Cash Flow Statements

Chapter – IX

DISCUSSION POINTS:

• Meaning of Cash Flow Statement

• Types of Cash Flows
• Differences Between Cash Flow and Funds Flow Statements
• Cash Flow Statement Accounting Standard-3 (Revised).

Meaning of Cash Flow Statement:

Cash Flow Statement provides information regarding the cash inflows and outflows of an
organization during a particular period. It provides a valuable analytical tool along with the
financial statements. The economic decisions that have to be taken by users of financial
statements include, to a large extent, an estimation of the cash and cash equivalents that the
organization may generate and the timing and certainty of such a generation. This is regardless of
the enterprise’s activities and irrespective of whether cash can be viewed as the product of the
enterprise, as may be the case with a financial enterprise. In many senses it is a narrower
definition of the term “Funds”, in a broader sense it means the net working capital of the
company, and in its narrow sense the word conveys the meaning of cash and its equivalents, to
the exclusion of all other current items.

Cash and Cash Equivalents

Cash and Cash equivalents are defined as follows in AS-3:
 Cash comprises cash on hand and demand deposits with banks.
 Cash equivalents are short-term, highly liquid investments that are readily convertible
into known amounts of cash and which are subject to an insignificant risk of changes in
value.
 Cash equivalents are held for the purpose of meeting short-term cash commitments
rather than for investment or other purposes.

Cash Flow from Operating Activities:

Operating Activities may be described as the principal revenue producing
activities of the enterprise and other activities that are not investing or financing [as per AS-3 and
IAS-7].These activities are what may be described as the cash that is generated or used in the core
business of the entity.

Cash Flow from Investing Activities

Investing Activities are the acquisition and disposal of long-term assets and other investments not
included in cash equivalents [as per AS-3 and IAS-7].

Cash Flow from Financing Activities

Financing Activities are activities that result in changes in the size and composition of the
owner’s capital (including preference share capital) and the borrowings of the enterprise [AS-3].

Accounting for Managers

Difference Between Cash Flow and Funds Flow Statements:
Funds Flow at the outset it is a broader concept encompassing a variety of current items, however
cash flow on the other hand is a basic cash concept whereby only the cash and cash equivalent
flows are traced.

Cash Flow Statement Accounting Standard-3 (Revised):

The following is the text of the revised Accounting Standard (AS) 3, ‘Cash Flow Statements’,
issued by the Council of the Institute of Chartered Accountants of India. This Standard
supersedes Accounting Standard (AS) 3, ‘Changes in Financial Position’, issued in June, 1981.In
the initial years, this accounting standard will be recommendatory in character. During this
period, this standard is recommended for use by companies listed on a recognised stock exchange
and other commercial, industrial and business enterprises in the public and private sectors.
Objective
Information about the cash flows of an enterprise is useful in providing users of financial
statements with a basis to assess the ability of the enterprise to generate cash and cash equivalents
and the needs of the enterprise to utilise those cash flows. The economic decisions that are taken
by users require an evaluation of the ability of an enterprise to generate cash and cash equivalents
and the timing and certainty of their generation. The Statement deals with the provision of
information about the historical changes in cash and cash equivalents of an enterprise by means
of a cash flow statement which classifies cash flows during the period from operating, investing
and financing activities.
Scope
An enterprise should prepare a cash flow statement and should present it for each period for
which financial statements are presented.
Benefits of Cash Flow Information
A cash flow statement, when used in conjunction with the other financial statements, provides
information that enables users to evaluate the changes in net assets of an enterprise, its financial
structure (including its liquidity and solvency) and its ability to affect the amounts and timing of
cash flows in order to adapt to changing circumstances and opportunities. Cash flow information
is useful in assessing the ability of the enterprise to generate cash and cash equivalents and
enables users to develop models to assess and compare the present value of the future cash flows
of different enterprises. It also enhances the comparability of the reporting of operating
performance by different enterprises because it eliminates the effects of using different
accounting treatments for the same transactions and events.
Cash and Cash Equivalents
Cash equivalents are held for the purpose of meeting short-term cash commitments rather than for
investment or other purposes. For an investment to qualify as a cash equivalent, it must be readily
convertible to a known amount of cash and be subject to an insignificant risk of changes in value.
Therefore, an investment normally qualifies as a cash equivalent only when it has a short maturity
of, say, three months or less from the date of acquisition. Investments in shares are excluded from
cash equivalents unless they are, in substance, cash equivalents; for example, preference shares of
a company acquired shortly before their specified redemption date (provided there is only an
insignificant risk of failure of the company to repay the amount at maturity). Cash flows exclude
movements between items that constitute cash or cash equivalents because these components are
part of the cash management of an enterprise rather than part of its operating, investing and
financing activities. Cash management includes the investment of excess cash in cash
equivalents.

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Presentation of a Cash Flow Statement
The cash flow statement should report cash flows during the period classified by operating,
investing and financing activities.
Operating Activities
The amount of cash flows arising from operating activities is a key indicator of the extent to
which the operations of the enterprise have generated sufficient cash flows to maintain the
operating capability of the enterprise, pay dividends, repay loans and make new investments
without recourse to external sources of financing. Information about the specific components of
historical operating cash flows is useful, in conjunction with other information, in forecasting
future operating cash flows.
Investing Activities
The separate disclosure of cash flows arising from investing activities is important because the
cash flows represent the extent to which expenditures have been made for resources intended to
generate future income and cash flows. When a contract is accounted for as a hedge of an
identifiable position, the cash flows of the contract are classified in the same manner as the cash
flows of the position being hedged.
Financing Activities
The separate disclosure of cash flows arising from financing activities is important because it is
useful in predicting claims on future cash flows by providers of funds (both capital and
borrowings) to the enterprise. Examples of cash flows arising from financing activities are:
a. cash proceeds from issuing shares or other similar instruments;
b. cash proceeds from issuing debentures, loans, notes, bonds, and other short or long-term
borrowings; and
c. cash repayments of amounts borrowed.
Reporting Cash Flows from Operating Activities
An enterprise should report cash flows from operating activities using either:
a. the direct method, whereby major classes of gross cash receipts and gross cash payments are
disclosed; or
b. the indirect method, whereby net profit or loss is adjusted for the effects of transactions of a
non-cash nature, any deferrals or accruals of past or future operating cash receipts or
payments, and items of income or expense associated with investing or financing cash flows.
Reporting Cash Flows from Investing and Financing Activities
To the extent that cash flows described in paragraphs 22 and 24 An enterprise should report
separately major classes of gross cash receipts and gross cash payments arising from investing
and financing activities, except are reported on a net basis.
Reporting Cash Flows on a Net Basis
Cash flows arising from the following operating, investing or financing activities may be reported
on a net basis:
a. cash receipts and payments on behalf of customers when the cash flows reflect the
activities of the customer rather than those of the enterprise; and
b. cash receipts and payments for items in which the turnover is quick, the amounts
are large, and the maturities are short.
Cash flows arising from each of the following activities of a financial enterprise may be reported
on a net basis:
a. cash receipts and payments for the acceptance and repayment of deposits with a
fixed maturity date;

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 b. the placement of deposits with and withdrawal of deposits from other financial
enterprises; and
c. cash advances and loans made to customers and the repayment of those advances
and loans.
Foreign Currency Cash Flows
Cash flows arising from transactions in a foreign currency should be recorded in an enterprise’s
reporting currency by applying to the foreign currency amount the exchange rate between the
reporting currency and the foreign currency at the date of the cash flow. A rate that approximates
the actual rate may be used if the result is substantially the same as would arise if the rates at the
dates of the cash flows were used. The effect of changes in exchange rates on cash and cash
equivalents held in a foreign currency should be reported as a separate part of the reconciliation
of the changes in cash and cash equivalents during the period.
Extraordinary Items
The cash flows associated with extraordinary items should be classified as arising from operating,
investing or financing activities as appropriate and separately disclosed.
Interest and Dividends
Cash flows from interest and dividends received and paid should each be disclosed separately.
Cash flows arising from interest paid and interest and dividends received in the case of a financial
enterprise should be classified as cash flows arising from operating activities. In the case of other
enterprises, cash flows arising from interest paid should be classified as cash flows from
financing activities while interest and dividends received should be classified as cash flows from
investing activities. Dividends paid should be classified as cash flows from financing activities.
Taxes on Income
Cash flows arising from taxes on income should be separately disclosed and should be classified
as cash flows from operating activities unless they can be specifically identified with financing
and investing activities.
Investments in Subsidiaries, Associates and Joint Ventures
When accounting for an investment in an associate or a subsidiary or a joint venture, an investor
restricts its reporting in the cash flow statement to the cash flows between itself and the
investee/joint venture, for example, cash flows relating to dividends and advances.
Acquisitions and Disposals of Subsidiaries and Other Business Units
 The aggregate cash flows arising from acquisitions and from disposals of subsidiaries or
other business units should be presented separately and classified as investing activities.
 An enterprise should disclose, in aggregate, in respect of both acquisition and disposal of
subsidiaries or other business units during the period each of the following:
a. the total purchase or disposal consideration; and
b. the portion of the purchase or disposal consideration discharged by means of cash and
cash equivalents.
Non-cash Transactions
Investing and financing transactions that do not require the use of cash or cash equivalents should
be excluded from a cash flow statement. Such transactions should be disclosed elsewhere in the
financial statements in a way that provides all the relevant information about these investing and
financing activities.
Components of Cash and Cash Equivalents
An enterprise should disclose the components of cash and cash equivalents and should present a
reconciliation of the amounts in its cash flow statement with the equivalent items reported in the
balance sheet.

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Other Disclosures
An enterprise should disclose, together with a commentary by management, the amount of
significant cash and cash equivalent balances held by the enterprise that are not available for use
by it.

END POINTS:

 Cash Flow Statement provides information regarding the cash inflows and outflows of an
organization during a particular period. It provides a valuable analytical tool along with
the financial statements.

 In the USA, FAS No.95, “Statement of Cash Flows” was issued in November 1987, and
made effective from the fiscal July 1988.
 The Institute of Chartered Accountants of India revised its AS-3 and replaced ‘Changes
in Financial Position’ with “Cash Flow Statements” from the year ending 31st March,
1997.

 Cash Flow Statement explains the flow of cash under three different heads. These are:
i. Cash Flow from Operating Activities
ii. Cash Flow from Investing Activities
iii. Cash Flow from Financing Activities.
 Funds Flow at the outset it is a broader concept encompassing a variety of current items,
however cash flow on the other hand is a basic cash concept whereby only the cash and
cash equivalent flows are traced.