Cash Flow Statement

Meaning of Cash Flow Statement

 A Cash Flow Statement is a statement depicting change in cash position from one period to another. The term
‘Cash’ here stands for cash and bank balances.

 The cash flow statement explains the reason for inflow or outflow of cash, as the case may be and also helps
management in making plans for the immediate future.

 A proper planning of cash resources will enable the management to have cash available whenever needed and
put it to some productive use in case there is surplus available.

Preparation of Cash Flow Statement

Prepared on the same pattern as the Funds Flow Statement. The change in cash position is computed by taking into
account the ‘sources’ and ‘applications’ of cash.

Sources of Cash

Internal Sources

Cash from Operations is the main internal source. The Net profit from the P & L account will be adjusted for the
following non-cash items to arrive at the cash from operations:

i. Depreciation : Does not result in cash outflow, hence added back to net profit.

ii. Amortization of intangible assets: Goodwill, preliminary expenses etc. when written off, have to be
added back to the net profit.

Preparation of Cash Flow Statement

i. Loss on sale of fixed assets :Added back to the net profit

ii. Gain on sale of fixed assets : Deducted from net profit.

iii. Creation of reserves: If profit for the year has been arrived at after charging transfers to reserves, the
same should be added back to the net profit.

Computation of cash from operations can be studied using two different situations:

i. When all transactions are cash transactions: In this case Cash from operations = Net Profit

ii. When all transactions are not cash transactions: In this case, cash from operations is calculated in two
stages:

1. Computation of funds from operations as explained earlier.

2. Adjustment of funds so calculated for changes in current assets ( excluding cash ) & current
liabilities.

Adjustments for changes in Current Assets & Current Liabilities

Effect of credit sales : Cash from operations can be calculated as per the following equation if there are debtors
outstanding at the end as in the beginning of the accounting year :

Cash from Operations = Net Profit + Decrease in Debtors

or - Increase in Debtors
Effect of credit purchases :

Cash from operations = Net Profit + Increase in Creditors

or - Decrease in Creditors.

Effect of opening and closing stocks: The amount of opening stock is charged to the debit side of the P& L account. It
thus reduces net profit without reducing cash from operations. Similarly, closing stock which appears.

On the credit side of the P& L Account increases net profit without increasing cash from operations. The following
adjustment is made :

Cash from Operations = Net Profit + Decrease in Stock

or - Increase in Stock

Effect of Outstanding expenses, income received in advance etc. : Net profit is calculated after charging all expenses,
whether paid or outstanding and income received in advance is not considered. Hence an increase in outstanding
expenses and income received in advance will increase the cash from operations and vice versa. The following
adjustment is made:

Cash from operations =

Net Profit + increase in Outstanding Expenses

+ Increase in income received in advance

- Decrease in Outstanding Expenses

- Decrease in income received in advance

Effect of Prepaid Expenses and outstanding Income : The effect on cash from operations is exactly opposite to the
effect of outstanding expenses and income received in advance . The following adjustment is made:

Cash from Operations =

Net Profit + Decrease in Prepaid expenses / Accrued Income

- Increase in Prepaid expenses/ Accrued Income.

The above adjustments may be summarized as :

 Increase in Current Asset / Decrease in Current Liability results in Decrease in Cash

 Decrease in Current Asset/ Increase in Current Liability results in Increase in Cash.

External Sources of Cash:

i. Issue of New Shares

ii. Raising of long term loans

iii. Purchase of Plant & Machinery on deferred payment : This should be shown as a separate source of
cash to the extent of the deferred credit. However, the cost of machinery purchased will be shown as
an application of cash.

iv. Short term borrowings – cash credit from banks

v. Sale of fixed Assets , Investments etc.

Applications of Cash:

i. Purchase of Fixed Assets

ii. Payment of Long-term loans

iii. Decrease in deferred payment liabilities

iv. Loss on account of operations

v. Payment of tax

vi. Payment of Dividend

vii. Decrease in Unsecured loans , deposits etc.

ii. Format for the Cash Flow Statement:

iii. Cash Flow Statement for the yr ending..

iv. Bal. as on Jan 1..

v. Cash Balance

vi. Bank Balance

vii. Add: Sources of Cash

viii. Add/ Less: Adjustments for Non- Cash Items

ix. Add: Increase in Current Liabilities

x. Decrease in Current Assets

xi. Less: Increase in Current Assets

xii. Decrease in Current Liabilities

xiii. Total Cash Available (1)

xiv. Less: Applications of Cash (2)

xv. Closing Balance ( 1-2)

Utility of Cash Flow Analysis

 Helps in efficient Cash Management : The management can know how much cash is needed, from
which source it will be obtained, how much can be generated internally and how much could be
obtained from outside.

 Helps in Internal Financial Management: Provides information about funds which will be available
from operations. This helps the management in determining policies regarding internal financial
management e.g dividend policy, possibility of repayment of long term debts.

 Discloses the movements of cash

 Discloses the success / failure of cash planning : This is determined by comparing projected with
actual cash flow statement.


Limitations of Cash Flow Analysis

 Cash flow statement cannot be equated with the income statement. Income statement takes into
account both cash and non- cash items and hence, net cash does not necessarily mean the net income
of the business.

 The cash balance as per the cash flow statement may not represent the real liquid position of the
business since it can be easily influenced by postponing purchases and other payments.

 Cash flow statement can not replace income statement or funds flow statement. Each of them has a
separate function to perform.