Cash flow statement
Cash plays a very important role in the economic life of a business. A firm
needs cash to make payment to its suppliers, to incur day-to-day expenses
and to pay salaries, wages, interest and dividends etc. In fact, what blood
is to a human body, cash is to a business enterprise. Thus, it is very essential
for a business to maintain an adequate balance of cash. For example, a
concern operates profitably but it does not have sufficient cash balance to pay dividends, what message does it convey to the shareholders and public
in general. Thus, management of cash is very essential. There should be
focus on movement of cash and its equivalents. Cash means, cash in hand
and demand deposits with the bank. Cash equivalent consists of bank
overdraft, cash credit, short term deposits and marketable securities.
Cash Flow Statement deals with flow of cash which includes cash
equivalents as well as cash. This statement is an 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.The purpose of the cash flow statement or statement of cash flows is to provide information about a company's gross receipts and gross payments for a specified period of time.The gross receipts and gross payments will be reported in the cash flow statement according to one of the following classifications: operating activities, investing activities, and financing activities. The net change from these three classifications should equal the change in a company's cash and cash equivalents during the reporting period. For instance, the cash flow statement for the calendar year 2013 will report the causes of the change in a company's cash and cash equivalents between its balance sheets of December 31, 2012 and December 31, 2013.In addition to the cash amounts being reported as operating, investing, and financing activities, the cash flow statement must disclose other information, including the amount of interest paid, the amount of income taxes paid, and any significant investing and financing activities which did not require the use of cash.The statement of cash flows is to be distributed along with a company's income statement and balance sheet.
The statement of cash flow serves a number of objectives which are as follows :
l Cash flow statement aims at highlighting the cash generated from operating activities.
2 Cash flow statement helps in planning the repayment of loan schedule and replacement of fixed assets, etc. l Cash is the centre of all financial decisions. It is used as the basis for the projection of future investing and financing plans of the enterprise.
3 Cash flow statement helps to ascertain the liquid position of the firm in a better manner. Banks and financial institutions mostly prefer cash flow statement to analyse liquidity of the borrowing firm.
4,Cash flow Statement helps in efficient and effective management of cash.
5 The management generally looks into cash flow statements to understand the internally generated cash which is best utilised for payment of dividends
6 Cash Flow Statement based on AS-3 (revised) presents separately cash generated and used in operating, investing and financing activities.
7 It is very useful in the evaluation of cash position of a firm
(a) Cash fund : Cash Fund includes
(i) Cash in hand
(ii) Demand deposits with banks, and (iii) cash equivalents.
(b) Cash equivalents are short-term, highly liquid investments, readily convertible into cash and which are subject to insignificant risk of changes in values.
2. Cash Flows are inflows and outflows of cash and cash equivalents. The statement of cash flow shows three main categories of cash inflows and cash outflows, namely : operating, investing and financing activities.
(a) Operating activities are the principal revenue generating activities of the enterprise.
(b) Investing activities include the acquisition and disposal of longterm assets and other investments not included in cash equivalents.
(c) Financing activities are activities that result in change in the size and composition of the owner’s capital (including Preference share capital in the case of a company) and borrowings of the FIRM.
PREPARATION OF CASH FLOW STATEMENT
Step -I
(i) Operating Activities Cash flow from operating activities are primarily derived from the principal revenue generating activities of the enterprise. A few items of cash flows from operating activities are (i) Cash receipt from the sale of goods and rendering services.
(ii) Cash receipts from royalties, fee, Commissions and other revenue.
(iii) Cash payments to suppliers for goods and services.
(iv) Cash payment to employees
(v) Cash payment or refund of Income tax.
Determination of cash flow from operating activities There are two stages for arriving at the cash flow from operating activities
Stage-1 Calculation of operating profit before working capital changes, It can be calculated in the following manner.
Net profit before Tax and extra ordinary Items
Add Non-cash and non operating Items which have already been debited to profit and Loss Account i.e. Depreciation xxx
Amortisation of intangible assets xxx
Loss on the sale of Fixed assets. xxx
Loss on the sale of Long term Investments xxx
Provision for tax xxx
Dividend paid xxx xxx xxx
Less : Non-cash and Non-operating Items which have already been credited to Profit and Loss Account i.e.
Profit on sale of fixed assets xxx
Profit on sale of Long term investment xxx xxx
Operating profit before working Capital changes. xxx
Stage-II
After getting operating profit before working capital changes as per stage I, adjust increase or decrease in the current assets and current liabilities. The following general rules may be applied at the time of adjusting current assets and current liabilities.
A. Current assets
(i) An increase in an item of current assets causes a decrease in cash inflow because cash is blocked in current assets
(ii) A decrease in an item of current assets causes an increase in cash inflow because cash is released from the sale of current assets.
B. Current liabilities
(i) An increase in an item of current liability causes a decrease in cash outflow because cash is saved. (ii) A decrease in an item of current liability causes increase in cash out flow because of payment of liability. Thus,
Cash from operations = operating profit before working capital changes + Net decrease in current assets + Net Increase in current liabilities – Net increase in current assets – Net decrease in current liabilities
Step - II - Investing Activities
Investing Activities refer to transactions that affect the purchase and sale of fixed or long term assets and investments. Examples of cash flow arising from Investing activities are
1. Cash payments to acquire fixed Assets
2. Cash receipts from disposal of fixed assets
3. Cash payments to acquire shares, or debenture investment.
4. Cash receipts from the repayment of advances and loans made to third parties. Thus, Cash inflow from investing activities are
– Cash sale of plant and machinery, land and Building, furniture, goodwill etc.
– Cash sale of investments made in the shares and debentures of other companies
– Cash receipts from collecting the Principal amount of loans made to third parties.
Cash outflow from investing activities are :
– Purchase of fixed assets i.e. land, Building, furniture, machinery etc.
– Purchase of Intangible assets i.e. goodwill, trade mark etc.
– Purchase of shares and debentures
– Purchase of Government Bonds
– Loan made to third parties
Step- III - Financing Activities
The third section of the cash flow statement reports the cash paid and received from activities with non-current or long term liabilities and shareholders Capital. Examples of cash flow arising from financing activities are
– Cash proceeds from issue of shares or other similar instruments.
– Cash proceeds from issue of debentures, loans, notes, bonds, and other short-term borrowings
– Cash repayment of amount borrowed Cash Inflow from financing activities are
- Issue of Equity and preference share capital for cash only.
– Issue of Debentures, Bonds and long-term note for cash only
Cash outflow from financing activities are :
– Payment of dividends to shareholders
– Redemption or repayment of loans i.e. debentures and bonds
– Redemption of preference share capital
– Buy back of equity shares.
TREATMENT OF SPECIAL ITEMS
(i) Payment of Interim Dividends The following procedure is followed
(i) The amount of interim dividend paid during the year is shown as outflow of cash in cash flow statement.
(ii) It will be added back to the profits for the purpose of calculating cash provided from operating activities.
(iii) No adjustment is necessary if the cash provided from operating activities is calculated on the basis of revised figure of net profit
(ii) Proposed dividend The dividend is always declared in the general meeting after the preparation of Balance Sheet. It is therefore, a non-operating item which should not be permitted to affect the calculation of cash generated by operating activities. Thus, the amount of proposed dividends would be added back to current years profit and payments made during the year in respect of dividends would be shown as an outflow of cash.
(iii) Share Capital The increase in share capital is regarded as inflow of cash only when there is a increase in share capital. For example, if a company issues 10000 equity shares of Rs.10 each for cash only, Rs. 100,000 would be shown as inflow of cash from financing activities. Similarly, the redemption of preference share is an outflow of cash. But where the share capital is issued to finance the purchase of fixed assets or the debentures are converted into equity shares there is no cash flow. Further, the issue of bonus shares does not cause any cash flows.
(iv) Purchase or sale of fixed Assets The figures appearing in the comparative balance sheets at two dates in respect of fixed assets might indicate whether a particular fixed asset has been purchased or sold during the year. This would enable to determine the inflows or outflows of cash. For example, If the plant and machinery appears at Rs 60,000 in the current year and Rs.50,000 in the previous year, the only conclusion, in the absence of any other information is that there is a purchase of fixed assets for Rs.10000 during the year. Hence, Rs.10000 would be shown as outflow of cash.
(v) Provision for Taxation It is a non-operating expenses or an item of appropriation in the Income statement/Profit and Loss Account and therefore should not be allowed to reduce the cash provided from operating activities. Hence, if the profit is given after tax and the amount of the provision for tax made during the year is given, the same would be added back to the current year profit figure. In the cash flow statement, the tax paid would be recorded separately as an outflow of cash. The item of provision for taxation, would not be treated as current assets. Sometimes, the only information available about provision for taxation is two figures appearing in the opening balance sheet and closing balance sheet. In such a case the figure in the opening balance sheet is treated as an outflow of cash while the figure in the closing balance sheet is treated as a non-cash and non-operating expense and thus is added back to net Income figure to find out the cash provided from operating activities.
The statement of cash flow serves a number of objectives which are as follows :
l Cash flow statement aims at highlighting the cash generated from operating activities.
2 Cash flow statement helps in planning the repayment of loan schedule and replacement of fixed assets, etc. l Cash is the centre of all financial decisions. It is used as the basis for the projection of future investing and financing plans of the enterprise.
3 Cash flow statement helps to ascertain the liquid position of the firm in a better manner. Banks and financial institutions mostly prefer cash flow statement to analyse liquidity of the borrowing firm.
4,Cash flow Statement helps in efficient and effective management of cash.
5 The management generally looks into cash flow statements to understand the internally generated cash which is best utilised for payment of dividends
6 Cash Flow Statement based on AS-3 (revised) presents separately cash generated and used in operating, investing and financing activities.
7 It is very useful in the evaluation of cash position of a firm
Cash flow statements – benefits
Cash flow information provided in the statement of cash flows can be beneficial, for example:
- Cash flow information is harder to manipulate as it just reflects cash in and cash out, it isn’t affected by accounting policies or accruals.
- The statement of cash flows provides information about all cash inflows and outflows, from all sources.
- Cash flow information can provide more detail about the quality of the entity’s revenue, for example, whether customers are (in general) paying their bills.
- Cash accounting methods used in the statement of cash flows can be easier for non-accountants to understand.
Cash flow statements – limitations
We’ve looked at all the benefits of a statement of cash flows, but there are limitations and drawbacks.
One of the major drawbacks is how information can be manipulated in the statement of cash flows:
- Management can delay paying suppliers to increase the net cash inflows
- Management can buy goods using leasing arrangements, to avoid paying cash
Cash flows also don’t reflect the earnings of the entity, although a company should be cash positive to trade in the short term, if it is doing this at the expense of sales, or is lossmaking, it may eventually cease trading.
None of the individual financial statements on their own show a full view of the entity’s performance.
Users of the financial statements should consider all parts of the financial statements together, and also other non-financial information about the company to assess its performance.
Cash and relevant terms as per AS-3 (revised)
As per AS-3 (revised) issued by the Accounting Standards Board
1. (a) Cash fund : Cash Fund includes
(i) Cash in hand
(ii) Demand deposits with banks, and (iii) cash equivalents.
(b) Cash equivalents are short-term, highly liquid investments, readily convertible into cash and which are subject to insignificant risk of changes in values.
2. Cash Flows are inflows and outflows of cash and cash equivalents. The statement of cash flow shows three main categories of cash inflows and cash outflows, namely : operating, investing and financing activities.
(a) Operating activities are the principal revenue generating activities of the enterprise.
(b) Investing activities include the acquisition and disposal of longterm assets and other investments not included in cash equivalents.
(c) Financing activities are activities that result in change in the size and composition of the owner’s capital (including Preference share capital in the case of a company) and borrowings of the FIRM.
PREPARATION OF CASH FLOW STATEMENT
Step -I
(i) Operating Activities Cash flow from operating activities are primarily derived from the principal revenue generating activities of the enterprise. A few items of cash flows from operating activities are (i) Cash receipt from the sale of goods and rendering services.
(ii) Cash receipts from royalties, fee, Commissions and other revenue.
(iii) Cash payments to suppliers for goods and services.
(iv) Cash payment to employees
(v) Cash payment or refund of Income tax.
Determination of cash flow from operating activities There are two stages for arriving at the cash flow from operating activities
Stage-1 Calculation of operating profit before working capital changes, It can be calculated in the following manner.
Net profit before Tax and extra ordinary Items
Add Non-cash and non operating Items which have already been debited to profit and Loss Account i.e. Depreciation xxx
Amortisation of intangible assets xxx
Loss on the sale of Fixed assets. xxx
Loss on the sale of Long term Investments xxx
Provision for tax xxx
Dividend paid xxx xxx xxx
Less : Non-cash and Non-operating Items which have already been credited to Profit and Loss Account i.e.
Profit on sale of fixed assets xxx
Profit on sale of Long term investment xxx xxx
Operating profit before working Capital changes. xxx
Stage-II
After getting operating profit before working capital changes as per stage I, adjust increase or decrease in the current assets and current liabilities. The following general rules may be applied at the time of adjusting current assets and current liabilities.
A. Current assets
(i) An increase in an item of current assets causes a decrease in cash inflow because cash is blocked in current assets
(ii) A decrease in an item of current assets causes an increase in cash inflow because cash is released from the sale of current assets.
B. Current liabilities
(i) An increase in an item of current liability causes a decrease in cash outflow because cash is saved. (ii) A decrease in an item of current liability causes increase in cash out flow because of payment of liability. Thus,
Cash from operations = operating profit before working capital changes + Net decrease in current assets + Net Increase in current liabilities – Net increase in current assets – Net decrease in current liabilities
Step - II - Investing Activities
Investing Activities refer to transactions that affect the purchase and sale of fixed or long term assets and investments. Examples of cash flow arising from Investing activities are
1. Cash payments to acquire fixed Assets
2. Cash receipts from disposal of fixed assets
3. Cash payments to acquire shares, or debenture investment.
4. Cash receipts from the repayment of advances and loans made to third parties. Thus, Cash inflow from investing activities are
– Cash sale of plant and machinery, land and Building, furniture, goodwill etc.
– Cash sale of investments made in the shares and debentures of other companies
– Cash receipts from collecting the Principal amount of loans made to third parties.
Cash outflow from investing activities are :
– Purchase of fixed assets i.e. land, Building, furniture, machinery etc.
– Purchase of Intangible assets i.e. goodwill, trade mark etc.
– Purchase of shares and debentures
– Purchase of Government Bonds
– Loan made to third parties
Step- III - Financing Activities
The third section of the cash flow statement reports the cash paid and received from activities with non-current or long term liabilities and shareholders Capital. Examples of cash flow arising from financing activities are
– Cash proceeds from issue of shares or other similar instruments.
– Cash proceeds from issue of debentures, loans, notes, bonds, and other short-term borrowings
– Cash repayment of amount borrowed Cash Inflow from financing activities are
- Issue of Equity and preference share capital for cash only.
– Issue of Debentures, Bonds and long-term note for cash only
Cash outflow from financing activities are :
– Payment of dividends to shareholders
– Redemption or repayment of loans i.e. debentures and bonds
– Redemption of preference share capital
– Buy back of equity shares.
TREATMENT OF SPECIAL ITEMS
(i) Payment of Interim Dividends The following procedure is followed
(i) The amount of interim dividend paid during the year is shown as outflow of cash in cash flow statement.
(ii) It will be added back to the profits for the purpose of calculating cash provided from operating activities.
(iii) No adjustment is necessary if the cash provided from operating activities is calculated on the basis of revised figure of net profit
(ii) Proposed dividend The dividend is always declared in the general meeting after the preparation of Balance Sheet. It is therefore, a non-operating item which should not be permitted to affect the calculation of cash generated by operating activities. Thus, the amount of proposed dividends would be added back to current years profit and payments made during the year in respect of dividends would be shown as an outflow of cash.
(iii) Share Capital The increase in share capital is regarded as inflow of cash only when there is a increase in share capital. For example, if a company issues 10000 equity shares of Rs.10 each for cash only, Rs. 100,000 would be shown as inflow of cash from financing activities. Similarly, the redemption of preference share is an outflow of cash. But where the share capital is issued to finance the purchase of fixed assets or the debentures are converted into equity shares there is no cash flow. Further, the issue of bonus shares does not cause any cash flows.
(iv) Purchase or sale of fixed Assets The figures appearing in the comparative balance sheets at two dates in respect of fixed assets might indicate whether a particular fixed asset has been purchased or sold during the year. This would enable to determine the inflows or outflows of cash. For example, If the plant and machinery appears at Rs 60,000 in the current year and Rs.50,000 in the previous year, the only conclusion, in the absence of any other information is that there is a purchase of fixed assets for Rs.10000 during the year. Hence, Rs.10000 would be shown as outflow of cash.
(v) Provision for Taxation It is a non-operating expenses or an item of appropriation in the Income statement/Profit and Loss Account and therefore should not be allowed to reduce the cash provided from operating activities. Hence, if the profit is given after tax and the amount of the provision for tax made during the year is given, the same would be added back to the current year profit figure. In the cash flow statement, the tax paid would be recorded separately as an outflow of cash. The item of provision for taxation, would not be treated as current assets. Sometimes, the only information available about provision for taxation is two figures appearing in the opening balance sheet and closing balance sheet. In such a case the figure in the opening balance sheet is treated as an outflow of cash while the figure in the closing balance sheet is treated as a non-cash and non-operating expense and thus is added back to net Income figure to find out the cash provided from operating activities.
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