Understanding Cashflow Statement

Preamble

Cashflow statement is part of financial statement. Before going in deep let's understand reason for which cash flow statement is prepare.

Companies may maintain books of account by adopting any one out of two method which are mentioned below. (Although Now Accural is mandatory for companies' small businessman maintains account by

1. Cash basis
2. Accrual

Cash basis accounting records revenue and expenses when actual payments are received or paid.

Accrual accounting records revenue and expenses when transactions occur but before money is received or paid.

Reason for preparing cashflow

To identify reason for the movement in the cash balance between two different accounting periods, with the help of corresponding two different balance sheets.

It helps the user/investor to ascertain the gross inflow and outflow of company and from which activity the company has generated cash. (Through core business, by sale of investment or by obtaining a loan).

To explain Cashflow statement, we need to break this word.

• Cash- Cash also includes Bank, Cash and Cash equivalent. (Cash liquated within 3 months)
• Flow- Movement of cash from 1st period to 2nd period.
• Statement- It means document.

Cash flow statement again divides into three parts

• Operational activity
• Investing activity
• Financial activity.

To understand cashflow statement lets understand these activities in the reverse manner.

1) Financial Activity: Financial activity means movement of cash throughfund raised (Sources) / fund paid. Business can not start with out money/capital/fund. To generate money/ capital/fund, company is require either to take a loan from bank, outsiders or issuing debentures, shares.

I. Equity- Shares

II. Debt- Debenture/ Fixed deposit- > 3 months

III. Loan, Redemption of Preference Share

IV. Interest paid (-)

V. Dividend Paid (-)

2) Investing activity: Business cannot run without assets (Plant & Machinary, long-term investments)

The following are examples of Investing activity. (Fixed asset)

Fixed asset & Long-term investments

I. Purchase of fixed assets & Investment (-) - non-current assets

II. Sale of fixed assets & Investment (+)- non-Current assets

III. Interest earned on the investment (+)

IV. Dividend earned on the investment (+)

V. Rent received (+)

3) Operational activities: All income earned, and expenses made on the movement of Current asset & Current liabilities. & reserves & Surplus. (Movements in the current assets and current liabilities)

I. Prepaid expenses

II. Creditors

III. Debtors, Bills receivable

IV. Salaries paid to employees

V. Taxes paid to Govt authority.

There are two types of methods

A. Direct Method: Operational activities - Sources (+ in cash flow)- Only Cash items are added

B. Indirect Method

Net profit before exceptional items

· Non-cash expenses (All non-expenses will be added)

i. Depreciation (Notional cost)

ii. Goodwill- Written off

iii. Preliminary expenses

iv. Change in CTR.

v. Discount on debenture

vi. Loss on asset (Add)

vii. Profit on sale of asset (Minus)

viii. Interest Paid ***

Operating profit before WC.

Less: Increase in current asset, Decrease in current liabilities

Add: Decrease in Current asset, Increase in current liabilities. Following is format of Cash flow statement (Indirect method- cashflow from operating activities)

Net Profit before extraordinary profit

Net Income

Adjustment (To convert net income to cash provided by operating statement)

+ expenses that do not impact cash (non-Cash expenses)

+ Losses on the investing activities

- Gain on the investing activities

+ Change in current assets

- Change in current liabilities.

Cash flow is governed by Ind AS 7

Flow of Cash and Cash equivalent. - Which can be liquidated immediately (Within 3 months). Which is marketable securities. Securities which can be readily realizable into cash.

When it is known amount of cash.

For e.g.,Treasury bills (USA based concept), Commercial papers and Govt securities.

Demand deposit- means positive balance in Saving and current account. (Overdraft)

If it is not provided than short term investment

Cash flow statement is a statement of cash receipts and payment of cash. It supplements financial information. (Annual accounts)- In addition of cash flow Balance sheet, P&L account, Notes to accounts, statement of equity changes.

Flow of cash is classified under 3 activities.

1. Operating activities: It can be classified by 2 methods.

A. Direct Method- Not permissible by AS/Ind AS.

B: Indirect method. - Permitted by AS 3/ Ind AS 7.

2. Investing activities

• Purchase of Investment-I
• Dividend received-I
• Raising of investment for fixed asset
• Brokerage paid

3. Financing activities.

• Issue of equity/ Preference shares
• Issue of debentures
• Int on Debenture
• Dividend Paid
• Corporate dividend tax paid

Treasure bill was introduced in the USA. Govt has requested company to show security( Plant& security, Land & building).

Govt has asked company to issue

Cash flow is governed by AS-3

Cash & Cash equivalent is marketable security. Long term security can not be said to be marketable securities. If it is not provided in the question It will assume it as marketable security.

Cash flow statement

Cash receipt and cash payment. It supplements financial information. Cash flow is part of financial statement. The flow of cash is divided into three activities

1. Operating activity

(2) Investing Activities

"Investing Activities are the acquisitions and disposals of long-term assets and other investments not included in cash equivalents."

(i) Cash outflow and inflow from purchase and sale of fixed assets and investments (other than those which have been classified as Cash Equivalents).

(ii) Cash flow for share warrants or debt instruments of other enterprises and interests in joint ventures.

(iii) Cash flow from advance and loan made to third parties.

(iv) Cash flow from future contracts, forward contracts, option contracts and swap contracts except when the contracts are held for dealing or trading purpose, or the payments are classified as financing activities; and

(v) Income received on investments (other than those, which have been classified as Cash Equivalents).

3) Financing Activities

"Financing Activities are activities that result in changes in the size and composition of the owners' capital (including preference share capital in the case of a company and borrowings of the enterprises.)"

(i) Cash flow from shares, debentures, loans, notes, bonds, and other short or long-term borrowings; and

(ii) Payment of dividend and interest.