Cash Flow Statement

A cash flow statement is the financial statement that shows the inflows and outflows of cash and cash equivalents during a particular period.

As per AS-3, the various activities are classified into three categories:

1. Operating activities
2. Investing activities
3. Financing activities

This classification is used to show separately the cash flows generated or used by each type of activity.

The objective of a cash flow statement is to provide useful information about cash inflows and outflows of an enterprise during a particular period under the heads of operating, investing, and financing activities. It helps users assess the enterprise’s ability to generate cash and cash equivalents and its need to utilise those cash flows.

The objectives of preparing a cash flow statement are:

- to show the changes in cash and cash equivalents during a period;
- to help users assess the enterprise’s ability to generate cash;
- to show the timing and certainty of cash generation;
- to help in evaluating the enterprise’s liquidity and solvency.

According to AS-3:

- Cash equivalents are short-term highly liquid investments that are readily convertible into known amounts of cash and are subject to an insignificant risk of changes in value.
- Cash flows mean the movement of cash in and out due to some non-cash items; receipt of cash is a cash inflow and payment of cash is a cash outflow.

A proforma of cash flow from operating activities under the indirect method is:

| Cash Flows from Operating Activities (Indirect Method) | |
|---|---:|
| Net Profit/Loss before Tax and Extraordinary Items | xxx |
| Add: Deductions already made in Statement of Profit and Loss on account of non-cash items such as depreciation, goodwill written-off | xxx |
| Add: Deductions already made on account of non-operating items such as interest | xxx |
| Less: Additions (incomes) made on account of non-operating items such as dividend received, profit on sale of fixed assets | xxx |
| Operating Profit before Working Capital Changes | xxx |
| Add: Increase in current liabilities / decrease in current assets | xxx |
| Less: Increase in current assets / decrease in current liabilities | xxx |
| Cash Flows from Operating Activities before Tax and Extraordinary Items | xxx |
| Less: Income tax paid | xxx |
| +/−: Effects of extraordinary items | xxx |
| Net Cash from Operating Activities | xxx |

The chapter says operating activities vary according to the nature of the enterprise. Examples:

- Hotel: lodging, food and related services
- Film production house: producing and distributing films
- Financial enterprise: lending and borrowing activities
- Media enterprise: publishing/broadcasting/advertising related activities
- Steel manufacturing unit: procurement of raw material, manufacturing steel, sale of steel
- Software development business unit: development and sale of software, maintenance/support services

The main idea is that operating activities are the principal revenue-generating activities of each enterprise.

Yes, I agree. The nature of the enterprise can change the classification of an activity.

For example, purchase of shares is an investing activity for most enterprises, but for a share brokerage firm it is an operating activity because buying and selling shares is part of its main business. Similarly, cash advances and loans given by a financial enterprise are treated as operating activities because lending is its main activity.

The procedure to prepare a cash flow statement is:

1. Ascertain cash flows from operating activities.
2. Ascertain cash flows from investing activities.
3. Ascertain cash flows from financing activities.
4. Find the net increase/decrease in cash and cash equivalents by adding the three net cash flows.
5. Add cash and cash equivalents at the beginning of the period.
6. Arrive at cash and cash equivalents at the end of the period.

The statement shows gross inflows and outflows under the three heads and the final change in cash and cash equivalents.

Under the indirect method, cash flow from operating activities begins with net profit/loss before tax and extraordinary items. Then it is adjusted for:

- non-cash items like depreciation and goodwill written off, which are added back;
- items whose cash effects are under investing or financing activities, such as interest paid/received, dividend received, profit on sale of assets;
- changes in working capital, i.e. current assets and current liabilities.

After these adjustments, income tax paid and extraordinary items are considered to arrive at net cash from operating activities.

The major cash flows from investing activities are:

Cash outflows:
- purchase of fixed assets including intangibles and capitalised research and development;
- purchase of shares, warrants or debt instruments of other enterprises other than trading investments;
- cash advances and loans made to third parties.

Cash inflows:
- sale of fixed assets including intangibles;
- repayment of advances or loans made to third parties;
- sale of shares, warrants or debt instruments;
- interest received on loans and advances;
- dividend received from investments in other enterprises.

The major cash flows from financing activities are:

Cash inflows:
- issue of equity shares or preference shares;
- issue of debentures, bonds, loans and other borrowings.

Cash outflows:
- repayment of borrowings;
- interest paid on debentures and long-term loans;
- dividends paid on equity and preference capital.

These activities relate to changes in the enterprise’s capital and borrowings.

Compute cash from operating activities by the indirect method:

- Net income = Rs. 5,00,000
- Add depreciation = Rs. 2,00,000
- Less profit on sale of assets = Rs. 50,000
- Less increase in trade receivables = Rs. 40,000
- Add increase in trade payables = Rs. 60,000

Calculation:

$5,00,000 + 2,00,000 - 50,000 - 40,000 + 60,000 = 6,70,000$

So, cash flow from operating activities is Rs. 6,70,000.

Cash paid for inventory is calculated as:

$$\text{Cash paid for inventory} = \text{Credit purchases} + \text{Opening trade payables} - \text{Closing trade payables}$$

Given:
- Credit purchases = Rs. 1,60,000
- Trade payables in the beginning = Rs. 14,000
- Trade payables in the end = Rs. 14,500

So,

$$1,60,000 + 14,000 - 14,500 = 1,59,500$$

Therefore, cash paid for inventory = Rs. 1,59,500.