Cash Flow Statement

MANAC I
Background ………..

 Accounting Equation

 Balance Sheet

 Profit and Loss Account

Questions to think
 Is the company growing or just maintaining its
competitive position?
 Will the company be able to meet its financial
obligations?
 Where did the company obtain funds?
 What use was made of net income?
 How much of the required capital was generated
internally?
 How as the expansion in plant and equipment financed?
 Is the business expanding faster than it can generate
funds?
 Is the company’s cash position sound, and what effect
will it have on the market price of stock
Statement of Cash Flows

· Accounts provide summarized information in

balance sheet and income statement.
· Third statement required by GAAP.
· Does not affect the way transactions are
recorded.
· Derived from data reported in the financial
statements i.e.
· Income Statement / Profit and Loss Account
· Balance Sheet
Balance sheet

· Status of firm’s funds at a point in time.

· Liabilities and owners’ equity side shows
sources of funds.
· Assets side shows uses of funds.
Flow Statements

· Explain the changes between two dates of

balance sheet snapshots.
· 2 types of flow statements:
· Income statement (and related statement of
retained earnings).
· Reconciles change in RE.
· Statement of Cash Flows.
· Reconciles changes in cash.
Statement of cash flows

· Provides info about cash flows associated

with the period’s operations and investing
and financing activities.
· Numbers on cash flow statement are
objective: cash is cash.
· Eliminates judgments and estimates involved
with accrual accounting as on income
statement and balance sheet.
Objective of Financial Statements

 Many believe:
 Balance Sheet and Income Statement provide
better about financial position of a business entity.

 But cash flow statement is a useful supplement.

Statement of Cash Flows:
2 Categories of Activities
· Sources = activities that generate cash.
· Uses = activities that involve spending cash

· List Down what are the various Sources of

cash for an entity or business

· List down what are the various Uses of cash

for an entity or business
Sources

· Operations – business related activities.

· New borrowings.
· New stock issues.
· Sale of property, plant, and equipment or
machinery.
· Sale of other non-current assets like
investments etc.
Uses

· Cash dividends.
· Repayment of borrowings.
· Repurchase of stock.
· Purchase of property, plant, and equipment.
· Purchase of non-current assets.
Definition of Cash

· Cash and cash equivalents.

· Highly liquid investments that are or can be
converted to cash in no more than 90 days.
Statement of Cash Flow

 A statement that presents the flow of cash to and

from an organization due to various transactions in a
given accounting period
 Helps assesses the ability of an enterprise to
generate cash and to utilize the cash
 Also helps to assess the liquidity and
solvency of the entity
Illustration – Nasir Enterprises

Profit & loss Account

For the period ending 31-03-20X7
Particulars Amount Particulars Amount
Rs. Rs.
Purchases 7,50,000 Sales 10,00,000
Salaries 50,000 (includes 50%
Wages 30,000 credit)
Office Expenses 10,000
Selling & Distribution
Expenses 12,000
Depreciation 8,000
Net Profit. 1,40,000
Total 10,00,000 Total 10,00,000
Observations…

 There is a profit of Rs 1,40,000 but assuming all

purchases to be cash purchases there is a net cash
outgo of Rs 8,52,000 during the period
 Since, the total cash inflow for the period is 5,00,000
(i.e., 50% of the total sales) and the total cash
outflow is Rs 8,52,000 (i.e., all the expenses other
than depreciation)
 In the same way there can be a business loss for the
period but still can result in a positive cash flow due
to the non-cash expenses like depreciation
Cash Flow Statement

 It provides information on changes during an

accounting period by cash and to classify cash flow
under three activities:
 Operating Activities
 The profit adjusted for depreciation, gains and/or

losses on sale of non-current assets, tax paid,

and working capital changes
 Investing Activities
 Purchases of non-current assets and proceeds

on the sale of non-current assets

Cash Flow Statement

 Financing Activities
 Proceeds on the issue of equity/preference shares

and loans/debentures and the redemption of

redeemable preference shares and
loan/debentures
 So, a cash flow statement is a consequence of the
difference between profits and cash
 It provides the user with a mechanism for providing
additional information on its business activities and a
better assessment of the current liquidity of a business
than a funds flow statement
Preparing a Cash Flow Statement

 All the cash flow activities are required to be

segregated under three activities viz., operating,
investing and financing
 The sum of these activities reflects the net increase
or decrease in the cash and cash equivalents
 Here, by cash we mean both cash in hand and bank
demand deposits, similarly cash equivalents means
all the short-term investments which can be readily
converted into cash without decline in its value
Operating Activities

 It is the principle revenue generating activities of an entity

 Two ways of calculating it
 Direct method
 We independently analyze the changes that cash

transactions cause in each balance sheet non-cash

account
 Indirect method
 The Profit and Loss Account is adjusted for the effects of

transactions of non-cash and non-operating nature

 Also known as “Reconciliation to Net Income”
Illustration – Kanishk Ent.
Profit & Loss Account
For the Year ending 31st March 20X7
Particulars Rs. Particulars Rs.
Purchases for the Year 80,000 Sales 1,65,000
Direct Expenses 20,000
Gross Profit 65,000
Total 1,65,000 Total 1,65,000
Rent 8,000 Gross Profit B/d 65,000
Salary 20,000 Profit on sale of old
Depreciation 15,000 machinery 13,000
Provision for Bad Debts 5,000
Proposed Dividends 10,000
Provision for Taxes 2,500
Preliminary Exp. written off 1,500
Net Profit 16,000
 Solution – Direct Method
Kanishk Enterprises
Cash Flow Statement
For the Year ending 31st March 20X7 (all figures in Rs)
Cash Flow From Operating Activities:
Cash received on account of sale of goods 1,65,000
Less: Payment made on account of
Purchases of goods 80,000
Freight and Cartage 20,000
Salary Paid 20,000
Rent Paid 8,000 1,28,000
Cash Inflow  37,000
Solution – Indirect Method

Kanishk Enterprises
Cash Flow From Operating Activities:
Net Profit as per Profit & loss Account 16,000
Add: Non-cash transaction
Provision for Bad Debts 5,000
Depreciation 15,000
Proposed Dividends 10,000
Provision for Taxes 2,500
Preliminary Expenses written off 1,500 34,000
Less: Non-operation incomes
Profit on sale of machinery
13,000
Cash Inflow  37,000
Investing Activities

 Activities related to acquisition and disposal of long-term

assets and other investments, which are not taken into
consideration under the cash equivalents head are investing
activities
 Also includes investments made by business entities in other
company’s shares and debentures
 Examples of investment activities include cash payments or
receipts to acquire or dispose fixed assets, shares, warrants,
debt instrument, etc.
Illustration - Kanishk
 The following transactions occur at Kanishk
Enterprises:

Amount
Particulars
(Rs.)
Purchased a machinery for 1,50,000
Sold shares worth of XYZ Ltd. 2,00,000
Received interest on debentures purchased
earlier 10,000
Received dividend on shares held 20,000
Sold old machinery 50,000
Solution

Kanishk Enterprises
Cash Flow Statement
Cash Flow from Investing Activities:
Sale of Shares of XYZ Ltd. 2,00,000
Interest received 10,000
Sale proceeds of old machinery 50,000
Dividend received 20,000
2,80,000
Less: Outflow on account of machine purchase 1,50,000
Cash flow from Investing Activities 1,30,000
Financing Activities

 The activities that result in the change in size and composition

of the long-term capital employed in the firm are known as
financing activities
 Includes both owner(s) capital and long-term borrowing of the
entity
 Example: cash received from issue of share capital, issue of
loans and cash payment on dividend, redemption, etc.
 Supposing during the year Kanishk Enterprises has taken a
loan of Rs 1,50,000 and paid an interest of Rs 15,000
thereon, the cash flow from financing activities for the year
comes to Rs 1,35,000 (i.e., 1,50,000 - 15,000)
Understand

 Concept of Working Capital

 Sources of Funds Application of Funds

 SC 300  FA 750
 RE 50
 LTL 500  CA 250
 Inventory 75
 CL 150
 Debtors 160
 ______
 Cash 15
 ______
 1000
 1000
 Imagine TWO companies identical in all the
respects
 How come ONE company does better over
the other?

 Depends upon Operating Cycle

 So what should be the ideal Operating Cycle
 Ans…………….
CA = Current Assets
CL = Current Liabilities
Change Adjustment to Net Income
 Decrease in CA  ADD

 Increase in CA  SUBTRACT

 Decrease in CL  SUBTRACT

 Increase in CL  ADD
Areas of Confusion
While preparing the statement of cash flow, the following
items usually create confusion:
 Interest received on long-term investments vis-à-vis
interest received on short-term investments (including
interest on trade advances and operating receivables)
 Interest paid on loans and debts vis-à-vis interest
paid on working capital loan
 Dividend received in case of financial enterprises vis-à-
vis dividends received by any other type of enterprise
 Dividend paid is always classified as financing activity
 Do the exercise
 Hand out problem
Given Net income as 60000 and depreciation on plant
charged was 25000, based on the following info.
Compute cash from operations
During 2010, the Zubo Corp sold its plant and
equipment for Rs.9000,000 and sold all of its
stock investment in Tredent Hotels, an
unrelated entity, for Rs.8000,000. It bought a
new plant for Rs.7000,000 and made a loan
of Rs.5500,000 to another company. Net
cash provided by the Corp’s investing
operations for the year 2010 is …………. ?

35
 In 2010, the Hidustan Herbals Ltd. Issued 2000
shares of its own common stock for Rs.2000,000
cash and Rs.10000,000 of its 10%, 10 year bonds. It
also issued another Rs.50000,000 in preferred stock
in return for land and buildings. HH Ltd. Then
reacquired 10,000 shares of its own common stock
for Rs.8800,000 and paid a cash dividend of
Rs.4000,000. Net cash provided by the corporations
investing operations for the year 2010 is
WHAT………?

36
Lastly,

 Indirect method is more widely used,

because it shows the relationship between
the Profit and Loss Account and the Balance
Sheet
 So, it helps in the analysis of these
statements

37