Accountancy Chapter 2.6 - Cash Flow Statement

Chapter 2.6 – Cash Flow Statement

Accountancy Chapter 2.6 – Cash Flow Statement

1. Introduction to Cash Flow Statement

Definition: A financial statement that tracks the inflow and outflow of cash and cash equivalents during a specific period.
Purpose:
- Provides insights into liquidity, solvency, and financial flexibility.
- Helps stakeholders assess an enterprise’s ability to generate cash and meet obligations.
Legal Requirement: Mandatory under AS-3 (Accounting Standard 3) as per the Companies Act, 2013.

2. Objectives of Cash Flow Statement

Track Cash Movements: Classify cash flows into operating, investing, and financing activities.
Assess Liquidity: Evaluate the ability to generate cash for debt repayment, dividends, and investments.
Predict Future Cash Flows: Aid in forecasting and budgeting.
Enhance Comparability: Standardize cash flow reporting across firms.

3. Benefits of Cash Flow Statement

Liquidity Analysis: Reveals cash availability for short-term obligations.
Investment Decisions: Shows cash used for long-term assets.
Debt Management: Highlights cash flows from financing activities (e.g., loans, equity).
Performance Evaluation: Compares cash profits with accrual-based profits.

4. Key Definitions

4.1 Cash

Includes:
- Cash in hand.
- Demand deposits (e.g., bank accounts).

4.2 Cash Equivalents

Short-term, highly liquid investments:
- Maturity ≤ 3 months.
- Examples: Treasury bills, commercial paper.
Excludes: Equity investments (unless redeemable within 3 months).

4.3 Cash Flows

Inflows: Receipts from sales, dividends, asset sales.
Outflows: Payments to suppliers, employees, taxes, asset purchases.

5. Classification of Activities

Cash flows are categorized into three activities:

5.1 Operating Activities

Definition: Core revenue-generating activities (e.g., sales, purchases).
Cash Inflows:
- Cash receipts from customers.
- Commission, royalties.
Cash Outflows:
- Payments to suppliers, employees.
- Income tax (unless linked to investing/financing).
Significance: Indicates operational efficiency.

5.2 Investing Activities

Definition: Transactions involving long-term assets and investments.
Cash Inflows:
- Sale of fixed assets (e.g., machinery, land).
- Interest/dividends from investments.
Cash Outflows:
- Purchase of fixed assets.
- Loans to third parties.
Significance: Reflects growth and capital expenditure.

5.3 Financing Activities

Definition: Transactions affecting equity and long-term liabilities.
Cash Inflows:
- Issuing shares, debentures.
- Borrowing loans.
Cash Outflows:
- Repayment of loans.
- Dividend payments.
Significance: Shows capital structure changes.

6. Treatment of Special Items

Extraordinary Items (e.g., natural disasters):
- Disclosed separately under respective activities.
Interest & Dividends:
- Financial Enterprise: Interest paid/received = Operating.
- Non-Financial Enterprise:
  - Interest paid = Financing; Interest received = Investing.
  - Dividends received = Investing; Dividends paid = Financing.
Taxes:
- Income tax = Operating.
- Dividend tax = Financing.
Non-Cash Transactions (e.g., asset acquisition via shares):
- Excluded from cash flow statement but disclosed in notes.

7. Methods to Calculate Cash Flow from Operating Activities

7.1 Direct Method

Formula:

Cash from Operations = (Cash Receipts from Customers−Cash Payments to Suppliers) / (Employees−Taxes Paid)

Steps:
1. Convert accrual-based revenues/expenses to cash basis.
2. Adjust for changes in working capital (e.g., receivables, payables).

7.2 Indirect Method

Formula:

Cash from Operations = Net Profit + Non-Cash Expenses (Depreciation) − Non- Operating income (Profit after sales) +/- Changes in working Capital

Steps:
1. Start with net profit before tax.
2. Add back non-cash expenses (depreciation, amortization).
3. Deduct non-operating incomes.
4. Adjust for changes in current assets/liabilities.

8. Preparation of Cash Flow Statement

8.1 Format

Particulars	Amount (Rs.)
A. Cash Flow from Operating Activities	XXXX
B. Cash Flow from Investing Activities	XXXX
C. Cash Flow from Financing Activities	XXXX
Net Increase/Decrease in Cash	XXXX
Cash at Beginning	XXXX
Cash at End	XXXX

8.2 Steps

Calculate Cash from Operating Activities (Direct/Indirect method).
Compute Cash from Investing Activities:
- Sale/Purchase of fixed assets, investments.
Compute Cash from Financing Activities:
- Issue/repayment of shares, loans.
Reconcile Opening & Closing Cash Balances.

9. Illustrative Example

Balance Sheet Data:

Cash at Start: Rs. 2,05,000 (2016), Rs. 3,27,000 (2017).
Fixed Assets: Rs. 5,00,000 (2016), Rs. 5,00,000 (2017).

Adjustments:

Equipment purchased: Rs. 80,000.
Depreciation: Rs. 15,000 (equipment), Rs. 3,000 (furniture).

Solution:

Cash Flow from Operating Activities	Amount (Rs.)
Net Profit before Tax	2,70,000
+ Depreciation	18,000
– Profit on Asset Sale	(5,000)
– Increase in Receivables	(40,000)
+ Increase in Payables	2,000
Cash Generated	2,45,000

10. Advanced Concepts

Proposed Dividend: Treated as a financing outflow when paid.
Provision for Taxation: Adjusted in operating activities.
Non-Cash Transactions: Disclosed in notes (e.g., asset acquisition via shares).

11. Key Takeaways

Operating Activities: Core business cash flows.
Investing Activities: Long-term asset transactions.
Financing Activities: Equity/debt-related cash flows.
Indirect Method: Starts with net profit and adjusts for non-cash items.
Direct Method: Focuses on actual cash receipts/payments.

12. Practice Problems & Solutions

Problem: Calculate cash flow from operations using indirect method:

Net Profit: Rs. 50,000.
Depreciation: Rs. 10,000.
Increase in Receivables: Rs. 5,000.

Solution: Cash from Operations = 50,000 + 10,000 − 5,000 = Rs. 55,000