABLE OF CONTENTS: 1.0 1.1 1.2 1.3 1.4 1.5 1.6 1.7 1.8 1.9 2.0 OBJECTIVES INTRODUCTION TO ACCOUNTING CONCEPT AND MEANING OF MANAGEMENT ACCOUNTING DEFINITIONS OF MANAGEMENT ACCOUNTING CHARACTERISTICS OF MANAGEMENT ACCOUNTING SCOPE OF MANAGEMENT ACCOUNTING FUNCTIONS OF MANAGEMENT ACCOUNTING SELF CHECK QUESTIONS POSSIBLE ANSWERS TO SELF-CHECK QUESTIONS REFERENCES AND SUGGESTED FURTHER READING GLOSSARY

1. INTRODUCTION TO MANAGEMENT ACCOUNTING

1.0 Objectives
By the end of this lesson, you will be able to understand and learn about: Functions of Management Accounting Scope of Management Accounting Meaning of Management Accounting

1.1

Introduction to Accounting
Accounting has rightly been termed as the language of the business. It

communicates the result of business operations to various parties, who have some stake in the business viz., the proprietor, creditors, investors, Government and other agencies. Earlier accounting was considered simply as a process of recording business transactions and the role of accountant as that of recordkeeper. However, accounting is now considered to be a tool of management providing vital information concerning the organizations future. Accounting today is thus more of an information system rather than a mere recording system.

1.2 CONCEPTS and Meaning of Management Accounting


Present business management is becoming complicated day by day. Large scale production, detailed operating systems; Development-Expansion, Research-Development and cutthroat competition has presented big challenges in front of business enterprises. To get rid of various problems, business world is taking help of management. Management accounting, is not a new system of accounting, rather it is a method of presenting concept of accounting in a new form, with which managers get assistance in taking decisions. Thus, management accounting, receives and analysis of accounting information, which can become useful for managers.

Management Accounting comprises of two words, Management + Accounting i.e., accounts which increase managerial efficiency or providing all those information and facts, which are necessary for managers. In management accounting, accounts are presented, classified, summarized and analyzed in a manner, so that it makes all those informations valuable from the point of view of managers. In short, a method of presentation of accounts, which facilitates decision making for managers, is known as Management Accounting.

1.3

Definitions Of Management Accounting


According to Cost and Management Accounts, London, Management

Accounting is concerned with the presentation of professional knowledge and abilities to reveal accounting information which may help to the management in policy formulation, planning and control for the undertakings. According to Anglo-American Council of Productivity, Management Account is the presentation of accounting information in such a way as to assist management in the creation of policy in todays operation of undertakings. According to Robert Anthony, Management Accounting is concerned with accounting information that is useful to management. According to the Chartered Institute of Management Accountants (CIMA), Management Accounting is "the process of identification, measurement, accumulation, analysis, preparation, interpretation and communication of information used by management to plan, evaluate and control within an entity and to assure appropriate use of and accountability for its resources. Management accounting also comprises the preparation of financial reports for non-management groups such as shareholders, creditors, regulatory agencies and tax authorities" (CIMA Official Terminology). The American Institute of Certified Public Accountants(AICPA) states that management accounting as practice extends to the following three areas:

- Strategic ManagementAdvancing the role of the management accountant as a strategic partner in the organization. - Performance ManagementDeveloping the practice of business decisionmaking and managing the performance of the organization. - Risk ManagementContributing to frameworks and practices for identifying, measuring, managing and reporting risks to the achievement of the objectives of the organization The Institute of Cost and Management Accountants, London has defined Management Accounting as the application of professional knowledge and skill in the preparation of accounting information in such a way as to assist management in the formation of policies and in the planning and control of the operations of the undertakings. The American Accounting Association has defined as follows,

Management Accounting includes the methods and concepts necessary for effective planning, for choosing among alternative business actions and for control through the evaluation and interpretation of performances. Thus, Management accounting or managerial accounting is concerned with the provisions and use of accounting information to managers within organizations, to provide them with the basis to make informed business decisions that will allow them to be better equipped in their management and control functions.

1.4

Characterstics of Management Accounting


1. A Managerial Function: Management accounting is a Managerial function which assists managers in formulating plans for business and in other activities.

2. It Provides Accounting Details; Management Accounting provides several accounting informations to managers, which facilitates their decision making process. 3. It Provides Feed Back: Management Accounting provides feed back of their activities to managers, due to this actual conditions are known and as a result it facilitates control. 4. Knowledge of Strength and Weakness: Through various techniques of management accounting managers are able to ascertain their strengths and weaknesses. 5. Helpful in Decision-Making: Before taking any decision, Managers evaluates various alternatives available, so that best financial results are attaained. 6. Repoting at Various Levels: In Management Accounting managers obtain reports related to operations, at various levels, time to time, which maintains proper control. 7. Make or Buy Decision: Manageemnt accounting provides base to managers for decision making through which mangers take valuable and useful decisions related to Make or Buy, Replacement of machine , etc. according to circumstances. 8. Increase in Efficiency and Effectiveness; Management accounting increses efficiency of managers, under which effective decisions are taken.

Scope of Management Accounting


Scope of management accounting includes various aspects of the business activities. Management accounting has its scope in the following fields or systems: 1. Financial accounting- Financial accounting is the foundation from management accounting as it provides the necessary information for preparation of details and reports to be presented to the management.

2. Cost Accounting- Cost accounting is one of the important branches of accounting. It ascertains the cost of producing a particular commodity and rendering of services cost of selling and distribution. It facilitates effective planning regarding commodities, proper decision-making and cost control. Some of the important tools of cost accounting are marginal costing, standard costing and budgetary control. 3. Revaluation accounting- Revaluation accounting ensures that capital is represented at its real value in the accounts and the profit has been calculated keeping this fact in mind. In other words, it assures that the assets are re-valued according to the need and its effect has been brought into the accounts. Management accounting helps to ascertain the revalued figures of the assets. 4. Control accounting- Controlling means to measure the variation, if any, between actual and the standard results and taking corrective measures to remove that variation. Management accounting is the indispensable part of control accounting, budgetary control, inventory control, equality control are some of the important techniques of management accounting for control accounting. 5. Statistical methods- Management accounting is concerned with presentation of accounting information in the most impressive and understandable manner. It makes use of graphs, charts, index numbers, pictorial presentation and other statistical methods in order to make the information more intelligible. For scientific analysis of financial statement and accounting information various statistical techniques such as mean, standard duration, co-correlation, t-test, etc and used in management accounting. 6. Interim reporting- Interim reporting means preparation of reports on monthly, quarterly and half-yearly basis. These reports include income statement, cash flow statement, funds flow statement, scrap reports etc. 7. Internal audit- Internal audit means audit of various departments by the internal members of the organization. The techniques of management

accounting can be used to judge the efficiency and economy of the organization. Ratio analysis and funds flow analysis are widely used to judge the efficiency of an organization. 8. Taxation- Tax planning and its management is an essential function of the management. It includes computation of income as per tax laws, filing of returns and payment of tax within stipulated time.

1.6

Functions of Management Accounting


Two types of functions are performed in Management Accounting:

1. Main or Primary Functions a). Providing accounting information b). Assistance in managerial activities 2. Secondary Functions a) Protection of Assets b) Helpful in Financial Planning c) Helpful in Tax determination d) Strategic Function e) Fixation of Accountability

1. Main or Primary Functions


1.Providing Accounting Information: The main function of management accounting is to provide necessary information to managers and other parties related to it: such as investors, Financers, Shareholders, etc. (a) Forecasting: This is a primary function of management accounting, in which forecasts are made for activities at certain level of confidence. (b) Recording Function: All the transactions are recorded in financial accounts & cost accounts within a definite period and then management arrives at conclusion after analyzing them. (c) Interpretation and Appraisal Function: Management accounting evaluates all the activities in the interest of managers and organization.

(d) Reporting: Management accounting provides reports, which are required by managers at different levels. 2. Assistance in Managerial Activities: Management accounting assists managers in their operations, management principles and practices. It includes six functions of management: (a)Planning (b)Organizing (c)Directing (d)Co-ordination (e)Motivating (f)Controlling

2. Secondary Functions
1.Protection of Assets: Management accounting projects a course of action for the long-term viability and continuity of the enterprise. Under this strategy various profitable and good tasks are identified and investments are made in them. 2. Financial Appraisal: Management accounting uses various accounting techniques such as: Financial planning cost control, Ratio analysis, etc. in financial appraisal. 3. Determination of Tax Policies: Management accounting formulates favorable Tax Policy with the proper use of capital. As a result of these policies efforts are made to make tax liabilities minimum. 4. Determination of Accountability: Management accounting ensures accountabilities of people through Reporting System so that people are not able to shift their responsibility on other ignorantly.

Self Check Question 1. What is management accounting? 2. Is management accounting a tool of management ?

Self Check Question 1. State whether the following statements are True of False: a) Management Accounting increases the managerial efficiency. b) Financial Accounting reveals the position of Profit & Loss and assets and liabilities only. c) Management accounting decreases the volume of Profitability. d) Management Accounting does not present the accounting information, figures and facts. e) Management accounting is the part of Financial Accounting.

Answers to self check questions: a) True, b) True, c) False , d) False, e) False

Self Check Questions


1. Write any two functions of management accounting. 2. Write any two functions of financial accounting.

LESSON 2

INTRODUCTION ACCOUNTING-II

TO

MANAGEMENT

TABLE OF CONTENTS: 2.0 2.1 2.2 2.3 2.4 2.5 OBJECTIVES IMPORTANCE OF MANAGEMENT ACCOUNTING LIMITATIONS OF MANAGEMENT ACCOUNTING SELF CHECK QUESTIONS REFERENCES AND SUGGESTED FURTHER READING GLOSSARY

LESSON 2

INTRODUCTION ACCOUNTING-II

TO

MANAGEMENT

2.0

OBJECTIVES
By the end of this lesson, you will be able to understand and learn about:

Importance of management Accounting Limitations of Management Accounting

Importance of Management Accounting


Management accounting is very useful in providing information to managers, which assists in business decision making. Thus, it can be stated that management accounting plays a vital role in decision making process. Importance of management accounting in decision making can be summarised as under: 1.Various sources of Information: Management accounting provides

information related to financial and non-financial activities to organization from various sources. 2.Reliability and Accuracy: Through various techniques of management accounting, different information are obtained from financial accounting and cost accounting. 3. A Detail Study: The management collects information from various sources such as, Accounting, Taxation, financial and non-financial sources, thereafter these information are studied in detail for taking decisions. 4. Getting Investment Opportunities: Management accounting provides various opportunities of investment to organization. It tests various proposals of investment and selects the best alternative.

5. Development and Expansion of Business: In case of expansion of business, management accounting proves to be useful for issue allotment of shares and proper utilization of capital. 6. Financial Investigation: Management accounting carries out financial investigation in such a manner, so that related parties can reap benefits out of it. 7. Helpful in Corporate Planning: Management accounting plays a vital role in management of a company. This assists management in formulating long-term plans. 8. Variance Analysis: Management accounting makes it simple for the firm to attain desired goals by analysis of variances. 9. Corrective Actions: Under management accounting corrective measures are taken against the adverse variances and decisions are implemented to attain desired goals.

Limitations of Management Accounting


1.Dependency for Data and Information: To an extent Management Accountant or controller has to depend on financial accounting and cost accounting for accuracy and information of facts and figure. 2.More Expensive: Management accounting is useful only for large scale organizations, small organizations are not able to bear burden of heavy expenditure on these provisions. 3. Lack of Knowledge: Managers should be efficient enough to use the techniques of Management Accounting. 4. Delays in Decision: At many instances when decision-making process is lengthy, decisions taken by managers become useless. 5. Possibilities of Manipulation: At times, information and figures obtained from financial accounting and cost accounting may manipulate for managerial use.

It is clear from above mentioned limitations that managerial decision to an extent depends upon the accuracy of data and information received. Lack of proper intelligence and efficiencies also adversely affect decision making process

2.3

Self-Check Questions:

1. Explain the Importance of Management Accounting. 2. Explain the Limitations of Management Accounting.

2.4 2.5

References Glossary

LESSON 3

INTRODUCTION ACCOUNTING-III

TO

MANAGEMENT

TABLE OF CONTENTS: 3.0 3.1 3.2 3.3 3.4 3.5 3.6 3.7 OBJECTIVES DIFFERENCE BETWEEN MANAGEMENT ACCOUNTING & FINANCIAL ACCOUNTING DIFFERENCE BETWEEN MANAGEMENT ACCOUNTING & COST ACCOUNTING ROLE & RESPONSIBILITIES OF MANAGEMENT ACCOUNTANT SELF-CHECK QUESTIONS POSSIBLE ANSWERS TO SELF-CHECK QUESTIONS REFERENCES AND SUGGESTED FURTHER READING GLOSSARY

LESSON 3

INTRODUCTION ACCOUNTING-III

TO

MANAGEMENT

3.0

Objectives
The Difference between Management Accounting and Financial Accounting The Difference between Management Accounting and Cost Accounting The Role and Responsibilities of Management Accountant

By the end of this lesson, you will be able to understand and learn about:

3.1

The Difference between Management Accounting and Financial Accounting


Management Accounting and Financial Accounting are two parts of accounting information. In fact, both management accounting and financial accounting are two different accounting systems but from the point of view of nature they are Supplementary. The objective of financial accounting is to record the transaction, classification and summarization, on the basis of which required results are ascertain. The difference between financial accounting and management accounting can be understood on the basis of following points:

Financial Accounting V/s Management Accounting Basis Objective The Financial Accounting primary objective Management Accounting of The main objective of

financial accounting is to make Management accounting is periodical reports to owners, to assist management in its creditors and govt. Subject Matter It deals with the task of planning and control. over-all It deals with the details of divisions, deptt., Products, types of inventory or funds of the business. Nature of data used Compulsion Scope It is concerned records with of the It is concerned with future past information (like budgeting, costing) monetary events. business. It covers entire range of It consider only parts of activity which are relevant to management making. Period of Report Annual report is prepared (in The period of reporting is case of financial accounting. of depends on the need of management. Qualification Knowledge system required. System Audit of System. and accounting Knowledge concept of accounting is statistics, Management, Law and Tax is required. It is based on Internal for decision business activity.

performance or position of the various business.

It is compulsory for every It is not compulsory.

It is based on Double Entry control and Double entry system.

Records

In India auditing is compulsory Auditing is not compulsory for financial accounting. for management accounting.

3.2

Difference Between Management Accounting and Cost

the objective of management accounting and cost accounting is almost similar, as management accounting uses various techniques of cost accounting. Management accounts are based on financial accounts, whereas cost accounts are indispensable for managerial control. Cost Accounting V/s Management Accounting Basis Nature It is Cost Accounting concerned with and ascertainment control. Subject Matter Part Tools Management Accounting cost It is concerned of with cost formulation policies,

improvement of productivity and profitability.

It deals primarily with cost It involves considerations of data. Accounting. It involvesunit cost, costing, operating costing, process costing, and both cost and revenue data. Accounting. job It involves- Ratio analysis , budget, costing, fund flow and cash flow contract statements, costing and Mis. MBA, CA and ICWAI for management accounting. standards budgeting, BEP, standard It is a part of Management It is not a part of Cost

Qualification costing. Audit Expenses ICWAI (members) accounting.

Auditing is compulsory for cost Auditing is not compulsory

Allocation

In Cost accounting expenses In management accounting are allocated as Direct cost expenses are allocated into and Indirect cost. two part fixed and vaiable.

3.3

Role of Management Accountant

The management accountant has very significant role to perform in the installation, development and functioning of an efficient and effective management accounting system. He designs the framework of the financial and cost control reports that provide each managerial level with the most useful data at the most appropriate time. Mr. P.L. Tandon has explained beautifully the position of the management accountant in the following words: The management accountant is exactly like the spokes in a wheel, connecting the rim of the wheel and the hub receiving the information. He processes the information and then returns the processed information back to where it came from. Consistent with other roles in today's corporation, management accountants have a dual reporting relationship. As a strategic partner and provider of decision based financial and operational information, management accountants are responsible for managing the business team and at the same time having to report relationships and responsibilities to the corporation's finance organization. The activities management accountants provide inclusive of forecasting and planning, performing variance analysis, reviewing and monitoring costs inherent in the business are ones that have dual accountability to both finance and the

business team. Examples of tasks where accountability may be more meaningful to the business management team vs. the corporate finance department are the development of new product costing, operations research, business driver metrics, sales management score carding, and client profitability analysis. Conversely, the preparation of certain financial reports, reconciliations of the financial data to source systems, risk and regulatory reporting will be more useful to the corporate finance team as they are charged with aggregating certain financial information from all segments of the corporation. One widely held view of the progression of the accounting and finance career path is that financial accounting is a stepping stone to management accounting. Consistent with the notion of value creation, management accountants help drive the success of the business while strict financial accounting is more of a compliance and historical endeavor.

Responsibilities of Management Accountant


It is the duty of the management accountant to keep all levels of management informed of his real position. He has, therefore, varied functions to perform. His important functions can be summarized as follows: 1. He administers tax policies and procedures 2. He supervises and coordinates the preparation of reports to government agencies. 3. He ensures fiscal protection for the assets of the business through adequate internal and proper insurance coverage. 4. He carries out continuous appraisal of economic and social forces, and the government influences and interprets their effects on the business.

3.4

Self-check Questions
Accounting.

1. Define Management Accounting. Explain how does it differ from Financial 2. Discuss the difference between Management Accounting and Cost Accounting.

3. Explain in detail the role and responsibilities of management accountant.

UNIT 2 FUND FLOW ANALYSIS


LESSON 4 LESSON 5 LESSON 6 CONTEXT THIS UNIT DEALSFUND FLOW STATEMENT- MEANING, OBJECTIVE, USERS AND LIMITATIONS. OBJECTIVESAFTER STUDYING THIS LESSON YOU SHOULD BE ABLE TO UNDERSTAND- MEANING OF FUND FLOW - MEANING OF FUND FLOW STATEMENT - OBJECTIVES OF FUND FLOW STATEMENT - SOURCES OF FUND FLOW STATEMENT

Fund Flow Analysis-I Fund Flow Analysis-II Fund Flow Analysis-III

- LIMITATIONS OF FUND FLOW STATEMENT

LESSON 4 - FUND FLOW ANALYSIS-I


TABLE OF CONTENTS: OBJECTIVES INTRODUCTION HISTORICAL BACKGROUND 4.3 4.4 4.5 4.6 4.7 4.8 4.9 MEANING OF FUND MEANING OF FUND FLOW STATEMENT DEFINITION OF FUND FLOW STATEMENT OBJECTIVES OF FUND FLOW STATEMENT USES OF FUND FLOW STATEMENT LIMITATIONS OF FUND FLOW STATEMENT SELF CHECK QUESTIONS

4.10 POSSIBLE ANSWERS TO SELF-CHECK QUESTIONS 4.11 REFERENCES AND SUGGESTED FURTHER READING

4.12 GLOSSARY

LESSON 4 - FUND FLOW ANALYSIS-I


4.0 OBJECTIVES-

AFTER STUDYING THIS LESSON YOU SHOULD BE ABLE TO UNDERSTAND- HISTORICAL BACKGROUND - MEANING OF FUND - MEANING OF FUND FLOW STATEMENT - DEFINITIONS OF FUND FLOW STATEMENT - OBJECTIVES OF FUND FLOW STATEMENT - USERS OF FUND FLOW STATEMENT - LIMITATIONS OF FUND FLOW STATEMENT

4.1 IntroductionsThe financial statement of the business indicate assets, liabilities and capital on a particular date and also the profit or loss during a period. But it is possible that there is enough profit in the business and the financial position is also good and still there may be deficiency of cash or of working capital in business. If the management wants to find out as to where the cash is being utilized, financial statement cannot help. Therefore, a statement is prepared of the sources and applications of funds from where Working Capital comes and where it is utilized. This is called Fund Flow statement. The main objective of accounting is to provide information to public regarding financial condition and profitability of an enterprise, through financial statements. Thus, to analyse financial changes occurring between the balance sheets prepared in two financial years it is necessary to prepare fund flow statement, which gives information regarding inflow and outflow of fund.

4.2

Historical Background

Fund Flow statement was initiated in the name of Where-got and where-gone statement. Few years later the heading was changed to Fund Statement. On the basis of studies carried out of American Institute of Certified Public Accountants (AICPA) in 1961. accounting Principle Board proposed the new name Sources and Application of Funds for Fund Flow Statement. In 1971, Accounting Principle Board made it mandatory to prepare Fund Flow Statement and also to attach it with financial statements, along with the Board proposed to name this statement as Statement of changes in Financial Position. According to proposal number 19 of Board, to fulfil the condition of International Accounting Standard, Statement of changes in financial position is divided into two parts: 1. Statement of changes in the working capital (Fund Flow Statement)

2. Statement of changes in cash (Cash Flow Statement)

4.2

Meaning of Fund:

In a popular and generally accepted sense the term fund is used to denote the excess of current assts over current liabilities : Working Capital = Current Assets Current Liabilities

4.3

Meaning of Flow of Fund

Flow of funds means transmigration (coming and going) of funds. In other words, Flow of funds means change in Working capital, as in funds flow statement the words funds mean net working capital .

4.4

Definition of fund flow statement:

According to R.N. Anthony, Fund Flow is a statement prepared to indicate the increase in cash resources and the utilization of such resources of a business during the accounting period. According to Smith Brown, Fund Flow statement is prepared in summary form to indicate changes occurring in items of financial condition between two different balance sheet dates.

4.5

SOURCES OF FUNDS-

IT INCLUDES THE FOLLOWING1-ISSUE OF NEW SHARES 2- ISSUE OF DEBENTURES

3-NEW LOAN 4- SALE OF FIXED ASSETS 5- NON TRADING INCOME 6- FUND FROM OPERATION APPLICATION OF FUND FLOW STATEMENT- IT INCLUDES THE FOLLOWING1-REDEMPTION OF PREFERENCE SHARES. 2- REDEMPTION OF DEBENTURE 3 PAYMENT OF LOAN 4- PURCHASES OF FIXED ASSETS 5- LOSS FROM BUSINESS OPERATION 6 PAYMENT OF DIVIDENDS

4.6

Importance of Fund Flow Statement

Funds Flow Statement is an an analytical tool in the hands of financial manager. The basic purpose of this statement is to indicate on historical basis the changes in the working capital i.e., where funds came from and were there are used during a given period. The Importance of this statement can be measured on the basis of its contributions to the financial management. It generally serves the following purposes:(1) Analysis of Financial Position. The basic purpose of preparing the statement is to have a rich into the financial operations of the concern. It analyses how the funds were obtained and used in the past. In this sens, it is a valuable tool for the finance manager for analyzing the past and future plans of

the firm and their impact on the liquidity. He can deduce the reasons for the imbalances in uses of funds in the past an take necessary corrective actions. (2) Evaluation of the Firm's Financing. One important use of the statement is that it evaluates the firm' financing capacity. The analysis of sources of funds reveals how the firm's financed its development projects in the past i.e., from internal sources or from external sources. It also reveals the rate of growth of the firm. (3) An Instrument for Allocation of Resources. In modern large scale business, available funds are always short for expansion programmes and there is always a problem of allocation of resources. It is, therefore, a need of evolving an order of priorities for putting through their expansion programmes which are phased accordingly, and funds have to be arranged as different phases of programmes get into their stride. The amount of funds to be available for these projects shall be estimated by the finance with the help of Funds Flow Statement. This prevents the business from becoming a helpless victim of unplanned action. (4) A Tool of Communication to Outside World. Funds Flow Statement helps in gathering the financial states of Business. It gives an insight into the evolution of the present financial position and gives answer to the problem 'where have our resources been moving'? In the present world of credit financing, it provides a useful information to bankers, creditors, financial, it provides a useful informations and government etc. regarding amount of loan required, its proposes, the terms of repayment an sources for repayment of loan etc. the financial manager gains a confidence born out of a study of Funds Flow Statement. In fact, it carries information regarding firm's financial policies to the outside world. (5) Future Guide. An analysis of Funds Flow Statements of several years reveals certain valuable information for the financial manager for planning the future financial requirements of the firm and their nature too i.e. Short term, longterm or mid term. The management can formulate its financial policies based on information gathered from the analysis of such statements. Financial manager can rearrange the firm's financing more effectively on the basis of such

information along with the expected changes in trade p payables and the various accruals. In this way, it guides the management in arranging its financing more effectively.

4.7

Limitations of Fund Flow Statement

The fund flow statement suffers from the following limitations: 1. The fund flow statement is prepared with the help of balance sheet and profit and loss account of the current period and these statements are based on historical cost. So a realistic comparison of profitability and the funds position is not possible as the current cost is not considered for the purpose of preparation of fund flow statement. 2. The cash position of the firm is not revealed by fund flow statement. To know the cash position a cash flow statement has to be prepared. 3. The various activities are not classified as operating activities, investing activities and financing activities while preparing fund flow statement

4.8
follows:

Uses Of Fund Flow Statement

Fund Flow Statement are used for various purposes and some of them are as 1. The users of fund flow statement, such as investors, creditors, bankers, government, etc., can understand the managerial decisions regarding dividend distribution, utilization of funds and earning capacity with the help of fund flow statement. 2. The quantum of working capital is revealed by the schedule of working capital changes, which is a part of fund flow statement. 3. The fund flow statement is the best and first source for judging the repaying capacity of an enterprise. 4. The management will be able to detect surplus/shortage of fund balance. 5. The fund from operation is not mentioned in the profit and loss account and balance sheet but it is separately calculated for the purpose of fund flow statement.

Self Check Questions 1. Define fund. 2. Write any two limitations of fund flow analysis. 3. State any three importance of fund flow analysis.

LESSON-5 FUND FLOW ANALYSIS-II

5.0 CONTEXT
THIS LESSON DEALS-ITEMS OF FUND,COMPUTATION FUND FROM OPERATIONS AND PREPARATION
OF FUND FLOW STATEMENT

5.1 OBJECTIVESAFTER STUDYING THIS LESSON YOU SHOULD BE ABLE TO UNDERSTAND - ITEMS OF FUND - COMPUTATION FUND FROM OPERATIONS PREPARATION
OF SCHEDULE OR STATEMENT OF WORKING CAPITAL AND

- PREPARATION

OF FUND FLOW STATEMENT

5.2 MEANING OF FUND THE


TERM

FUND

HAS A SPECIAL MEANING WITH REFERENCE TO

FUND

FLOW STATEMENT

. IT

SIGNIFIES FOR THIS PURPOSE

WORKING

CAPITAL ONLY, AND NOT CASH OR CAPITAL AS SUCH. ASSETS

WORKING

CAPITAL IS ALSO CALLED

NET

HENCE THE DIFFERENCE BETWEEN

CURRENT

ASSETS AND

CURRENT LIABILITIES

IS CALLED

FUND

. IN

OTHER WORDS

FUND IS EQUAL TO

CURRENT ASSETS LESS CURRENT LIABILITIES.

5.3 ITEMS OF FUND ITEMS OF CURRENT ASSETS1-CASH IN HAND 2- CASH AT BANK 3- B/R 4- DEBTORS 5- SHORT TERM INVESTMENTS 6-LOAN AND ADVANCES 7- PREPAID EXPENSES 8- ACCRUED INCOME 9- STOCK ITEMS OF CURRENT LIABILITIES1-B/P 2- CREDITORS

3- OUTSTANDING EXPENSES 4-BANK OVERDRAFT 5-DIVIDEND PAYABLES 6- PROVISION FOR TAXATIONS 7- SHORT TERM LOAN ITEMS OF NON-CURRENT ASSETS 1. EQUITY SHARE CAPITAL 2. PREFERENCE SHARE CAPITAL 3. DEBENTURE 4. LONG-TERM LOANS 5. SHARE PREMIUM 6. SHARE FORFEITED 7. PROFIT AND LOSS (BALANCE OF PROFIT) 8. CAPITAL RESERVE 9. CAPITAL REDEMPTION RESERVE ETC. ITEMS OF NON-CURRENT LIABILITIES 1. GOODWILL 2. LAND 3. BUILDING 4. PLANT AND MACHINERY

5. FURNITURE AND FITTINGS 6. TRADE MARK 7. PATENT RIGHT 8. LONG-TERM INVESTMENT 9. DISCOUNTS ON ISSUE OF SHARES AND DEBENTURES 10. OTHER DEFFERED EXPENSES ETC.

5.4 Preparation of Fund Flow Statement


The changes which occurred in the current accounts as a result flow of fund are reflected in a statement known as schedule of changes in working capital . The similar changes in non current accounts are shown in Fund Flow Statement. Therefore, following two statements under this techniques . 1. 2. Statement. Schedule of Changes in Working Capital It discloses the changes in individual item of current asset & current liabilities between two period & there effect on working capital. Working capital will increase when there is an increase in current asset and decrease in current liabilities, whereas, working capital will decrease when there is a decrease in current asset & increase in current liabilities. Net increase in working capital is treated as use of funds & the net decrease in working capital is treated as source of funds. Statement or Schedule of Changes in Working Capital. Statement of Sources and Uses of Funds or Funds Flow

Self Check Questions 1. What is Fund? 2. What is Working Capital? 3. How to compute working capital? 4. Write the sources of fund flow operations.

5.5 Statement or Schedule of Changes in Working Capital


Item Previous Year Current Year Effect on Working capital Increase Decrease Rs. (A) Current Assets Cash at bank Cash in hand Stock in trade Debtors Bills receivable Advance payment Short investment Prepaid expense Accrued income Total (A) (B)Current Liabilities Short term loans Bank overdraft term Rs.

Creditors Bills payable Outstanding exp. Unclaimed dividend Total (B) Net Working Capital (A-B) Increase / Decrease in Working Capital Total -

Fund Flow Statement Sources of Fund Fund from operation Issue of share Issue of debenture long term loans Sale of fixed assets / Investment Non trading receipts Decrease in working capital (if any) Amount Uses Of Funds Loss from operation Redemption of preference shares Redemption of debentures Repayment of long term loans Purchase of fixed assets / Investments Payment of dividend & taxes Increase in working capital (if any) Amount

Fund from operations :


The profit made by a firm through normal operations is a major source of funds. The amount of sales as shown in the P&L A/c is a source of funds by way of increase in cash , debtor and B/R. Profit & loss Adjustment Account Particular Depreciation Loss on sale of fixed assets Under writing commissions Discount on issue of shares & debentures Preliminary expense written off Deferred revenue expenses Goodwill written off Patent or trademark Provision for taxes (If treated non current) Amount Particular Profit or gain on sale of fixed asset Dividend received Interest received of investment Profit on revaluation of asset Fund from operation Amount

Self check questions1- Which is a current assets ? a- Stock c-Cost b-Capital d- Debenture

2- Which is not a current assets ? a- Creditors c Debtors b- Cash d- B/R

3-- Which is a current liability a- Stock c- Bank overdraft

? b-Capital d- Debenture

4- Which is not a Non- current assets ? a- Stock c- Plant b- Patents d- Land

5-Which is a Non- current assets ? a- Stock c- Goodwill b-Capital d- Debenture

LESSON-6 FUND FLOW ANALYSIS-III

6.0 CONTEXT
THIS LESSON DEALS-PRACTICAL PROBLEMS RELATED TO COMPUTATION FUND FROM
OPERATIONS AND

PREPARATION OF FUND FLOW STATEMENT

6.1 OBJECTIVESAFTER STUDYING THIS LESSON YOU SHOULD BE ABLE TO UNDERSTAND COMPUTATION FUND FROM OPERATIONS PREPARATION
OF SCHEDULE OR STATEMENT OF WORKING CAPITAL AND

- PREPARATION

OF FUND FLOW STATEMENT

6.2 WHILE PREPARING THE SCHEDULE OF WORKING CAPITAL CHANGES , ONLY


CURRENT ASSETS AND CURRENT LIABILITIES FROM THE BALANCE SHEETS SHOULD BE TAKEN INTO ACCOUNT.

THE FOLLOWING PROBLEMS ARE GIVEN AS FOLLOWS-

Illustration-1 You are given the following Balance Sheets of a Company: Balance Sheets

Liabilities Accounts Payable Capital Retained Earnings

2008 Rs. 7,000 1,000

2009 Rs. 4,500 Cash 2,300 Land

Assets

2008 Rs. 3,000 5,000

2009 Rs. 4,700 6,600

20,000 25,000 Accounts Receivable

12,000 11,500 8,000 9,000 28,000 31,800

Stock 28,000 31,800 Prepare a statement showing the changes in working capital. Solution: Statement or Schedule of Changes in Working Capital

Effect Item 2008 2009

on

Working capital Increase Decrease Rs. Rs. 500 -

(A) Current Assets Cash Stock Accounts Receivable Total (A) (B)Current Liabilities Accounts Payable Total (B) Net Working Capital (A-B) Increase Working Capital Total 20,700 20,700 5,200 5,200 in 4,700 4,700 7,000 7,000 16,000 4,500 4,500 20,700 2,500 3,000 12,000 8,000 23,000 4,700 11,500 9,000 25,200 1,700 1,00

Assignment-1 You are given the following Balance Sheets of a Company: Balance Sheets Liabilities 2008 Rs. 2009 Rs. Assets 2008 Rs. 2009 Rs.

Accounts Payable Capital Retained Earnings

21,000 13,500 Cash 60,000 75,000 Accounts Receivable 3,000 6,900 Land Stock 84,000 95,400

9,000 14,100 36,000 34,500 15,000 19,800 24,000 27,000 84,000 95,400

Prepare a statement showing the changes in working capital. [Ans. Increase in Working Capital Rs.14,100] Illustration-2 Comparative Balance sheet of Shyam Ltd. As on year 2008 and 2009 were as follow: Balance Sheets Liabilities Account payable Notes payable Loan on Mortgage Capital Sinking fund Retained Earning Provision for DD Accumulated Depreciation Building Furniture 12,000 9,000 1,61,500 1,51,600 3,200 2,400 1,61,500 1,51,600 2008 Rs. 15,000 10,000 40,000 50,000 16,000 13,950 1,350 2009 Rs. 18,000 Cash 7,500 Account receivable 40,000 Stock 45,000 Sinking 12,000 investment 16,275 Land 1,425 Building Furniture fund Assets 2008 Rs. 11,200 21,300 35,000 16,000 10,000 60,000 8,000 2009 Rs. 8,500 23,500 30,600 12,000 10,000 60,000 7,000

You are giving information:1. Net profit for the year 2001 amounted 6,675. 2. Dividend amounted to Rs.5,000 was paid during the year. Prepare a statement of sources and uses of fund.

Solution: Statement or Schedule of Changes in Working Capital Effect Item 2008 2009 on Working capital Increase Decrease Rs. (A)Current Assets:Cash Account receivable Stock TOTAL of CA (A) (B) Current Liab.:Account payable Note payable Provision for D D Total of CL (B) Difference b/w (A-B) Decrease in W C Total 15,000 10,000 1,350 26,350 41,150 41,150 18,000 7,500 1,425 25,925 35,675 5,475 41,150 5475 10175 10175 2,500 3,000 75 11,200 21300 35,000 67,500 8,500 23,500 30,600 62,600 2,200 2,700 4,400 Rs.

Fund flow statement Sources of Fund Sale of sinking fund investment Fund from operation Decrease capital in working 5,475 10,000 Profit & loss adjustment Account 10,000 525 Amount Uses Of Funds Amount 5,000 5,000

4,000 Redemption of share capital Dividend paid

Particular To Accumulate dep. On furniture To Dividend paid To Balance c/d

Amount

Particular By sinking fund

Amount 13,950 4,000 3,000 525 21,475

200 By balance b/d 5,000 By accumulate dep. On 16,275 building By fund flow operation 21,475

Accumulative deprecation Building Account Particular To P/L a/c To balance c/d Amount 9,000 12,000 Particular Amount 12,000 12,000 3,000 By balance b/d

Accumulative deprecation Furniture Account Particular To furniture a/c To balance c/d Amount Particular Amount 3,200 200 3,400 Furniture Account Particular To balance b/d Amount Particular By balance c/d 8000 Amount 1000 7000 8000 8000 By deprecation 3,400 1,000 By balance b/d 2,400 By P/L a/c

Assignment-2 From the following information relating to Koli Ltd., prepare Funds Flow Statement: Balance Sheets ( Rs.000) Liabilities Share Capital Reserve Retained Earnings Accounts Payable 2008 Rs. 300 100 30 45 475 Additional Information: (a) The company issued bonus shares for Rs.50,000 and for cash Rs.50,000. (b) Depreciation written off during the year Rs.15,000. [Ans. Increase in Working Capital Rs.60,000; Fund Flow Statement Rs.95,000; Fund From Operation Rs.45,000.] Assignment-3 From the following information relating to Sumit Ltd., prepare Funds Flow Statement: Balance Sheets ( Rs.000) Liabilities Share Capital Reserve Retained Earnings Accounts Payable 2008 Rs. 600 200 60 90 950 2009 Rs. 800 Cash 100 Account receivable 120 Stock 270 Fixed Assets 1,290 Assets 2008 Rs. 60 210 300 380 950 2009 Rs. 180 300 390 420 1,290 2009 Rs. 400 Cash 50 Account receivable 60 Stock 135 Fixed Assets 645 Assets 2008 Rs. 30 105 150 190 475 2009 Rs. 90 150 195 210 645

Additional Information: (c) The company issued bonus shares for Rs.1,00,000 and for cash Rs.1,00,000. (d) Depreciation written off during the year Rs.30,000. [Ans. Increase in Working Capital Rs1,20,000; Fund Flow Statement Rs.1,90,000; Fund From Operation Rs.90,000.] Illustration 3: The following are the summarized Balance Sheets of X Ltd, as at 31st December 2008 and 31st December 2009: Balance Sheets Liabilities Share Capital Profit & Loss A/c Debentures Sundry Creditors Provision doubtful debts Provision Depreciation: Land & Building Plant and 30,000 30,000 32,000 10,35,000 11,27,000 for for 5,000 2008 Rs. 5,00,000 1,50,000 2,00,000 1,20,000 2009 Rs. 5,00,000 Land 2,52,000 Buildings 2,00,000 Plant 1,05,000 Machinery Sundry Debtors 4,000 Stock Bank Preliminary 34,000 Expenses 10,35,000 11,27,000 and Assets and 2008 Rs. 2,00,000 3,50,000 1,47,000 2,50,000 83,000 5,000 2009 Rs. 2,50,000 3,60,000 1,38,000 2,74,000 1,01,000 4,000

Machinery The following additional information is available: a.

The net profit for the year ending 31st December, 2009 was Rs.2,52,000 and is arrived at after charging loss on sale of machinery and written off preliminary expenses and adjusting provisions for doubtful debts.

b. c.

During the year a part of machinery costing Rs.7,000 accumulated depreciation thereon being Rs.1,000 was sold for Rs.5,000. Dividend of Rs.50,000 was paid during the year ended 31st December, 2009.

Prepare statements to show the changes in working capital for the year 2009 and the sources and applications of funds for 2009.

Solution: Schedule of Changes in Working Capital Effect Item 2008 2009 on Working capital Increase Decrease Rs. (A)Current Assets:Sundry Debtors Stock Bankl TOTAL of CA (A) (B) Current Liab.:Sundry Creditors Provision for Doubtful debts Total of CL (B) Difference b/w (A-B) Increase in W C Total 5,000 1,25,000 3,55,000 49,000 4,04,000 4,000 1,09,000 4,04,000 4,04,000 58,000 49,000 58,000 1,000 1,20,000 1,05,000 15,000 1,47,000 2,50,000 83,000 4,80,000 1,38,000 2,74,000 1,01,000 5,13,000 24,000 18,000 9,000 Rs.

Fund flow statement (for the year ended 31st December, 2009) Sources of Fund Sale of Plant and Machinery Fund From Operations Amount Uses Of Funds Purchase 1,61,000 Machinery Dividend Paid 1,66,000 Increase in Working Capital of Plant & Amount 50,000 17,000 50,000 49,000 1,66,000 5,000 Purchase of Land & Building

Working Note: Land and Building Account Particular To balance b/d To Cash (Purchase) Amount 50,000 2,50,000 Particular Amount 2,50,000 2,50,000 2,00,000 By balance c/d

Provision For Depreciation A/c (Land & Buildings) Particular To balance c/d Amount Particular By Adjusted profit and loss a/c 34,000 Plant and Machinery A/c Particular To balance b/d To Cash (Purchase) Amount 17,000 By Particular Provision for Amount 5,000 1,000 1,000 3,60,000 3,67,000 3,50,000 By Cash (Sales) Depreciation By Adjusted P & L A/c (Loss) By Balance c/d Provision For Depreciation A/c (Plant and Machinery A/c) Particular To Plant & Machinery To balance c/d Amount Particular Amount 30,000 3,000 33,000 Particular Amount 1,000 By balance b/d 32,000 By Adjusted profit and loss a/c 33,000 Adjusted Profit and Loss A/c Particular Amount 3,67,000 4,000 34,000 Amount 30,000 34,000 By balance b/d

To

Plant

and

Machinery

1,000 By Balance b/d 4,000 By Funds from Operations 3,000 1,000 50,000 2,52,000 3,11,000

1,50,000 1,61,000

(Loss) To Provision for Depreciation (land & buildings) To Provision for Depreciation (Plant & Machinery) To Preliminary Expenses To Dividend To Balance c/d

3,11,000

Assignment 4: The following details are available from a company: Balance Sheets Liabilities Share Capital Debentures Reserves doubtful debts Trade Creditors P & L A/c for 700 10,360 2008 Rs. 70,000 12,000 2009 Rs. 74,000 Cash 6,000 Debtors Stock 800 Land 11,840 Goodwill 10,560 1,03,200 Assets 2008 Rs. 9,000 14,900 49,200 20,000 10,000 1,03,100 2009 Rs. 7,800 17,700 42,700 30,000 5,000 1,03,200

10,040 1,03,100 Additional Information:

(a) Dividend Paid Rs.3,500 (b) Land was purchased for Rs.10,000 (c) Amount provided for amortisation of goodwill Rs.5,000. (d) Debentures paid off Rs.6,000. Prepare cash flow statement. [Ans: Cash from operations Rs.14,300; Cash inflows Rs.18,300; Cash outflows Rs.19,500] Illsutration 4: From the following particulars prepare a schedule of changes in working capital and a Funds Flow Statement: 2008 2009

Assets: Land & Building Plant & Machinery Merchandise Debtors Cash Goodwill

Rs. 1,05,000 70,000 55,000 40,000 250 2,70,250

Rs. 1,00,000 79,500 42,000 32,100 4,300 2,500 2,70,250

Liabilities: Share Capital General Reserve Profit & Loss A/c Bank Loan (Short Term) Provision For Tax Creditors Additional Information: (i) (ii) (iii) Dividend of Rs.10,000 was paid during the year 2008-09. Depreciation charged on Plant & Machinery was Rs.5,000 Provision for tax made during the year 2008-09 was Rs.15,000. 1,20,000 5,000 20,250 35,000 10,000 80,000 2,70,250 1,45,000 10,000 20,300 12,500 72,600 2,60,400

Solution: Schedule of Changes in Working Capital

Effect Item 2008 2009

on

Working capital Increase Decrease Rs. Rs. 13,000 7,900

(A)Current Assets:Cash Marchandise Debtors TOTAL of CA (A) (B) Current Liab.:Creditors Bank Loan Total of CL (B) Difference b/w (A-B) Increase in W C Total 80,000 35,000 1,15,000 -19,750 25,550 5,800 Fund flow statement (for the year ended 31st December, 2009) Sources of Fund Issue of share capital Fund From Operations Amount Uses Of Funds Purchase 40,050 Machinery Payment of Dividend Payment of Income-tax 65,050 Fund from Operations of Plant & Amount 2,500 14,500 10,000 12,500 25,550 65,050 25,000 Purchase of Goodwill 72,600 72,600 5,800 5,800 46,450 25,550 46,450 7,400 35,000 250 55,000 40,000 95,250 4,300 42,000 32,100 78,400 4,050 -

Adjusted Profit and Loss A/c Particular Amount Particular Amount

To

Depreciation

(land

&

5,000 By Balance b/d By Funds from Operations 5,000 15,000 10,000 5,000 20,300 60,300

20,250 40,050

buildings) To Depreciation (Plant & Machinery) To Provision for tax To Dividend To General Reserve To Balance c/d

60,300

Illustration 5: Following are the Balance Sheets of Shyam Ltd. As at 31 st March, 2008 and 2009: Assets: Building Plant & Machinery Stock Debtors Cash Liabilities: Share Capital General Reserve Profit & Loss A/c Bank Loan (Short Term) Provision For Tax Creditors 10,62,500 Additional Information: (i) Rs.62,500 as depreciation has been charged on Plant and Machinery during the year 2008-2009. 14,68,750 2008 Rs. 1,00,000 6,25,000 1,25,000 1,87,500 25,000 10,62,500 6,25,000 1,25,000 62,500 50,000 1,91,250 8,750 2009 Rs. 1,50,000 10,00,000 93,750 2,00,000 25,000 14,68,750 8,75,000 2,00,000 87,500 62,500 2,37,500 6,250

(ii)

A Machinery was sold for Rs.10,000 during the year 2008-09, which has cost Rs.15,000 and depreciation Rs.8,750 has been provided on it.

Prepare Fund Flow Statement and Schedule of Working Capital. Solution: Item Schedule of Changes in Working Capital Effect 2008 2009 on Working capital Increase Decrease Rs. (A)Current Assets:Cash Debtors Stock TOTAL of CA (A) (B) Current Liab.:Sundry Creditors Bills Payable Outstanding Expenses Total of CL (B) Difference b/w (A-B) Increase in W C Total 50,000 1,91,250 8,750 1,15,000 87,500 87,500 62,500 2,37,500 6,250 72,600 12,500 75,000 87,500 75,000 90,000 90,000 2,500 12,500 46,250 25,000 1,87,500 1,25,000 3,37,500 25,000 2,00,000 93,750 3,18,750 12,500 31,250 Rs.

Fund flow statement (for the year ended 31st December, 2009) Sources of Fund Amount Uses Of Funds Amount

Issue of share capital Fund From Operations Sale of Machinery Decrease capital in working

2,50,000 Purchase of Building 1,58,750 Purchase 10,000 Machinery 75,000 4,93,750 Adjusted Profit and Loss A/c of Plant &

50,000 4,43,750

4,93,750

Particular To Depreciation To General Reserve To Balance c/d

Amount 25,000 By

Particular Profit on sale of

Amount 1,25,000 3,750 1,58,750 2,87,500

62,500 By Balance b/d 2,00,000 machinery By Funds from Operations 2,87,500

Self Check Questions 1. What is Fund Flow Statement? 2. Explain importance of Fund Flow Statement. 3. Explain the procedure for the preparation of funds flow statement. 4. What are the major sources and uses of funds? 5. What are the limitations of funds flow statement?

UNIT 3 CASH FLOW ANALYSIS


LESSON 7 LESSON 8 LESSON 9 CONTEXT THIS UNIT DEALSCASH FLOW STATEMENTCASH FLOW ANALYSIS. MEANING, OBJECTIVE, USERS, LIMITATIONS,

CASH FLOW ANALYSIS -1 CASH FLOW ANALYSIS -2 CASH FLOW ANALYSIS -3

PROBLEMS

OF

OBJECTIVESAFTER STUDYING THIS UNIT YOU SHOULD BE ABLE TO UNDERSTAND - MEANING OF CASH - MEANING OF CASH FLOW AND CASH FLOW STATEMENT - OBJECTIVE, USERS CASH FLOW STATEMENT

- SOURCES OF CASH FLOW STATEMENT - LIMITATIONS CASH FLOW STATEMENT - COMPUTATION OF CASH FROM OPERATIONS AND - PREPARATION
OF

CASH FLOW STATEMENT

LESSON 7
TABLE OF CONTENTS: 7.0 7.1 7.2 OBJECTIVES INTRODUCTION

CASH FLOW ANALYSIS -1

CASH FLOW STATEMENT


7.2.1 MEANING OF CASH AND CASH FLOW 7.2.2. OBJECTIVE 7.2.3. USERS 7.2.4 LIMITATIONS

7.3

ASSIGNMENTS
7.3.1 CLASS ASSIGNMENTS 7.3.2 HOME ASSIGNMENTS

7.4 7.5
7.6

TERMINAL QUESTIONS POSSIBLE ANSWER TO SELF-CHECK QUESTION REFERENCES AND SUGGESTED FURTHER READING

LESSON 7
7.0 Objectives

CASH FLOW ANALYSIS -1

At the end of this lesson, you will be able to understand and learn about: Meaning of Cash Meaning of Cash Flow Meaning of Cash Flow Statement Objectives of Cash Flow Statement Users of Cash Flow Statement Limitations of Cash Flow Statement

7.1

INTRODUCTION
Cash is an important component of working capital of business, which

provides speed and power to business. Keeping in view the present wealth dominated scenario, it can be said that cash is the life blood of business, as it governs and operates all the activities of business. For all the activities of business, continuous and healthy flow of cash is the main pillar of business solvency, thus cash is both the beginning and end of working capital cycle. In all

the business organizations monetary and non-monetary activities takes place and out of which monetary transactions result in inflow and outflow of cash, so it is very important for business to know that from what sources and in how much quantity cash has been used. The cash flow statement is prepared to attain the above-mentioned objective.

7.2

CASH FLOW STATEMENT

7.2.1 MEANING Cash flow statement is the statement, which depicts the inflow and

outflow of cash and equivalents during the specified period in an organization. This statement shows the reasons for changes in cash balances during two balance sheet periods. A cash flow statement is a statement depicting change in cash position from one period to another. A projected Cash Flow Statement or a cash budget will help the management in ascertaining how much cash will be available to meet obligations to trade creditors, to pay bank loans and to pay dividend to the shareholders. Cash Flow Statement is a statement of cash flow and cash flow signifies the movement of cash in and out of a business concern. Inflow of cash is known as source of cash and Outflow of Cash is called Use of Cash. This statement also depicts factors for such inflow and outflow of cash. Thus, Cash Flow Statement is a statement designed to highlight upon the causes, which bring changes in cash position between two Balance Sheets dates. It virtually takes the nature and character of cash receipts and cash payments, though the basic information used in the preparation of this statement differs from that which is used in recording cash receipts and cash payments.

Meaning of Cash Flow: It means the movement of cash into enterprise referred to as sources (cash inflow) and also movement of cash out of the enterprise referred to as uses (Cash outflow). Thus cash flows are inflows and outflows of cash and cash equivalents. The difference between the cash inflows and cash outflows is known as net cash flow which can be either a net cash inflow or a net cash outflow depending upon the magnitude or amount of two components. It is clarified that the term cash when used in cash flow statement includes cash and cash equivalents. Definitions: According to I.C.W.A. (India), Cash Flow Statement is a statement setting out the flow of cash under different heads of sources and their utilization to determine the requirements of cash during the given period and to prepare for its adequate provisions. 7.2.2. OBJECTIVES
OF

CASH FLOW STATEMENT

1. Primary Objective: A primary purpose of cash flow statement is to provide information about the cash receipts and cash payments of a business entity for the accounting period covered by the income statement. It is necessary to maintain a record of cash flows on a continuing basis in order to keep the business free of troubles is respect of liquidity problems. 2. Secondary Objective: A secondary purpose of cash flow statement is to provide information about a business entitys operating, investing and financing activities during the accounting period. 7.2.3. USEFULNESS

OF

CASH FLOW STATEMENT

Objectives According to Accounting Standard 3 the main objective of preparation of 1. Helpful in short term policies of cash flow statement, is toplanning information to users regarding cash flows financial provide 2. Useful in preparing cash which gives description of changes in cash or cash equivalents. Following are the budget objectives and 3. Knowledge of solvency uses of cash flow statement: 4. Helpful in control 5. Helpful in internal financial control 6. Useful to external investors 7. Study of trends of cash receipts and payments from various activities

1. Helpful in short term policies of financial planning: Cash flow statement provides several information to finance managers for formulating policies for short term financial requirements on the basis of which, finance manager is able to ascertain the amount of cash which will be required in future and how much cash will be available from internal sources and how much will have to be arranged from external sources. 2. Useful in preparing cash budget: Cash flow statement helps managers in preparing cash budget, it gives information about preparing cash budget, it gives information about surplus or deficiency of cash to managers and on the basis of this managers can plan to invest surplus of cash in short term investments or to cover the deficit from the search of other sources of short term goodwill. 3. Knowledge of Solvency: Knowledge of solvency can be obtained with the help of cash flow statement, as it provides the real information about the available cash in the organization. 4. Helpful in Control: Cash flow statement acts as a control device for finance managers. With comparison of cash flows statement with cash budget management can come to know about the extent, to which financial sources have uses, in accordance with plan.

6. Helpful in Internal Financial Management: On the basis of information available from cash flows statement payment of long-term liabilities, formulation of dividend policy is facilitated. 7. Useful to External Investors: External investors are able to obtain information about liquidity of organization with the help of cash flows statement on the basis of which they can take their decision regarding lending loan to organization or not. 8. Study of the Trends of Cash Receipts and Payments from Various Activities: With the help of this statement managers are able to obtain information about the frequency of cash receipts from current assets and what is frequency of payments of current liabilities so that future cash requirements can be ascertained. 7.2.4 LIMITATIONS Following are the main limitations of cash flow statement: 1. Incomplete Substitute: Cash flow statement is not a substitute of income statement as net cash flow depicted by cash flows statement is not equal to net profit shown by income statement. 2. It does not show the Liquidity Position of the Firm: This statement depicts the inflow and outflow of cash, liquidity position of the firm cannot be ascertained from this. 3. Accrual Basis: Cash flow statement does not pay attention to accrual basis concept of accounting. 4. Misleading Comparison: Cash flows statement has proved to be misleading in comparison of industry and firm.

LESSON 8
TABLE OF CONTENTS: 8.0 8.1 8.2 OBJECTIVES

CASH FLOW ANALYSIS -2

DIFFERENCE BETWEEN FUND FLOW STATEMENT & CASH FLOW STATEMENT TECHNIQUES OF CASH FLOW STATEMENT

METHODS OF CASH FLOW STATEMENT PROVISIONS OF CASH FLOW STATEMENT CLASSIFICATION OF CASH FLOWS ACCORDING TO AS-3 8.6 8.7 8.8 TERMINAL QUESTIONS POSSIBLE ANSWER TO SELF-CHECK QUESTION REFERENCES AND SUGGESTED FURTHER READING

LESSON 8
8.0 Objectives

CASH FLOW ANALYSIS -2

After Studying this lesson you should be able to understand: The difference between Fund Flow Statement & Cash Flow Statement Various Techniques of Cash Flow Statement Method to Prepare Cash Flow Statement Provisions of Cash Flow Statement Classification of Cash Flows According To AS-3

8.1

Difference Between Fund Flow Statement & Cash Flow Statement


Basis of Difference Meaning Fund Flow Statement Fund Flow refers to the Cash business transactions. Uses Cash Flow Statement Flow Statement is a

changes in the Fund by statement of cash flow and cash flow signifies the movement of cash in and out of a business It helps the reader to concern. understand not only the A cash flow statement if of financial stability of the primary importance to the

business also the

concern

but financial management. It is an tool of short-term of financial analysis. of

successful essential policies

implementation financial Basis of management.

accounting Fund Flow Statement is based on accrual basis of Cash Flow Statement is based on Limitation accounting. Fund does Flow not Statement provide Working Capital being a wider about concept of funds, a funds flow presents a more cash basis of accounting.

information

changes in Cash; which statement relevant Capital. than Working Statement.

are more important and complete picture than Cash Flow

8.2 Technique of Cash Flow Statement- It would be more useful to


describe the technique of Cash Flow Statement before highlights upon its nature and utility. As mentioned above, cash inflow and cash outflow are explained and shown in Cash Flow statement. On the one hand, all sources from which cash moves in the concern are natured and on the other hand, the various uses to which cash is put on and thus cash moves out of the concern are shown in this statement. The net effect of such cash movements is known as Net Cash Flow which is added/deducted to the opening balance of Cash/Bank to give closing balance of Cash/Bank. Therefore, it becomes necessary to have at least theoretical knowledge about the various items of cash inflow and the various items of cash outflow. 1. Items of Cash Inflow (Sources)- The various sources from which cash moves in the business concern may be put into two categories: (a) Activities relating to current operations; (b) Financial activities. A number of sub-activities may be grouped within these two categories. A summary of these activities is given below: Activities relating to Current operations: Cash sale of goods and services Cash sale of waste, bye-product and spoilage

Collection from customers- receipts from debtors and Bills Receivables Rent received from assets let out on rent Cash dividends and interest received on Investments. Refund of Tax Cash sale of fixed assets and current investments. Financial Activities: Discounting of Bills Receivables Issue of debentures for cash Raising loans for cash Issue of shares for cash 2. Items of Cash Outflow (uses)- The activities for which cash is put to use in a business concern may be (a) operational activities (b) activities relating to the purchase of fixed assets and (c) financial activities. A number of sub-activities may be grouped into these three distinct activities as summarised below: Operational activities: Cash payment of wages, production expenses and other operating expenses. Cash purchase or raw materials Cash payment to creditors and bills payable Cash payment of interest Cash payment of income-tax Cash dividends Cash payment of any sum payable under some legal decisions. Activities relating to the purchase of fixed assets: Cash purchase of fixed assets Cash expenses on the extraordinary repairs of plant and other equipments Cash purchase of temporary investments. Financial Activities: Repayment of long-term loan and redemption of debenture in cash Redemption of preference shares for cash. Self Check Questions What is Cash? What is difference between cash and fund? Write any four items of investment activities.

In practice information collected for the construction of Cash Flow Statement may contain the items of non-cash transactions also. Such transactions will have to be

separated. Thus, knowledge about such non-cash items is also imperative for the preparation of this statement. The following are included in such non-cash transactions: Recognition of depreciation, diminution and wastage in the value of assets. Recording of prepaid expenses Writing-off obsolete and irrecoverable assets and receipts, Appropriations of earned profit, Increased/decrease in the value of fixed asses on account of revaluation Recording of fixed assets written-off. In addition to the above, it also becomes necessary that after taking into account the adjustments made for outstanding expenses and receivable incomes, suitable adjustments should be made, so that accurate information in respect of current expenses and incomes may be obtained. The changes in stock, debtors, bills receivables, creditors and bills payable should be examined and analysed in such a way that their probable impact on cash position may easily and correctly be measured.

8.3

Formats of cash flow statement

Accounting Standard-3 (Amended) has not prescribed any format for cash flows statement. Following is the pro forma of cash flows statement, prepared by direct and indirect method and which has been prescribed by SEBI and is used by maximum number of organizations. Cash Flow Statement (Direct Method) For the year ended 31st March,.

Particulars A. Cash Flows From Operating Activities: Cash receipts from customers (See note 1) Cash paid to suppliers and employees (See .Note 2) Cash generated from operating activities Income Tax Paid Cash flow before extraordinary items (+) or (-) Extraordinary items

Rs. () ()

Rs. Note 1. Calculation of Cash Receipts From Customers Rs. Rs. Cash Sales Credit Sales (as stated in P&L A/c) Add: Debtors and B/R at the beginning Less: Debtors and B/R at the end Less: Discount allowed Less: Bad Debts written off Cash Generated from Credit Sales

() Net Cash from operating activities () B. Cash Flows From Investing Activities Purchase of Fixed Assets Sales of Fixed Assets Purchase of Investment (Long-term) Sales of Investment (Long-term) Interest received Dividend received Net Cash from investing activities C. Cash Flows From Financing Activities Proceeds from issue of share capital Proceeds from long-term borrowings Repayments of long-term borrowings Interest Paid Dividend Paid Net cash from financing activities Net Increase (or decrease) in cash (A + B + C) Cash and Cash equivalents at the beginning of the period Cash and Cash equivalents at the end of the period Cash Received Sales and Customers

() () ()

Note 2. Calculation of Paid to Suppliers and Employees Rs. Rs. Cost of Goods Sold* (as stated in P&L A/c) Operating Expenses (Adm. + Sell. + Fin exp) Add: Creditors at the beginning Outstanding expenses at the beginning Stock at the end Prepaid expenses at the end Less: Creditors at the end Outstanding expenses at the end Stock at the beginning Prepaid expenses at the beginning Cash paid to suppliers and employees

*If Purchases are given in the question instead of cost of goods sold, adjustment will not be made for stock at the end and stock at the beginning.

Cash Flow Statement (Indirect Method) For the year ended 31st March,. Particulars A. Cash Flows From Operating Activities: Net profit before tax and extraordinary items Adjustment For: Depreciation Loss on sale of fixed assets Gain on sale of fixed assets Interest paid Interest received Dividend received Goodwill written off Preliminary Exp. written off Provision for taxation (See Note-3) Proposed Dividend (Current Year) Operating profit before working capital Changes Add: Decrease in Current Assets Rs. () () () Rs.

Increase in Current Liabilities Less: Increase in Current Assets Decrease in Current Liabilities Cash generated from operating activities Income Tax Paid Cash flow before extraordinary items (+) or (-) extraordinary items Net Cash from operating activities

() () B. Cash Flows From Investing Activities Purchase of Fixed Assets (See Note-5) Sales of Fixed Assets Purchase of Investment (Long-term) Sales of Investment (Long-term) Interest received Dividend received Net Cash from investing activities () () C. Cash Flows From Financing () Activities Proceeds from issue of share capital Proceeds from long-term borrowings Repayments of long-term borrowings Interest Paid Proposed Dividend Paid (Previous Year) Net cash from financing activities Net Increase (or decrease) in cash (A + B + C) Cash and Cash equivalents at the beginning of the period Cash and Cash equivalents at the end of the period Note 3. Provision For Taxation

Adjustment for Tax depends upon, whether Provision for tax account is given or not given in the question. 1. When provision for tax account is not given in the Balance Sheet- In this case, there will be an adjustment or additional information given in the question. It will regarding the income tax paid. This item will affect Cash Flow from Operating Activities in the sense that it will be deducted from operating net profit after carrying out adjustment for increase/decreae in Current Assets/Current Liabilities. It Should be noted that income tax paid will be added to net profit during the year also. 2. When provision for Taxation Account is given in the question- In this case there are two situations. (a) When provision for tax account is given in the balance sheet and there is no adjustment: Under this situation provision for Tax should be treated as current liability and given effect in the calculation of Cash Flow from operating activities. (b) When provision for taxation account is given in the balance sheet as well as there is an adjustment also in the question. It is always advised that Provision for Taxes A/c should be prepared (See Note.4) to dig out the missing information regarding taxes paid/taxes provided.

Note 4. Provision For Taxation Account Particulars Amount To Bank A/c (Paid Tax) To Balance C/d (Current Year) Note 5. Fixed Assets A/c Particulars To Balance b/d (Current Year) To P & L A/c (Profit on Sales of F.A.) To Bank A/c (Balance Figure) (Purchase of assets)

Particulars By Balance B/d (Previous Year) By P & L A/c (Provision for tax)

Amount

Amount Particulars By Bank A/c (Sale Price of Assets) By Depreciation A/c . By P & L A/c (Loss on Sales of F.A.)

Amount

8.6

Classification of Cash Flows According to AS-3

Meaning of Cash Flows: In any organization inflows and outflows of cash and cash equivalents are termed as cash flows. Meaning of Cash: Cash refers to cash in hand and demand deposits with bank. Meaning of Cash Equivalents: Cash equivalents are short-term, highly liquid investments that are readily convertible into known amounts of cash. For example: treasury bills, commercial papers etc. Cash flows or sources and applications of cash: According to accounting Standard 3 cash flows has been divided into three parts: 1. Cash flows from operating activities: Operating activities refer to those activities, which generate revenue or are those activities, which generate sufficient cash flows. Cash flows from operating activities is a result of those transactions which determine net profit/loss. 2. Cash flows from Investing Activities: Investing activities are the acquisition and disposal of long-term assets and other investments not included in cash equivalents. For example: Land, Building, Plant, Machinery etc. 3. Cash Flows from Financing Activities: Financing activities refers to those activities, which are related to cash flows, which provide capital and loan to organization. Cash flows from financing activities change the size and structure of capital and loan.

Clarification by Table of Cash Flows from Operating Activities


Cash Inflow 1. Cash sale of goods and services. 2. Cash received from debtors. commissions receipts. and other Cash Outflow 1. Cash payments to suppliers of goods and services. revenue representatives. 3. In case of insurance company cash

3. Cash receipts from royalties, fees, 2. Cash payments to employers or their

4. Cash receipts from claims, annuity payments for insurance claims, annuity

and other policy profits in case of and other policy profits. insurance company. related to specific financing 4. Cash payments of Income tax. and contracts, forward contracts, option contracts and swap contracts when the 5. Refund of Income tax unless it is 5. Cash payments relating to future investing activities.

6. Cash receipts relating to future contracts are held for dealing or trading contracts, forward contracts, option purposes. contracts and swap contracts when the contracts are held for dealing or trading purposes.

CLARIFICATION OF OPERATING ACTIVITIES BY CHART OPERATING ACTIVITIES Cash in Flow Cash Out Flow

CASH FLOWS FROM INVESTING ACTIVITIES

CASH INFLOWS 1. Amount received from sale of fixed assets (Including intangible assets) 2. Amount received from sale of shares, bonds or debentures of other companies excluding those receipts, which are treated as cash or cash equivalent for business purposes. 3. Amount received as repayment of loans or advances given to third parties previously. 4. Cash option receipts contracts from and future swap contracts, contracts. 5. Dividend and Interest received in cash. 6. Insurance claim received from insurance company for assets destroyed in accident. forward contracts,

CASH OUTFLOWS 1. Purchase of fixed

assets

(Including intangible assets) 2. Purchase of shares, bonds or debentures of other companies. 3. Cash advances and loans given to third parties. 4. Cash payments for future contract, forward contract, option contract and swap contracts.

CLARIFICATION OF INVESTMENT ACTIVITIES BY CHART


INVESTING ACTIVITIES Cash in Flow Cash Sales of fixed assets Sales of investments and collection of loan Interest and dividend received on loan and investments Investing Activities Cash Out Flow Purchase of fixed assets Purchase of Investments Loan and advances to 3rd parties

CLARIFICATION OF FINANCING ACTIVITIES BY CHART


FINANCING ACTIVITIES Cash In Flow Cash Out Flow

Amount received from issue of share capital Amount received from issue of debentures Amount received from long-term loans Financing Activities

Redemption of shares & Debentures Payment of loans

Payment of interest and dividend Payment of finance and lease liabilities

Terminal Questions
1. What do you understand by Cash flow statement? How does it differ from Fund flow statement? Discuss their importance. 2. Explain the difference between Investing and Financing activities. 3. Prepare a Cash Flow statement by using imaginary figures (at least eight items in total)

LESSON 9
TABLE OF CONTENTS: 9.0 9.1 8.2 COMPUTATION OBJECTIVES

CASH FLOW ANALYSIS -3

PREPARATION OF CASH FLOW STATEMENT SOURCES OF CASH

PROVISIONS OF CASH FLOW STATEMENT CLASSIFICATION OF CASH FLOWS ACCORDING TO AS-3 8.6 8.7 8.8 TERMINAL QUESTIONS POSSIBLE ANSWER TO SELF-CHECK QUESTION REFERENCES AND SUGGESTED FURTHER READING