Notes on Cash Flow Statement

Presented by

Mr. Kamal Krishna Sharma

MBA (Finance), B.Sc. Economics
What is a Cash Flow Statement?

• It is a statement that shows flow (Inflow or outflow) of cash and cash equivalents during a
given period of time.

• As per Accounting Standard-3 (Revised) the changes resulting in the flow of cash & cash
equivalent arises on account of three types of activities i.e.,

(1) Cash flow from Operating Activities.

(2) Cash flow from Investing Activities.
(3) Cash flow from Financing Activities.
Definitions
1) Cash: Cash comprises cash in hand and demand deposits with bank.

2) Cash equivalents: Cash equivalents are short-term, highly liquid investment that are
readily convertible into known amount of cash and which are subject to an insignificant risk
of change in the value e.g. short-term investment. Generally, these investments have a
maturity period of less than three months.
Some examples of cash equivalent: Short-term deposits, marketable securities.

(3) Some types of transaction which are considered movement between cash and cash
equivalents are given below:
(a) Cash deposited into bank.
(b) Cash withdrawn from bank.
(c) Sale of cash equivalent securities (e.g. Sale of short-term investment, sale of commercial
papers)
(d) Purchases of cash equivalent securities (e.g. Purchase of short-term investment, Purchases of
Treasury bills).
Objectives of Cash Flow Statement:

i. To determine the sources of Cash and Cash Equivalents under operating,

investing and financing activities of the enterprise.

ii. To determine the applications of Cash and Cash Equivalents for operating,
investing and financing activities of the enterprise.

iii. To determine the net change in Cash and Cash Equivalents due to cash
inflows and outflows for operating, investing and financing activities of the
enterprise that take place between the 2 balance sheet dates.
Importance or Uses of Cash Flow Statement:
i. To facilitate Short-term Planning: It helps in planning investments and assessing the financial requirements of the
enterprise based on information provided in the statement about the sources and applications of Cash and Cash
Equivalents.

ii. To assess Liquidity and Solvency: It helps in identifying the ability of the enterprise to meet its liabilities on time.

iii. To manage Cash Efficiently: It provides information about the cash position by reflecting either a surplus of cash or
a deficit of cash in the statement.

iv. To facilitate Comparative Study: It facilitates the comparison of actual cash flows with the budgeted cash flows to
identify whether the inflows and outflows of cash are moving as per the plan.

v. To justify Cash Position: Cash flow statement is prepared to record all the cash inflows and outflows which result in
the surplus or deficit of cash for an enterprise. Since, all the cash transactions are presented in the statement, it
becomes easy to identify the items which increase or decrease the cash balances.

vi. To evaluate Management Decisions: This statement classifies the cash transactions under 3 separate heads namely,
operating, investing and financing. Such classification helps the users of the statement to evaluate whether the
decisions taken by the management are appropriate from investing and financing point of view.

vii. To take dividend decisions

Limitations of Cash Flow Statement:
i. Non-cash transactions are not shown: It takes into consideration only cash inflows and cash
outflows. Non-cash transactions are not considered for preparation of cash flow statement.

ii. Not a substitute for an Income Statement: Cash flow statement cannot be used as a substitute
for an Income Statement because Income Statement is prepared on accrual basis of accounting
whereas cash flow statement is prepared on cash basis. Also, it is not possible to compute net
profit or loss from the cash flow statement.

iii. Not a substitute for Balance Sheet: Cash flow statement do not show the financial position of
the enterprise and therefore, cannot be used as a substitute for Balance Sheet.

iv. Historical in Nature: Cash flow statement is prepared based on the cash inflows and outflows
that have already taken place during the year and hence, it is historical in nature.

v. Accuracy of Cash Flow Statement: Since, the cash flow statement is prepared from the
financial statements of an enterprise, accuracy of the same shall depend upon how accurately the
financial statements of the enterprise are prepared.
Cash From Operating Activities

• Operating activities are the activities that constitute the primary or main activities of an enterprise.
For example, for a company manufacturing garments, operating activities are procurement of raw
material, incurrence of manufacturing expenses, sale of garments, etc.

• These are the principal revenue generating activities (or the main activities) of the enterprise and
these activities are not investing or financing activities.

• The amount of cash from operations’ indicates the internal solvency level of the company, and is
regarded as the 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, paying dividends, making
of new investments and repaying of loans without recourse to external source of financing.

• They generally result from the transactions and other events that enter into the determination of net
profit or loss.
Cash Inflows from operating activities
• cash receipts from sale of goods and the rendering of services.
• cash receipts from royalties, fees, commissions and other revenues.

Cash Outflows from operating activities

• Cash payments to suppliers for goods and services.
• Cash payments to and on behalf of the employees.
• Cash payments to an insurance enterprise for premiums and claims,
annuities, and other policy benefits.
• Cash payments of income taxes unless they can be specifically identified
with financing and investing activities.
Indirect Method of calculating the cash flow from Operating Activities : Under this method
Net Profit before Tax and Extra-ordinary Item is the starting point for further calculations.
Cash from Investing Activities

• Investing activities are the acquisition and disposal of long-term assets and other
investments not included in cash equivalents.

• Investing activities relate to purchase and sale of long-term assets or fixed assets
such as machinery, furniture, land and building, etc. Transactions related to long
term investment are also investing activities.

• Separate disclosure of cash flows from investing activities is important because

they represent the extent to which expenditures have been made for resources
intended to generate future income and cash flows.
Cash from Financing Activities

• Financing activities relate to long-term funds or capital of an enterprise, e.g., cash proceeds
from issue of equity shares, debentures, raising long-term bank loans, repayment of bank
loan, etc.

• Financing activities are activities that result in changes in the size and composition of the
owners’ capital (including preference share capital in case of a company) and borrowings of
the enterprise.

• 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.