UNIT4

Funds Flow Analysis

Thi s Sectio n includes:

e e e e e

Meanin g and concept of Funds Meanin g and Definitio n of Fund Flow Statement Funds Flow Statement - Positio n in India Significance , Importance and Uses of Funds Flow Statement Cash Flow Statement

INTRODUCTION: Ever ybusines s concer n prepare s two basic financial statement s at the end of accountin g period, namel y the Balance Sheet or positio n Statement and Profit and Loss Account or Income Statement . Balance Sheet reveal s the financial positio n of the busines s concer n at a certain point of time. It reveal s the financial statu s of the busines s concern . The assets side of a Balance Sheet shows the deployment of resource s of an undertakin g while the liabilitie s side indicates its obligation s i.e., the manne r in whic h these resource s obtained . The Profit and Loss Account or Income Statement reveal s the net result s of operation s over a period of time i.e. ,how much profit was earne d (or loss sustained ) by the busines s enterprise durin g the accountin g period. The Balance Sheet provide s only a static view of the business . It is a statement of assets and liabilitie s on a particula r date. It does not show the movement of funds. Inbusines s concerns, funds flow from different source s and similarl y funds are investe d in variou s source s of investment . It is a continuou s process. The stud y and control of this funds flow proces s is the mai n objective of financial management to assess the soundnes s and solvenc y of a busines s tell little about its flow of funds ,i.e. ,financin g and investin g activities over the relate d period . Like the Balance Sheet, even the Profit and Loss Account does not depict the change s that have taken place in financial conditio n of a busines s concer n betwee n two dates . Hence there is a need to prepare an additional statement to know the change s in assets ,liabilitie s and owners' equit y betwee n dates of two Balance Sheets. Such a statement is called Funds Flow Statement or Statement of Sources and uses of funds or where come and where gone statement.

Thefunds flow statement ,whic his also known as the Statement of Change s infinancial positio n, is yet anothe r tool of analysi s of financial statements.

MEANING AND CONCEPTS OF FUNDS : Funds Flow Statement is a widel y used tool in the hand s of financial executive s for analysing the financial performance of a busines s concern. Funds keep on movin g in a busines s which itself is based on a going concer n concept. The term Funds has a variet y of meanings.
(a) In a narrow sense -Ina narro w sense fund mean s only cas h Funds Flow Statement prepared on this basis is called as Cash Flow Statement . In thi s type of statement only in flow and outflow of cash is taken into account. (b) In a broader sense - In a broade r sense the term fund refers to mone y value in whatever for m it may exist. Here funds mean all financial resource s in the for m of men ,materials ,money, machiner y etc.

(c) Popular sense - In a popula r sense the term funds mean s Workin g Capital I.e., the excess of current assets over current liabilities. Whe n the funds move inward s or outward s they cause a flow or rotatio n of funds. Here the word fund mean s net workin g capital. In short , if funds mea n workin g capital , then the statement prepare d on the basis is called Funds Flow Statement. The concept s of funds as workin g capital is the most popula r one and in this chapte r we shall refer to fund workin g capital and a funds flow statement as a statement of source s and applicatio n of funds. MEANING AND DEFINITION OF FUNDS FLOW STATEMENT: Funds Flow Statement is prepare d to stud y the change s in the financial positio n of a business over a period of time generall y one year. Funds Flow Statement reveal s bot h inflow and outflow of funds. The inflow of funds is known as source s of the funds and the outflo w of funds means use s or applicatio n of the funds. Funds flow statement is also known as Statement o fsources and Applications of funds or where got-where gone statement . Funds Flow Statement highlights and change s in the financial structure of an undertaking . It determine s the financial consequence s of busines s operations. Funds Flow Statement gives detaile d analysi s of change s in distributio n of resource s between two Balance Sheet dates. This statement is widel y used by the financial analysist s and credit grantin g institution s and financial and financial manager s in performin g their jobs. Thus ,Fund s, Flow Statement , in general is able to present that informatio n which either is not available or not readil y apparent from an analysi s of other financial statements.
Definitions

A statement of source s and applicatio n of funds is a technical device designe d to analyse the change s in the financial conditio n of a busines s enterprise betwee n two dates. - Foulke Funds Flow Statement describe s the source s from whic h additional funds were derive d and the use to whic h these source s were put. -Anthony

A statement of change s in financial positio n or statement of source s and applicatio n of funds in whic h element of net income and workin g capital contributio n to an understandin g of the whole of financial operation s durin g the reportin g period replace totals of these items. Kotler A statement either prospective or retrospective , settin g out the source s and application s of the funds of an enterprise . The purpos e of the statement is to indicate clearly the requirement s of funds and how they are propose d to be raised and the efficient utilisatio n and applicatio n of the same. FUNDS FLOW STATEMENT - POSITION IN INDIA: The Funds Flow Statement is now regarde d as an important part of financial reporting . The necessit y of this statement is now undoubtedl y realise d by all owners , managements,investors and others. In India , thoug h the funds flow statement or statement of change s in financial positio n has not so far become a part of the financial reporting ,bank s and financial institutions are insistin g whe n a compan y approache s them for loans. In India , unde r the existin g legal requirements , companie s are unde r no legal obligatio n to publis h a statement of change s in financial positio n along wit h their financial statement. Howeve r there is a growin g practice to publis h such statement along with financial statement especiall y in the case of companie s listed on the stock exchange s and other large commercial, industrial and busines s concern s in the public and private sectors. SIGNIFICANCE, IMPORTANCE AND USES OF FUNDS FLOW STATEMENT: Funds flow statement is prepare d to know the change s in assets , liabilitie s and owner s equity betwee n dates of two Balance Sheets.lt is a statement of source s and uses of funds. Funds Flow Statement is also known as Statement of Sources and Applicatio n of funds or movement of Funds Statement etc. Funds flow statement reveal s both inflow and outflo w of funds. The inflow of funds is known as Sources of the funds and the outflo w of funds mean s uses or Applicatio n of the funds. In other words Financial Statement gives detaile d analysi s of change s in the distributio n of resource s betwee n two dates.
It is very useful tool in the financial manager s analytical kit. It provide s a summar y of management decision s on financin g activities of the firm and investment policy. The following are the advantage s of Funds Flow Statement.

1. Analysis of financial operations - The Funds Flow Statement reveal s the net affect of variou s transaction s on the operational and financial positio n of the busines s concern. It determine s the financial consequence s of busines s operations . This statement discloses the causes for change s in the assets and liabilitie s betwee n two different points of time. It highlight s the effect of these change s on the liquidit y positio n of the company. 2. Financial policie s - Funds Flow Statement guide s the management policies such as dividend , reserve etc. in formulatin g the financial

3. 4.

Control device -It serves as a measure of control to the management . If actual figures are compared with budgeted/projecte d figures ,management can take remedial actio n if there are any deviations. Evaluatio n of firm's financin g -Funds Flow Statement helps in evaluatin g the firm's financing.

It shows how the funds were obtained from various sources and used in the past. Based on this, the financial manager can take corrective action.

5.

Acts as a future guide -Funds Flow Statement acts as a guide for future ,to the management. It helps the management to know various problems it is going to face in near future for want of

funds.
6. 7. 8. 9. Appraisin g the use of workin g capital - Funds Flow Statement helps the management in knowing

how effectively the working capital put into use.

Reveal s financial soundnes s - Funds Flow Statement reveals the financial soundnes s of the business to the creditors, banks, financial institutions.

Change s in workin g capital -Funds Flow Statement highlights the changes in working capital.

This helps the management in framing its investment policy.

Assessin g the degree of risk - Funds Flow Statement helps the bankers, creditor s,finandal institution s in assessing the degree of risk involved in grantin g the credit to the business concern.

10. Net result s -This statement reveals the net results of operations durin g the year in terms of cash. National Associatio n of Accountant s (NAA)-National Association of Accountant s states the following

uses of Funds Flow Statement : (i) Estimating the amount of funds needed for growth. (ii) Improvin g the rate of income on assets. (iii) Planning the temporar y investment of idle funds. (iv) Securing additional working capital when needed. (v) Securin g economie s in the centralise d management of cash in organisatio n whose management is centralised.

(vi) Planning the payment of dividend s to shareholder s and interest to creditors. (vii) Easing the effects of an insufficient cash balance.
Limitation s of Funds Flo w Statement

The following are the important limitations of Funds Flow Statement 1. Funds Flow Statement is not a substitute of Income Statement or a Balance Sheet. It furnishe d only some additional informatio n as regards changes in workin g capital.

2. 3. 4. 5. 6. 7.

This statement lacks originality . It is simpl y rearrangement of data appearin g in account books.
It indicate s only the past changes . It can not reveal continuou s changes.

When bot h the aspect s of the transactio n are current , they are not considered. When bot h the aspect s of the transactio n are non-current , even then they are not included in funds flow statement. Some Management Accountant s are of the opinio n that this statement is not ideal tool for financial analysis. Funds Flow Statement is historic in nature . Hence this projecte d funds flow statement cannot be prepare d with muc h accuracy.

Source s of Funds

1.

Issue of share capital -If there is any increase in share capital it denote s issue of additional share s durin g the period . Issue of share s is a source of funds as it constitute s inflow of funds. Even calls received on partl y paid share s constitute an inflow of funds. If share s are issue d at premium , the premium will also become a source of fund.
Note -If share s are issue d and allotte d for other than cash, consideratio n do not generate fund.

2.

Issue of debentures of long tenn loans - Issue of debentures , acceptin g public deposits, and raisin g long term loans result s in the flow of funds.
Note - If debenture s like share s have bee n allotte d to some body other tha n cash, consideratio n do not generate fund.

3.

Sale of fixed assets or long term investment s -Whe n any fixed asset like Land, Building, Machinery , Furniture on long term investment s etc. are sold,it generate funds and becomes a source of funds. Non-tradin g income -Any non-tradin g receipt s like dividends , rent, interest etc., Decrease in working capital -If workin g capital is decrease d durin g the accountin g period, whe n compare d wit h previou s period , it denote s release of funds from workin g capital and it constitute s a source of funds. Redemption of preference share capital - If there is any decrease in preference share capital durin g current year , whe n compare d wit h previou s year , we must assume that the preference share s are redeemed . It results in the outflow of funds and is taken as Application of funds. Redemption of debentures - If any debenture s are redeeme d durin g the account period ,it constitute applicatio n of funds.

4. 5.

APPLICATIO N OR USE OF FUNDS:

1.

2.

3.

Repayment of long-term loans- Repayment oflong-termloanals o constitute an application of funds. Purchase of fixed assets or long term investments -If any fixed assets like land ,buildings, furniture , long-term investment s etc., are purchase d for cash, funds outflow from the business.
Note - If any fixed asset is purchase d for a consideratio n of issue of shares or debenture s, it does not involve any funds and hence not an applicatio n of funds.

4.

5.

Non-trading payment - Payment of dividend s and tax etc. reduce the working capital and is an applicatio n of funds. Mere declaration of dividend or creating a provisio nfor taxation, do not be treated as an outflow of funds. Any other non-trading payment -Any payment or expense not related to the trading operations of the business amounts to outflow of funds and also taken as applicatio n of funds. Funds lost in operations -If there is any loss durin g the accountin g perio d,it amounts to loss of funds in operations . Such loss of funds in trading operation s treated as outflow of funds.

6.
7.

CASH FLOW STATEMENT: To underline the importance of Funds Flow Statement the Institute of Chartered Accountants of India (ICAI) issued in June 1981 Accountin g Standard - 3 dealing with the preparation o f Statement of changes in financial position during a particular period. While preparin g this statement the term funds was defined as Cash and Cash equipments or working capital. The main purpos e of preparing the Funds Flow Statement is to provide a meaningful link betwee n the Balance Sheet at the beginning and at the end of period and the Profit and Loss Account for the period. In spite of its importance Accounting Standard - 3 suffers from the following limitations. 1. 2. Accounting Standard - 3 did not provide any standard format for the preparation of Funds
Flow Statement.

When Funds Flow Statement is prepare d on cash basis, it did not disclose cash flows from operating ,investin g and financial activities separately. It nearly provided information regarding inflows and outflows of funds. Accounting Standard - 3 allowed considerable flexibility regardin g the meaning of the term Funds. As a result some business concerns prepare d this statement on working capital basis, whereas others prepared it on cash basis. However most of the business firms prepared this statement on working capital basis. Working capital includes items like inventories and prepaid expenses which are not easily convertible into cash within a short period. Further these items do not contribute to the ability of the firm to pay the short term obligations as and when they become due.

3.

Due to these limitations there was a need for cash flow statement prepare d in standar d format. The Financial Accountin g Standard Board, U.S.A . also stressed the need of preparing the cash flow statement in standard form.

In June 1995 the Securities and Exchange Board of India (SEBI)amended clause 32 of the listing agreement requiring every listed company to submit along with Balance sheet and Profit and Loss Account , a Cash Flow Statement prepared in the prescribed format showing separately cash flow from operating activities, investin g activities and financing activities.

Recognizin g the importance of cash flow statement , the Institute of Chartere d Accountant s of India issue d Accountin g Standard - 3 Revised in March 1997. This revised accountin g standard supercede s Accountin g Standard- 3 change s in financial positio n issue d in 1981. Revised Accountin g Standard - 3 has given the objectives of the Cash Flow Statement are as under. Informatio n about the cash flows of an enterprise is useful in providin g users of financial statement s wit h a basis to assess the abilit y of the enterprise to generate cash and cash equivalent s and the needs of enterprise s to utilize those cash flows. The economic decisions that are taken by users require an evaluatio n of the ability of an enterprise to generate cash and cash equivalent s and the timing and certaint y of their generation. This statement deals with the provisio n of informatio n about the historical change s in cash and cash equivalent s of an enterprise by mean s of a cash flow statement which classified cash flows durin g the perio d from operating , investin g and financin g activities. Meanin g - Cash Flow Statement reveal s the causes of change s in cash positio n of business concer n betwee n two dates of Balance Sheets. Accordin g to Accountin g Standard - 3 (Revised ) an enterprise shoul d prepare a cash flow statement and shoul d present it for each period with financial statement s prepared . A5-3 (Revised) has also given the meanin g of the words cash, cash equivalent and cash flows.
1. Cas h -Thi s include s cash on hand and deman d deposit s wit h banks. Cas h equivalent s -Thi s include s purel y short term and highly liquid investment s which are readil y convertible into cash and which are subject to an insignificant risk of change s in value. Therefore an investment normall y qualifie s as a cash equivalent only whe n it has a short maturity , of say three month s or less. Cas h flow s - This include s inflow s and outflow s of cash and cash equivalents . If the effect of transactio n result s in the increase of cash and its equivalents,it is called an inflow (source) and if it results in the decrease of total cash ,it is known as outflo w (use cash of).

2.

3.

Classificatio n Of Cash Flows Accordin g to A5-3 (Revised) cash flows are classified into three main categories: 1. 2. 3. 1. Cash flows from operatin g activities. Cash flows from investin g activities. Cash flows from financin g activities. Cash flows from operatin g activitie s - Operatin g activities are the principal revenue producin g activities of the enterprise and other activities that are not investin g or financing activities.

The arn.ount of cash flows arisin g from operatin g activitie s is a key indicatc.n v lll<= <=Al<=lll ,v whic h the l operation s of the enterprise have generate d sufficient cash flows to maintai n the operatin g capabilit y of the enterprise ,pay dividends , repa y loan s, and make new investments without recourse to external source s of financing. Cas hflow s from operatin g activities are primaril y derive d from the principal revenue-producing of the enterprise . The followin g are the important operatin g activities. (i) Cash receipt s from the sale of goods and the renderin g of services. (ii) Cash activitie s

Cash receipt s from royalties , fees, commission s and other revenue. (iii) payment s to supplier s for goods and services. (iv) (v) (vi) (vii) (viii) Cash payment s to and on behalf employees.

Cash receipt s and cash payment s of an insurance enterprise for premium s and claim s, annuitie s and other policy benefits, Cash payment s or refund s of income taxes unles s they can be specificall y identified with financin g and investin g activitie s and Cas h receipt s and payment s relatin g to future contracts , forwar d contract s, option contract s and swa p contracts whe n the contract s are held for dealin g or tradin g purposes. Some transaction s such as the sale of an item of plant , may give rise to a gain or loss whic h is include d in the determinatio n of net profit or loss. However , the cash flows relatin g to such transaction s are cash flows from investin g activities.

An enterprise may hold securitie s and loans for dealin g or tradin g purposes , in whic h case they are similar to inventor y acquire d specificall y for sale. Therefore , cash flows arisin g from the purchase and sale of dealin g or tradin g activitie s are classifie d as operatin g activities. Similarl y cash advance s and loans made by financial enterprise s are usuall y classifie d as operatin g activitie s since they relate to the mai n revenue producin g activit y of that enterprise.

2.

Cash flow s from investin g activitie s - Investin g activitie s are the acquisition and disposal of long-term assets and other investment s not include d in cash equivalents . The separate disclosure of cash flows arisin g from investin g activities is important because the cash flows represent the extent to whic h expenditure s have been made for resource s intended to generate future income and cash flows.

Example s of cash flow s arisin g from investin g activitie s are

(i) (ii)

Cash payment s to acquire fixed assets (includin g intangibles ). These payment s include those relatin g to capitalise d research& development costs and self constructe d fixed assets. Cash receipt s from disposal of fixed assets (includin g intangibles ) (iii) Cash payment s to acquire shares , warrants , or debt instrument s of other enterprise s

and interest s in joint ventures.

(iv) (v) (vi) (vii)

Cash receipt s from disposal of shares , warrants , or debt instrument s of other enterprises and interest s in joint venture. Cash advance s and loans made to third partie s (other than advance s and loans made by a financial enterprise ). Cash receipt s from the repayment of advance s and loans made to third partie s (other than advance s and loans of a financial enterprise ). Cash payment s for future contracts ,forwar d contracts ,optio n contracts ,and swap contracts except whe n the contract s are held for dealin g or tradin g purpose s or the payment s are classifie d as financin g activities and

(viii) Cash receipts from future contracts ,forwar d contracts ,optio n contracts and swap contracts except whe n the contract s are held for dealin g or tradin g purpose , or the receipt s are classifie d as financin g activities. When a contract is accounte d for as a hedge of an identifiable position , the cash flows of the contract are classified in the same manne r as the cash flows of the positio n being hedged. 3. Cash flows from financin g activitie s - Financin g activities are activitie s that result in changes in the size and composition of the owners capital (includin g preference share capital in the case of a company ) and borrowing of the enterprise. The separate disclosure of cash flows arisin g from financin g activities is imporant because it is useful in predictin g claims on future cash flows by provider s of funds (both capital and borrowing ) to the enterprise. Examples Of Cash Flows Arising From Financing Activitie s Are (a) (b) (c) Cash proceed s from issuin g share s or other similar instruments. Cas h proceed s fro m issuin g debentures , notes , bonds borrowing s and and other short-o r long-term

Cas h repayment s of amount s borrowe d suc h as redemptio n of debentures , bonds, preference shares.

Treahnento f some typical items -AS- 3 (Revised) has also provide d for the treatment of cash flows from some peculia r items as discusse d below :
1.

Extraordinary Items - The cash flows associate d wit h extraordinar y items shoul d be classifie d as arisin g from operating , investin g or financin g activities as appropriate and separatel y disclose d in the cash flows statement to enable users to understan d their nature and effect on the present and future cash flows of the enterprise.

2.

Interest and Dividends - Cash flows from interest and dividend s receive' be disclose d separately . Further , the total amount of interest paid during be disclose d in the cash flow statement whethe r it has been recognise d as an expense m the statement of profit and loss or capitalised . The treatment of interest and dividends receive d and pai d depend s upon the nature of the enterprise . For this purpose , the enterprise s are classifie d as (i) Financial enterprises , and (ii) Other enterprises.
(i)

Financial enterprise s -In the case of financial enterprises , cash flows arisin g from interest paid and interest and dividen d receive d shoul d be classified as cash flows arisin g from operatin g activities. Othe r enterprise s -In the case of other enterprises , cash flows arisin g from interest paid shoul d be classifie d as cash flows from financin g activitie s while interest and dividend s received shoul d be classified as cash flows from investin g activities.

(ii)

Dividend s paid shoul d be classifie d as cash flows from financin g activities. 3.

Taxes on income - Cashflow s arisin g from taxes on income shoul d be separatel y disclosed and shoul d be classifie d as cash flow s fro m operatin g activitie s unles s they can be specificall y identifie d with financin g and investin g activities.

Taxes on income arise on transaction s that give rise to cash flows that are classified as operating investin g or financin g activitie s in a cash flows statement . While tax expense may be readily identifiable wit h investin g or financin g activities , the relate d tax cas h flow s are often impracticable to identif y and may arise ina different period from the cashflow s of the underlying transactions . Therefore , taxes paid are usuall y classified as cash flows from operatin g activities. However , whe n it is practicable to identif y the tax cash flow wit h an individual transaction that gives rise to cash flows that are classified as investin g or financin g activities the tax cash flow is classifie d as an investin g or financin g activit y as appropriate . Whe n tax cash flows are allocate d to ever more than one class of activity , the total amount of taxes paid is disclosed. 4. Acquisition s and disposal s of subsidiarie s and othe r busines s unit s - The aggregate cash flows arisin g from acquisition s and from disposal s of subsidiarie s or other business units shoul d be presente d separatel y and classifie d as investin g activities . An enterprise shoul d disclose ,in aggregate in respect of bot h acquisitio n and disposal of subsidiarie s or other busines s unit s durin g the perio d each of the following: (i) The total purchase or disposal consideratio n and (ii) The portio n of the purchase or disposal consideratio n discharge d by mean s of cash and cash equivalents. The separate presentatio n of the cash flow effects of acquisition s and disposal s of subsidiaries and other busines s unit s as single line items helps to distinguis h those cash flows from other cash flows , the cash flow effects of disposal s are not deducte d fro m those of acquisitions. 5. Foreig n currenc y cash flows - Cash flows arisin g from transaction s ina foreig n currency shoul d be recorde d in an enterprise' s reportin g currenc y by applyin g to the foreign currenc y amount the exchant"' r:. <=> h < = > h A T < = > < = h<=> r<=>nrwtinrr r11rrency and the foreign >n

currenc y at the date of the cash flow. A rate that approximate s the actual rate may be used if the result is substantiall y the same as woul d arise if the rates at the dates of the cash flows were used. The effect of change s in exchange rates on cash and cash equivalents held in a foreig n currenc y shoul d be reporte d as a separate part of the reconciliatio n of the change s in cash and cash equivalent s durin g the period. Umealise d gains and losses arisin g from change s in foreig n exchange rates are not cash flows. However , the effect of exchange rate change s on cash and equivalent s held or due in a foreig n currenc y is reporte d in the cash flow statement in order to reconcile cash and cash equivalent s at the beginnin g and the end of the period . This amount is presented separatel y from cash flows from operating ,investin g and financin g activities and includes the difference , if any had those cash flows been reporte d at the end of perio d exchange rates. 6. Non-cash transactions - Many investin g and financin g activities do not have a direct impact on current cash flows althoug h they do affect the capital and asset structure of an enterprise . Example s of non-cas h transaction s are : (a) The acquisitio n of assets by assumin g directl y relate d activities. (b) The acquisitio n of an enterprise by means of issue of shares; and (c) The conversio n of debt to equity. Investin g and financin g transaction s that do not require the use of cash or cash equivalents shoul d be exclude d from a cash flow statement . Such transaction s shoul d be disclose d elsewhere in the financial statement s in a way that provide s all the relevant informatio n about these investin g and financin g activities. Method s of Calculatin g Cash flows (Used in) Operating Activities There are two method s of reportin g cash flows from operatin g activities namel y (1) Direct Metho d and (2) Indirect Method. 1. The Direct Method - Unde r the direct method , cash receipt s (inflows) from operating revenue s and cash payment s (outflows ) for operatin g expense s are calculate d to arrive at cash flows from operatin g activities. The difference betwee n the cash receipt s and cash payment s is the net cash flow provide d by (or used in) operatin g activities . The following are the example s of cash receipt s and cash payment s (called cash flows) resultin g from operatin g activitie s : (a) Cash receipt s from the sale of goods and the renderin g of services. (b) Cash receipt s from royalties , fees commission s and other revenues (c) to supplier s for goods and services (d) Cash payment to and on behalf of employees. (e) Cash receipt s and cash payment of an insurance enterprise for premium s and claims annuitie s and other policy benefits. Cash payment

(f) (g) (h)

Cash payment s or refun d of income taxes unless they can be specificall y indentified wit h financin g and investin g activitie s and Cash receipt s and payment s relatin g to future contracts , forwar d contract s, option contract s and swa p contract s whe n the contract s are held for dealin g or trading purposes. The formatio n about major classes of gross cash receipt s and gross cash payments ma y be obtaine d either: (i) From accountin g record s of the enterprise; or
(ii) By adjustin g sales ,cost of sales (interest and similar income and interest expense and similar charge s for a financial enterprise ) and other items in the statement of profit and loss for;

(i) Change s durin g the perio d in inventorie s and operatin g receivable s and payables,
(j)

Other non-cas h items , and

(k) Other items for whic h the cash effects are investin g or financin g cash flows.
Format of Cash Flow s Statement - AS-3 (Revised) has not provide d any specific format for preparin g a cash flows statement . However , an idea of the suggeste d format can be inferred fro m the illustration s appearin g in the appendice s to the accountin g standard . The cash flow statement shoul d report cash flows durin g the perio d classifie d by operating , investin g and financin g activities; a widel y used format of cash flow statement is give n below: Cash Flow Statemen t (for the year ende d.....) Pa rticulars from Operatin g Activities Rs. Rs. Cash Flows

Cash receipt s from customers Cash paid to supplier s and employees Cash generate d from operations Income tax paid Cash flow before extraordinar y items Extraordinar y items Net cash fro m (used in) Operatin g activities
(Or) Net profit before tax and extraordinar y items Adjustment s for non-cas h and non-operatin g items (List of individual items suc h as depreciation, foreig n exchange loss, loss on sale of fixed assets,

X XX

XX X XXX

(xx x)
XX X XXX

(x x)

XXX

in terest income , dividen d income , interest expense etc.) xxx

Format of Cash Flo w Statemen t approve d by Sebi is give n below:

Cash Flow Statement (for the year ende d.....)

Particulars
(A) Cash Flo w from operatin g activities

Rs.

Rs.

Net Profit I Loss before tax and extraordinar y items

Adjustment s for :

Depreciation Gain I Loss on sale of fixed assets Foreign exchange Miscellaneous expenditure written off Investment income Interest Dividend Operatin g profit before workin g capital changes
Adjustment s for :

Trade and other receivables Inventories Trade payables Cash generated from operations Interest paid Direct taxes paid Cash flow before items extraordinar y items
Net cash from operating activities (B) Cash Flo w from investin g activities

Purchase of fixed assets Sales of fixed assets Purchase of investments Sale of investments Interest received Dividend received
Net cash from

I used in investin g activities

(C)

Cash flow from financin g activities Proceeds from issue of share capital Proceeds from long-term borrowing s /banks Payment of long-term borrowings Dividen d paid
Net cash from/ used in financing activities
XXX XXX XXX XXX

Net increase I (decrease) in cash and cash equivalents Cash and cash equivalent s as at... (Openin g Balance ) Cash and cash equivalent as at.... (Closing Balance )

2.The Indirect Method - Unde r the indirect method , the net cash flow from operating activities is determined by adjustin g net profit or loss for the effect of: (a) Non-cas hitems such as depreciation ,provisions ,deferre d taxes ,and unrealise d foreign exchange gains and losses ' and (b) Change s durin g the perio d in inventorie s and operatin g receivable s and payables. (c) All other items for whic h the cash effects are investin g or financin g cash flows. The indirect metho d is also called reconciliatio n metho d as it involve s reconciliatio n of net profit or loss as given in the profit and loss account and the net cash flow from operating activitie s as shown in the cash flow statement . In other words, net profit or losses adjuste d for non-cas h and non-operatin g items whic h may have been debite d or credite d to profit and loss account as follows. Calculatio n of Cash Flow From Operating Activities

Particulars Flows from Operating activities Cash receipt s from customers to supplier s and employees operations Income tax paid C a E x N e
Or)

Rs.
XXX

Rs. Cash

Cash paid (xxx) Cash generate d from

XXX

(xx)

Financial Analysi s and Plan ning

Net profit before tax and extraordinar y items xxx Add: Non-cas h and non-operatin g items which have alread y been debited to P.L. Account (a) Depreciation XXX
(b) Transfe r to reserve s and provisions
XXX XXX XXX

(c) Goodwill writte n off (d) Preliminar y expense s writte n off (e) Other intangible assets writte n off such as discount or loss on issue of share s I debentures , underwritin g comm ission etc. (f) Loss on sale or disposal of fixed assets xxx (g) Loss on sale of investments xxx (h) Foreig n exchange loss xxx Less: Non-cas h and non-operatin g items whic h have alread y been credite d to P.L. Account (a) Gain on sale of fixed assets
(b) Profit on sale of investments from interest or dividend s on investments xxx

xxx

XXX XXX

XXX

xxx (c) Income xxx (d) Appreciation

(e) Reserve s writte n back (f) Foreig n exchange gain Operatin g Profit Before Workin g Capital Changes

XXX XXX XXX XXX

Adjustment s for change s in current operatin g assets and liabiliti es: Add : Decrease in Account s of Current Operatin g Assets

(except cash and cash equivalents ) such as: Decrease in trade debts Decrease in bills receivables Decrease in inventorie s I stock-in-trade Decrease in prepai d expense s etc. Add: Increase in account s of current operatin g liabilities (except Bank overdraft ) such as : Increase in creditors Increase in bills payable Increase in outstandin g expenses
XXX XXX XXX XXX

XXX XXX XXX XXX

xxxx

FIANANCIAL

MANAGEMENT

& INTERNATIONAL

FINANCE

Particulars Less : Increase in account s of current operatin g assets (as state d above) Less : Decrease in account s of current operatin g liabilities (as state d above)

Rs.

Rs.
XXX XXX

XXX XXX XXX

Cash generate d from (used in) operation s before tax Less : Income tax paid Cash flows before extraordinar y items Add/ Less : Extraordinar y items if any Net cash flow from (used in) operatin g activities Importan t note to Students
1. An increase in liability

XXX XXX XXX XXX XXX

Cash inflow Outflo w of cash Outflo w of cash Cash inflow

2. A decrease in liability 3. An increase in an asset 4. A decrease in an asset

Nee d of Preparin g Cash flo w Statement

Funds Flow Statement highlight s the change s that have taken place in the financial structure of the busines s concer n since the last reportin g date. In other words Funds Flow Statement takes into account the inflow and outflo w of funds in terms of workin g capital , durin g the perio d unde r consideration . Funds Flow Statement did not reveal the quantum of inflow and outflo w of cash. In short it did not explai n the change s in cash balance. The cash plays an important role in the busines s firm' s economic life. What blood is to human body, cash is to busines s enterprise . Therefore , the major responsibilit y of financial manage ment of the busines s firm is to maintai n adequate cash in the busines s is one of the prerequi sites for successful operation . A busines s firm needs cash to make payment s for purchase of goods or raw materials , to meet day to day expense s and to pay salaries , wages , interest and dividend s etc. The movement of cash is of vital importance to management . If the inflow s of cash are not sufficient to meet the outflow s of cash, the firm cannot meet its current obliga tions. Hence the need of prope r plannin g and control of cash flow arises. Cash constitute s the basic foundatio n of all busines s transaction s without which the other component s of current assets have little significance . Hence there is a need for cash analysis . For analysi s of cash, a separate statement is to be prepare d known as cash flow statement. In a narro w sense the term Funds mean s cash and the statement of change s in the financial positio n prepare d on cash basis is called a Cash Flow Statement.

Cash Flow Statement is a statement of cash flow. Cash flow studie s the movement s of cash in and out of a busines s concern. Inflow of cash is known as source and outflo w of cash is called use of cash. The term Cash here stand s for cash and bank balance. Cash Flow Statement shows the change s in cash positio n betwee n two Balance Sheet dates . It provide s the details in respect of cash generate d throug h operating , investin g and financial activitie s and utilise d for operating ,investin g and financial activities . The transaction s which increase the cash positio n of the busines s are known as Inflows of cash (ex: Sale of current and fixed assets, Issue of share s and debenture s etc.) The transaction s whic h decrease the cash positio n are known as outflow s (ex: Purchase of current and fixed asset s, redemptio n of de bentures ,and preference share s and other long term debts ). Cash Flow Statement concentrates on transaction s that have a direct impact on cash. This statement depict s factor s responsible for suc h inflow and out of flow of cash. In brief_ cash flow statement summarie s the causes of change s in cash positio n betwee n dates of two balance sheets. 1. Cash Flow Statement reveal s the causes of change s in cash balance s betwee n two bal ance sheet dates. 2. This statement helps the management to evaluate its abilit y to meet its obligation s i.e., payment to creditors , the payment of bank loan , payment of interest , taxes ,dividen d etc. 3. It throw s light on causes for poor liquidit y in spite of good profits and excessive liquid ity in spite of heav y losses. 4. It helps the management in understandin g the past behaviou r of cash cycle and in con trolling the use of cash in future. 5. Cash Flow Statement s help s the management in plannin g repayment of loans , replace ment of assets etc. 6. This statement is helpful in short-term financial decision s relatin g to liquidity. 7. This statement helps the management in preparin g the cash budget s properly. 8. This statement helps the financial institutio n who lend s advance s to busines s concerns in estimatin g their repayin g capacities. 9. Since a Cash Flow Statement is based on the cash basis of accountin g it is very useful in evaluatio n of cash positio n of a firm. 10. Cash Flow Statement disclose s the complete stor y of cash movement . The increase in, or decrease of cash and the reaso n therefore can be known. 11. Cash Flow Statement provide s informatio n of all activities financin g activitie s separately. such as operating , investing, and

12. Since Cash Flow Statement provide s informatio n regardin g the source s and utilisation of cash durin g a particula r period ,it is easy for the management to plan carefull y for the cash requirement s in the future , for the purpos e of redeemin g long-term liabilitie s or I and replacin g some fixed assets.

13. A projecte d Cash Flow Statement reveal s the future cash positio n of a concern. Through this cash flow statement the firm can know how muc h cash it can generate and how muc h cash will be neede d to make variou s payments. 14. Cash Flow Statement prepare d accordin g the AS-3 (Revised) is more suitable for mak ing compariso n than the funds flow statement s as there is no standar d format s used for the same.
Limitation s of Cash Flow Statement

Cash Flow Statement suffers from the followin g limitations.

1. A Cash Flow Statement only reveals the inflow and outflo w of cash. The cash balance disclose d by the Cash Flow Statement may not represent the real liqui d positio n of the concern.

2. 3.

Cash Flow Statement is not suitable for judgin g the profitabilit y of a firm as non-cash change s are ignore d while calculatin g cash flows from operatin g activities. Cash Flow Statement is not a substitute for Income Statement or Funds Flow Statement. Each of them has a separate functio n to perform . Net Cash Flow disclose d by cash flow statement does not necessaril y be the net income of the business , because net income is determine d by taking into account bot h cash and non-cas h items. Cash Flow Statement is based on cash accounting . It ignore s the basic accountin g con cept of and accrual basis. Cash Flow Statement reveal s the movement of cash only. In preparatio n it ignore s most liqui d current assets (ex: Sundry debtors , Bills Receivable etc.)
It is difficult to precisel y define the term cash. There are controversie s amon g accoun tants over a numbe r of near cash items like cheques , stamps , postal order s etc., to be include d in cash.

4. 5. 6.

7. Cash Flow Statement does not give a complete picture of financial positio n of the con cern.

Difference s Betwee n l'unds tlo w Statemen t And Cash tlo w Statement

The followin g are the main difference s betwee n a Funds Flow Statement and a Cash Flow Statement.
F u 1 . F u 2. F u 3 . I n 4. F u n 5. F u 6 . F u n d s