Cash Flow Statement

Cash Flow Statement is a statement showing the change in cash position from
one period to another. The cash flow statement summarizes the reasons for
increase or decrease in the amount of cash between two balance sheet dates. In
other words, it explains the reasons for inflow or outflow of cash. It explains how
much cash comes in and goes out of business over a period of time. It is a
statement showing the changes in cash flow by analyzing the changes in all
balance sheet accounts as inflows and outflows and classifying the flows into
operating, financing and investing activities.

In short, statement of changes in financial position prepared on cash basis is

called Cash Flow Statement (CFS).

In the Indian context preparation of Cash Flows Statement is governed by IND

AS-7 for companies who have adopted IND-AS and for other entities AS-3.

Objective of Ind AS 7
The objective of Ind AS 7 is to provide information about the historical changes
in cash and cash equivalents of an entity during the reporting period from its
operating, investing and financing activities. Cash flows are inflows and outflows
of cash and cash equivalents.

Need for Cash Flows Statement:

* Cash Flows Statement (CFS) or Statement of Cash Flows helps us to understand
cash flows in an organization.
* CFS bifurcate movement of cash flows in three broad categories viz Operating
Activities, Investing Activities and Financing Activities.
* Profits or losses depicted by Statement of Profit & Loss may or may not be
realized in Cash, this is the reason we see many well performing organizations
having huge profits are unable to meet their loan obligations and ultimately default.

According to famous Management consultant Peter F. Drucker

“Entrepreneurs believe that profit is what matters most in a new enterprise.
But profit is secondary. Cash flow matters most.”

Key Terminologies used in Cash Flows Statement:

Cash: cash comprises cash on hand and demand deposits with banks.

Cash and cash equivalents: As per IND AS-7 “Short-term, highly liquid
investments that are readily convertible to known amounts of cash and which are
subject to an insignificant risk of changes in value.”
For example: Fixed Deposits, treasury bill, commercial paper, short term deposits ,
marketable securities etc.

Cash Flows: cash flows are inflows or out flows of cash and cash equivalents.
When there is a change in any transaction, there will be flow of cash. If the effect
of transaction results in the increase of cash and cash equivalents, it is called an
inflow (i.e., source). If it results in the decrease of cash, it is called outflow (i.e.,
use/application)

Operating Activities: As per IND-AS 7 “Cash flows from operating activities are
primarily derived from the principal revenue producing activities of the entity“
In Simple terms , whatever an organization earns purely from its business activities
can be termed as operating activities.
For example- For an IT Company, consultancy & development of software can be
termed as operating activity.
What constitutes operating activities differ from business to business.

Investing Activities: As per IND-AS 7 “The cash flows represent the extent to
which expenditures have been made for resources intended to generate future
income and cash flows. Only expenditures that result in a recognized asset in the
balance sheet are eligible for classification as investing activities”

In other words , whatever a business invests today to generate future income or for
growth or for expansion or for replacement of existing resources with new one can
be termed as investing activities.
For example- Investment in Plant & Machinery, replacement of obsolete plant and
machinery etc. can be categorized under investing activities.

Financing Activities: As per IND AS-7 “Activities that result in changes in the
size and composition of the contributed equity and borrowings of the entity.”

In other words whatever a business borrows, repays or raise capital and their
related payments (like interest, dividend etc.) to manage Operating and Investing
activities can be termed as financing activities.
For example- Repayment of loans, Borrowings from banks , Issue of Debentures ,
Equity shares etc.

Importance or Managerial Uses (Advantages) of CFS:

There are many managerial decisions which are taken in the light of the
availability of cash position. Cash flow statement provides information for
managerial decision-making. It is an important technique for short term financial
analysis. Its main uses are as follows:
1. Helpful in short term planning: Cash is the basis for formulating any financial
plan. The absence of cash, a plan cannot be accomplished successfully. Cash flow
state gives information regarding sources and application of cash for a specific
period. This enables to plan investment, operating and financial activities of an
enterprise.
2. Helpful in formulation of financial policies: Cash flow statement is helpful in
formulating financial policies like dividend policy, credit policy etc.
3. Provide a basis for cash budget: Cash flow is the foundation of cash budget. It
forms the basis for preparing monthly or quarterly or even the annual cash budget.
4. Reveals liquidity and solvency: Cash flow statements helps to ascertain
liquidity and solvency of a business in a better way.
5. Helps in efficient cash management: Cash flow statement provides
information relating to surplus or deficit of cash. Hence an organization can decide
about the short term investment of the surplus. Similarly it can arrange short term
credit in case of deficit.
6. Shows the causes of change in cash position: Cash flow statement explains the
reasons for lower and higher cash balance with the enterprises. Sometimes, there is
a lower cash balance in spite of higher profits or higher cash balance in spite of
lower profits. Reasons for such situations can be analyzed with the help of cash
flow statements.
7. Helpful in control: Cash flow statement is a control device, A comparison of
cash flow statement with a previous year or with a cash budget shows the
variations between original forecasts and actual results. This indicates to what
extent the financial resources were used according to plan.
8. Helpful in short term financial decisions: On the basis of information
provided by cash flow statements, it is possible to take short term financial
decisions like repayment of loan, payment of bonus, investment outside the firm
etc.
Limitations of Cash Flow Statements
A cash flow statement has the following limitations:
1. Ignores non-cash transactions: Cash flow statement does not show non-cash
transactions like purchase of machinery by the issue of shares/debentures.
2. Not a substitute for Income Statement: An income statement shows both cash
and non-cash items. It shows the net profit or net loss of the firm. But cash flow
statement shows only the net cash inflow or outflow. This is not equal to the net
profit/net loss of the enterprise.
3. Historical in nature: A cash flow statement is only the rearrangement of
information available in income statement or balance sheet. Thus it is historical in
nature.
4. Limited scope: Cash flow statement shows inflows and outflows of cash alone.
Its scope is very limited when compared to fund flow statement. Thus cash flow
statement does not show the overall financial position.
5. Easily influenced by managerial decisions: The cash balance can be easily
influenced by managerial decisions such as making certain payments in advance or
postponing payments. Hence, a CFS does not present a realistic picture.
6. Does not present true picture of liquidity: A CFS does not present true picture
of liquidity of a firm because the liquidity does not depend upon cash alone.
Liquidity depends also upon those assets which can be converted into cash easily.

Presentation of Cash Flow Statement

In cash flow statement all cash flows are classified into three. They are:

a) Cash Flow from Operating activities

 b) Cash Flow from Investing activities

c) Cash Flow from Financing activities

Cash Flows from Operating Activities

Operating activities are the main revenue producing activities of the enterprise
these involve producing goods and services and selling them. Cash flows from
operating activities generally result from the transactions and events that enter into
the determination of net profit or loss; In short, operating activities are activities
relating to operation

Examples of cash flows from operating activities

Cash inflows:

a) Cash sales.
b) Cash receipts from debtors for sale of goods or rendering services.
c) Cash receipts from royalty, fees, commission and other revenue.

Cash Outflows:

d) Cash purchases.
e) Cash payments to suppliers of goods and services.
f) Payments for operating expenses (wages, salaries, rent, insurance etc.).
g) Cash payments to govt. for tax and duties.

There are some transactions such as sale of an item of plant etc. that may result
in profit or loss. These are usually taken in the determination of net profit or loss.
However, these are cash flows from investing activities.

Cash Flows from Investing Activities

 Investing activities include purchase and sale of fixed assets, securities (share,
debentures) etc. Cash flow from investing activities discloses the expenditures
incurred for resources intended to generate future income and cash flows.

Examples of cash flow from investing activities

Cash inflows:

a) Cash receipts from sale of fixed assets and intangible assets.

b) Cash receipts from sale of securities such as shares, debentures etc.
c) Receipt of interest and dividend on investment.

Cash out flows:

d) Cash payment for purchase of fixed assets and intangible assets (investment
in assets).
e) Cash payment for purchase of securities (investment in securities).
f) Loans given to borrowers.
It may be noted that the cash receipt on sale of fixed and intangible assets are
taken as cash flows from investing activities. Thus profit or loss on sale is
automatically adjusted here. That is why profit or loss on sale of fixed assets and
intangible assets is not taken as cash flow from operating activities.

Cash Flows from Financing Activities.

Financing activities are those activities which result in changes in size and
composition of owners' capital (or shareholders' funds) and borrowings of the
enterprise. These include raising funds from owners, borrowing from creditors and
repayment/ redemption.

Examples of cash flow from financing activities.

Cash inflows:
a) Cash proceeds from issue of shares.
b) Cash proceeds from issue of debentures, bonds etc.
c) Short term and long term loans or borrowings.
Cash outflows:
d) Redemption of preference shares.
e) Redemption of debentures, bonds etc.
f) Repayment of loans (short term and long term)
g) Payment of dividend
h) Payment of interest on debentures and loans.
It may be noted that interest and dividend on investment (inflow) are cash flow
from investing activities, while payment of interest and dividend on capital and
borrowings are cash flows (outflow) from financing activities.

Note: In case of financial enterprise such as Bank or Mutual Fund Company cash
outflow and cash inflow arising from the purchase and sale of securities will be
treated as flow from Operating Activities. This is, because, purchase and sale of
securities is a part of operating activity in case of financial enterprises. In addition,
interest paid and interest received as well as dividend received will also be treated
as cash flows from operating activities in case of financial enterprises.

Procedure of Preparing a Cash Flow Statement

Understanding Cash Flows Statement: Cash Flows Statement can be prepared
using Direct Method or Indirect method. However in Indian Context, organizations
follow indirect method.
 Cash flow statement is prepared with the help of financial statements and
additional information. The preparation of cash flow statement involves the
following steps:
1. Calculate the net increase or decrease in cash and cash equivalents by
comparing these accounts given in the comparative balance sheets.
2. Calculate the net cash flow provided/ used in operating activities. This is
done by analyzing the P/L A/c, B/S and additional information. There are
two methods of calculating cash flows from operation - Direct method and
indirect method.
3. Calculate the net cash flow from investing activities.
4. Calculate the net cash flow from financing activities.
5. Prepare a cash flow statement showing the net cash flow from (or used in)
operating, investing and financing activities separately.
6. Make an aggregate of net cash flows from the three activities and ensure that
the net cash flow is equal to the net increase or decrease in cash and cash
equivalent calculated in step1.
7. Report significant non-cash transactions that do not involve cash or cash
equivalents a separate schedule to the CFS.
Note: The sum of cash flow from all the activities taken together, along with
the opening cash and cash equivalents shall be equal to the closing cash and
cash equivalents.
Calculation of Cash Flow from Operating Activities
Cash from operation means the cash generated in the business as a result of
producing goods and services. It can be ascertained either by direct method or
by indirect method.
Direct method: Under the direct method major classes of gross cash receipts
(inflows) and gross cash payments (outflows) are disclosed. In this method,
cash receipts from operating revenues and cash payments for operating
expenses are calculated to arrive at cash flows from operating activities. The
difference between the cash receipts and the cash payments is the net cash flow
from (or used in) operating activities. The information about major classes of
gross cash receipts and gross cash payments may be obtained either:
(a) From the accounting records of the enterprise, or
(b) By adjusting sales, cost of sales and other items in the P/L A/c for:
i) Changes during the period in inventories and operating receivables and
payables.
ii) Other non-cash items, and
iii) Other items for which the cash effects are investing or financial cash
flows.
How cash flows from investing and financial activities are shown can be seen in
the format.

Form of cash flow statement

Cash flow statement contains sources of cash (cash inflows) and uses or
applications of cash (cash outflows). A widely used format of CFS is given as
follows:
Cash flow statement (Direct Method)
For the year ended…….
1. Cash flows from operating activities: Xxxx xxxx

a. Operating cash receipts:

Cash sales