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Cash flow statement

Definition
A statement of changes in the financial position of a firm on cash basis is called
cash flow statement
Such as a statement effect of a various business transaction on cash and takes
into account receipts and disbursement of cash. It summarizes the causes of
changes in cash position of an enterprise between dates of two balance sheets. It’s
called cash flow statement because it describes the cash inflow (sources) and cash
outflow (uses).
Preparation of cash flow statement
Cash flow statement shows the impact of various transactions on cash position
of a firm it prepared with the help of financial statement such balance sheet,
income statement or profit& loss account and some additional information . It
starts with opening balance of cash and balance at bank. All the inflow of cash is
added to opening balance and out flow of cash is deducted from total. The
preparation of cash flow involves the determining of
• Inflow (sources)of cash
• Out flow (application)of cash

Sources of cash inflow


1. Cash from operations or trading profit.
2. Sale of fixed assets and investment for cash.
3. Raising of long term loans.
4. Shorterm borrowing from bank& from other financial institutions.
5. Issue of share capital for cash.
6. Issue of debentures and bonds for cash.

Application of cash OR cash outflow


1. Cash loss in operations or trading loss.
2. Purchase of fixed assets and investment by cash.
3. Redemption of debentures and bonds or redeemable performance share etc.
4. Repayments of loans.
5. payment of dividend ,tax etc

Advantages of cash flow statement


1. It is help full in understanding the cash position of a firm. Cash flow
statement is based on cash basis accounting. It is help full to evolution of
cash position firm.
2. Its help in evaluating financial policies and cash position. It will enable the
management to plan and co-ordinate the financial operations properly.
3. It helps in planning the repayment of loan, replacement of fixed assets.
4. Cash flow statement discloses the complete story of cash movement.
5. The extent of success or failure of cash planning can be known by
comparing the projected cash flow statement with actual cash flow
statement and necessary remedical measures can be taken.
6. It is helpful in making short term financial decision relating to liquidity and
the ways & means position of the firm.
7. A comparison of cash flow statement with the cash budget for the same
period helps is comparing and controlling cash expenditures.

Format and contents of cash flow statement


Cash flow statement
For the year ended---------
RS RS
Opening balance of cash (hand or in bank) -----------
Add : sources of cash ------------
Cash from operation ------------
Sale of fixed assets ------------
Rising of long term loans ------------
Short term borrowings ------------
Issue of share of cash ------------
Issue of debentures or bond ------------ -----------
-----------
Less : application of cash:
Purchase of fixed assets ------------
Purchase of long term investment ------------
Payment of loans ------------
Redemption of debentures ------------
Cash lost in operations ------------
Payment of dividend ------------
Payment of taxes ------------ (---------)

Closing balance of cash -----------

From the flowing statement calculate the cash from operations:-


Profit and loss account balance on 1-1-1998 500000
Profit and loss account balance on 31-12-1998 700,000
Amount transferred to general reserve 40000
Dividend paid 220,000
Income tax provision made 130000
Discount on shares written off 12000
Outstanding expenses 31-12-1998 30000
Prepaid expenses 01-01-1998 7000
Accrued income 31-12-1998 9000
Income of 1998 received in advance in 1997 6000
Profit on sale of machinery 3000
Loss on sale of furniture 4000
Income on investments 3000
Deprecation provided 55000

Calculation of cash from operation


RS RS
Profit & loss A/C 31-12-1998 700000
Less :-profit & loss A/C 1-1-1998 (500000)
200000
Add :-depreciation provided 55000
Loss on sale of furniture 4000
Transfer to general reserve 40000
Provision for income tax 130000
Dividend 220000
Discount on share written of 12000
Outstanding expenses 30000
Prepaid expenses 7000 498000
698000
3000
Less :-profit on sale of machinery
3000
Income on investment
9000
Accrued income
6000 (21000)
Income of 1998 received in 1997
Cash from operation 677000
Intangible assets
Definition:-
The assets which are not physically routable, but still valuable
for business enterprise.
The assets which have no physical bodily substance are called intangible
assets. The example of such assets is goodwill, patents, copyright, design,
trademark, etc as these assets have a salable valuable they are recorded in
balance as separate heading.

Classification of intangible assets


The intangible assets are classified as under
1. Intangible assets with limited useful life.
2. Intangible assets with unlimited useful life.
Although it is very difficult to ascertain the useful life of certain intangible
assets such as goodwill, but still the intangible assets such as copyright, patents
leasehold, liscences, etc have a definite period of their usefulness.
Therefore it is quit reasonable that the cost of intangible assets should be
written-off over the period of there usefulness.
1. Goodwill
Goodwill refers to the value associated with the good reputation
of a firm. It is signified as the present value of the expected future earnings
over and above the normal earnings of the industry. This average earnings
(usually called as super profit) may arise not only from favorable customer’s
relation but also from the factors like location, market condition,
manufacturing efficiency and super management.
Goodwill is usually not shown in the balance sheet of the firm
but when any change in ownership of business is effected or business is sold, it
is valued according to mutual agreement. The valuation of goodwill can be
made in any of the following ways:-
• Arbitrary agreement
• Multiple of post average profit
• Multiple of excess earnings
• Capitalized value of excess earning

These are explaining in detail bellow:-


• Arbitrary agreement
This mean that the concerning parties may determine
the amount of goodwill by arbitrary agreement. E.g. if the net worth of
business is 95000 and its purchase price is settled at 100000 then the excess
amount of 5000 is payment of goodwill.
• Multiple of post average
Goodwill can be ascertained by multiplying of the post
profit by certain number like 2, 3, and 4. The number by which average profit
are multiplied are called as year of purchase.

• Multiple of excess earnings:-


Goodwill can be ascertained as multiple of
the amount by which the average annual earnings exceed the normal earning of
an industry. E. g normal earning of an industry is 10% of capital invested a
firm is earning 14% with capital investment of 100000. The goodwill is too
ascertained for three year purchase of average excess earning.

• Capitalized value of excess earnings:-


Goodwill can be ascertained as the
capitalized value of the excess earning power of a firm. The excess power
means the earning capacity over the normal profit. E. g excess earning are 4000
these excess earning are capitalized as under
4000*10 or 4000*100/10 =4000
In this case goodwill of firm is 40000.

2. Leasehold
“Lease” is written agreement made according to law, by which
the use of a building, land, or any other property, is given by its owner to some
body else for certain time in return of rent. The owner of the property is called
“lessor” and tenet is called lessess.the owner retains the title to the leased
property and transfer the rights to use that property for defined period. E.g. a
house is acquired on lease of 10 years at cost of 300000.this mean that right to
use the house is purchased for 10 years against advance payment of 300000.
3. Patents
A patent is an exclusive right granted by the government for
manufacturing using or selling a particular patent is generally granted for 19-years
and period of amortization must not exceed this. However if the patent is likely to
lose its usefulness in less than 19 years, the amortization should the shorter period.
Assumed that a patent is purchased for 30000 for a period of 5
years. It will be amortized for 6000 annually .every year book value of patent will
decreased by this amount and at the end of fifth year its value will be zero.

4. Copyright
A copyright is an exclusive right granted to protect the production and
sale of literary and artistic material. Copyright are usually granted for a period up
to 28 years. If the cost of acquiring the copyright is minor, then it’s admissible to
charge the expense account. In case it is heavy expenditure than its treated as
capital expenditure and its amortized every year by mean of following general
journal entry:-
Amortization exp (copyright) (dr)
Copyright (cr)

5. Trade marks:-
This mean a permanent exclusive right to use a trade mark,
brand name or commercial symbol, this trade mark have unlimited legal life as
such they are carried without amortization at their original cost its written off
when its use is abandoned or when its contribution to earning become doubtful.

Tahir Rauf Awan


MBA 1st ( A )
tahir_awan991@hotmail.com
Gvot College of Management Sciences
Abbottabad.