Cash Flow Statement

Cash Flow Statement shows the inflows and outflows of cash and cash equivalents. Cash
includes cash in hand and demand deposits with the banks while cash equivalents are highly
liquid investments i.e. they can be readily converted into cash like marketable securities,
commercial papers and short-term government bonds. It explains the changes in the cash in hand
and cash at bank at the beginning and the end of the accounting period. So, cash flow statement
is a statement specifying the cash inflows and cash outflows arising from the Operating,
Investing and Financing activities during the two successive balance sheets explaining the
difference between the opening and closing cash balance. It is inflows and outflows of cash and
cash equivalents.

Objectives of Cash Flow Statement

 Cash Flow Statement aims at highlighting the cash generated from operating activities.
 Cash Flow Statement helps in planning the repayment of loan schedule and replacement
of fixed assets.
 Cash is the center of all financial decisions. It is used as the basis for the projection of
future investing and financing plans of the enterprise.
 Cash Flow Statement helps ascertain the liquid position of the firm in a better manner.
Banks and financial institutions mostly prefer cash flow statement to analyze liquidity of
the borrowing firm.
 Cash Flow Statement helps in efficient and effective management of cash. 

Differences between Cash Flow Statement and Fund Flow Statement

Factors Cash Flow Fund Flow
Cash Flow Statement is a statement Fund Flow Statement is a statement
showing the inflows and outflows of showing the changes in the financial
Meaning
cash and cash equivalents over a position of the entity in different
period. accounting years.
To show the reasons for movements To show the reasons for the changes in
Purpose of
in the cash at the beginning and at the the financial position, with respect to
Preparation
end of the accounting period. previous year & current accounting year.
Basis Cash Basis of Accounting. Accrual Basis of Accounting.
Analysis Short-term analysis of cash planning. Long-term analysis of financial planning
Discloses Inflows and outflows of cash Sources and applications of funds
Opening and It contains opening and closing It doesn’t contain opening balance of
Closing Balance balance of cash and cash equivalents. cash and cash equivalents.
Financial
It is a part of the Financial Statement. It is not a part of the Financial Statement.
Statement

Segments of Cash Flow Statement

Cash flow statement is partitioned into three segments namely —
 Cash flow from operating activities
 Cash flow from investing activities
 Cash flow from financing activities

Accounting Standard  – 3 deals with the cash flow statement. It has been classified into three
broad categories:

Cash Flow Statement (PH: Lecture sheet 2) Page1

  Operating Activities – representing movements of money due to regular business
operations like the purchase, sale and production of goods.
 Investing Activities – representing the movement of cash due to the purchase or sale of
assets or any other investment activities of the business.
 Financing Activities – accounts for the funds raised through the issue of shares or
debentures, long-term loans and utilized for the redemption of shares or debentures and
payment of dividend.

Operating Activities
Cash Inflows Cash Outflows
 Cash Sale  Cash Purchase Payment to creditors
 Cash received from debtors  Payment of wages
 Cash received from commission & Fees  Cash operating expenses
 Cash operating revenues

Investing Activities
Cash Inflows Cash Outflows
 Sale of fixed assets  Purchase of fixed assets
 Sale of investment  Purchase of investment
 Interest received
 Dividend received

Financing Activities
Cash Inflows Cash Outflows
 Issue of shares  Cash repayments of amounts borrowed
 Issue of debentures in cash  Interest paid on loans/debentures
 Proceeds from long-term to short-term  Dividends paid on equity & preference
borrowings share capital

There are two methods of preparation of a Cash Flow Statement. The methods are —
 Direct Method
 Indirect Method
Direct Method versus Indirect Method of Presentation
There are two methods for producing a statement of cash flows — the direct method and the
indirect method.
In the Direct Method, all individual instances of cash that is received or paid out are tallied up
and the total is the resulting cash flow.
In the Indirect Method, the accounting line items such as net income, depreciation, etc. are used
to arrive at cash flow.  In financial modeling, the cash flow statement is always produced via the
indirect method.

Statement of Cash Flows:( Indirect Method) The indirect method uses changes in balance
sheet accounts to reconcile net income to cash flows from operations.
Assets = Liabilities + Stockholders Equity
Or, Cash + Noncash Assets = Liabilities + SE
Or, Cash = L + SE – NCA
This means that we can evaluate changes in cash by looking at changes in balance sheet
accounts. We can adjust this further by noting that
SE = NI – Dividends .
Cash Flow Statement (PH: Lecture sheet 2) Page2
Or, Cash = L + NI – Dividends – NCA
To get cash flows from operations we start with net income and adjust for changes in current
assets and current liabilities. The operating cash flow section of the Statement of Cash Flows
using the indirect method has the following form: Net Income + Depreciation Expense - Current
Assets (minus increases, plus decreases) + Current Liabilities (plus increases, minus decreases)
= Cash flows from operations.

Below is a comparison between the direct method and the indirect method. 

Sample Problem: Use the following data to construct a statement of cash flows using the direct
and indirect methods.
Particulars 2019 2018
Cash Flow Statement (PH: Lecture sheet 2) Page3
 Cash 4000 14000
Accounts receivable 25000 32500
Prepaid insurance 5000 7000
Inventory 37000 34000
Fixed assets 316000 270000
Accumulated Depreciation -45000 -30000
Total assets 342000 327500

Accounts payable 18000 16000

Wages payable 4000 7000
Note payable 173000 160000
Capital stock 88000 84000
Retained earnings 59000 60500
Total Liabilities & Equity 342000 327500

Sales 200000
Cost of goods sold -123000
Depreciation expense -15000
Insurance expense -11000
Wage Expense -50000
Net Income 1000

 During 2000 declared and paid dividends of $2,500.

 During 2000, ABC paid $46,000 in cash to acquire new fixed assets.
 The accounts payable was used only for inventory.
 No debt was retired during 2000.

Solution: Indirect Method

Cash Flow from Operations:
Net Income 1000
Depreciation Expense 15000
Accounts receivable 7500
Prepaid insurance 2000
Inventory (3000)
Accounts payable 2000
Wages payable (3000)
Cash Flow from Operations 21,500
Cash Flow from Investments:
Cash paid for fixed assets (46,000)
Cash flow from financing activities:
Cash dividend payments (2,500)
Proceeds from issuance of note payable 13000
Proceeds from issuance of stock 4,000
Cash flows from financing activities 14,500
Net Cash Flow (10,000)
Beginning Cash Balance 14,000
Ending Cash Balance 4,000

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