CASH FLOW STATEMENT

- Dr. Manisha Singh

8/18/12

Statement depicting change in cash position from one period to another. It explains the reasons for inflow or outflow of cash and helps the management to plan for immediate future.

Meaning:
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 Balance Sheet P&L A/c It shows the relationship

insufficient. of net income to changes in cash balances. It reports past cash flows as an aid to:

It

identifies changes in the mix of productive assets.

Predicting future cash flows Evaluating the way management generates and uses cash Determining a companys ability to pay interest and dividends and to pay debts when they are due

Why CFS?
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The statement of cash flows, along with the income statement, explains why balance sheet items have changed during the period. Legal rules.

Why CFS? . . .
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The

relationship among the balance sheet, income statement, and statement of cash flows:
Balance Sheet December 31, 20X0 Balance Sheet December 31, 20X1

Income Statement Statement of Cash Flows

Why CFS?

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The Cash Flow Statement

The cash flow statement provides information about: cash receipts (cash inflows) uses of cash (cash outflows) during a period of time Inflows and outflows are reported for:
Operating activities Investing activities Financing Activities
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Cash Inflows and Outflows

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The change in the cash position from one period to another is computed by taking in account the Application and Sources of cash. other words, change in cash position = Sources of cash Application of cash.

In

PREPARATION OF CASH FLOW STATEMENT

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Preparing a Statement of Cash Flows

There are two methods of preparing the statement of cash flows:

Indirect method: derives cash flows from accrual based statements Direct method: derives cash flows directly for each source or use of cash

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Accrual Based Statements

Income Statement items & Changes in Current Assets and Current Liabilities Balance Sheet: Changes in Non-Current Assets

Cash Flow Statement

Operating activities: Adjust net income for accruals and non-cash charges to get cash flows Investing activities: Inflows from sale of assets and Outflows from purchases of assets Financing activities: Inflows and outflows from loan and equity transactions

Balance Sheet: Changes in Non-Current Liabilities and Equity

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Steps in preparing Cash Flow statement:

Preparation

of adjusted P/L Account to find out cash from operation. Comparison of current items (assets and liabilities) to find out inflow and outflow of cash. Preparation of Cash Flow Statement.

The Statement of Cash Flows: Direct Method 8/18/12

Sources of cash
Internal sources: Cash from operation = Net Profit + Depreciation (+) Loss on the sale of fixed assets (+) Amortization of intangible assets (+) Creation of reserves (+) Profit from sale of fixed assets (-) External sources:
Issue of new shares Long term loans Purchase of plant and

machinery on deferred payment Short term borrowings/ cash credits from banks Sale of fixed assets, investments etc.
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Application of Cash:
Purchase of fixed assets Payment of long term loans Decrease in deferred payment liabilities Loss on account of operation Payment of tax Payment of dividends Decrease in unsecured loans, deposits etc. 8/18/12

Computation of cash from operation

When all transactions are cash transaction:

Net profit as per P/L A/c will be taken as CASH of cash from NET PROFIT the amountFROM OPERATION = operations.

When

all transactions are not cash transactions:

The computation of cash from operation can be done in two stages: Computation of fund from operation Adjustments in the fund so calculated for 8/18/12

1. 2.

Adjustments for changes in CA and CL:

1. Effect of credit sales:

If out of total sales of 30,000, credit sales is Rs. 10,000 cash flow from sales = 20,000

Thus while computing cash from operations, it would be necessary that suitable adjustments for the outstanding debtors are also made. Like deducting the amt. of credit sale from the net profit as debtors outstanding atprofit + debtors o/s at the Cash from operation = Net the year end.
beginning debtors o/s at the end of the year

Cash from operation = Net profit +OR Decrease in debtors or (increase in debtors) 8/18/12

2. Effect of credit purchase:

If sale = 30,000, Purchase = 25,000 out of which credit purchase is 10000 Cash from operation = 15,000 Adjustments in the Net profit would be made by adding the amt. of credit purchases to get the cash from operation. Decrease in creditors from one period to another would mean decrease in cash from operation and vice versa. This is because more cash payments have from operation to Net profit + creditors at the Cash been made = the creditors which results in outflow of cash. end of the year creditors at the beginning

Cash from operation = Net profit + OR Increase in creditors OR -(Decrease in creditors)

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Ex: Sales = 50,000, debtors o/s at the beginning

= 8000, debtors o/s at the end = 15000, creditors at the beginning = 12000, creditors at the end = 15000, Purchases = 30000, expenses = 5000

Sol: Rs.

Cash from operation

Sales 50000 Less: Purchase Expenses 35000 15000 Add: debtors at the beginning creditors at the end 23000 38000 8/18/12 Less: creditors at the beginning

30000 5000 Net Profit 8000 15000

12000

3. Effect of opening and closing stock:

The amt. of opening stock is charged to the debit side of P/L a/c. thus it reduces the profit without reducing the cash from operation. Similarly, amt. of closing stock is put on the credit side, which increases the net profit without increasing the cash from operation. Hence suitable adjustments to the net profit is made in the form of adding back the opening stock and deducting the closing stock to get cash from operation. Thus :
Cash from operation = Net profit + Opening stock closing stock

Cash from operation = Net profit + Decrease in stock OR

OR -(Increase in stock)

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Ex: Opening stock = 5000, Purchases = 20000, Sales = 35000, Expenses = 5000, Closing stock = 10000

Sol: Particulars
Amount Opening stock 35000 Purchases 10000 Expenses Net Profit

Profit and Loss a/c Amount Particulars

5000 20000 5000 15000 45000 Sales Closing stock

45000 Cash from operation: Net profit for the year 15000 8/18/12 Add: Opening stock

4.Effect of change in Outstanding expenses, Income received in advance etc.

If certain expenses are not paid (i.e., o/s) or some income is received in advance, it will result in decrease in net profit without actually decreasing the cash. This is because net profit is computed after charging to it all expenses whether paid or outstanding. Therefore cash from operation will be higher than the actual profit as per P/L account. Thus :

Cash from operation = Net profit + (Expenses o/s + Income received in advance) at the end (Expenses o/s + income received inOR advance) at the beginning Cash from operation = Net profit +Increase in (o/s expenses and income received in advance) OR Decrease in (o/s expenses and income
8/18/12 received in advance)

Ex: Gross Profit = 30000, Expense paid = 10000, Interest received = 2000 Rs 2000 are o/s on account of expenses while Rs 500 has been received as Interest for the next year

Sol:
Particulars
Amount Expenses paid 30000 Add: o/s exp. 2000 Net Profit 500 1500 31500

Profit and Loss account

Amount 10000 2000 12000 19500

Particulars
Gross profit Interest received Less: interest rece-ived in advance

31500

Cash from operation: Net profit for the year 8/18/12 19500

5.Effect of Prepaid expenses and outstanding income:

It is similar to the effect of debtors. While computing net profit from operations, the expenses only for accounting period are charged to P/L a/c. This means pre-paid expenses (since not charged) do not decrease net profit for the year but actually reduces the cash from operation. Similarly income earned during the year is credited to P/L a/c, whether received or not. Thus o/s income increases the profit but not the cash from operation. Thus:

Cash from operation = Net profit + (Prepaid expenses + o/s income) at the beginning of the year - (Prepaid expenses + o/s income) at the end of the year OR Cash from operation = Net profit + Decrease in (Prepaid expenses + o/s income) OR 8/18/12 Increase in (Prepaid

Ex: Net Profit = 20000, Prepaid Expenses as on 1/1/07 = 2000, Prepaid Expenses as on 31/12/07 = 3000, O/S (accrued) income on 1/1/07 = 1000, O/S (accrued) income on 31/12/07 = 2000. Calculate cash from operation.

Cash from operation:

Net profit
20000

Less: Prepaid expenses as on 31/12/07 3000 o/s income as on 31/12/07 2000

5000 15000

Add: Prepaid expenses as on 1/1/07 o/s income as on 1/1/07

3000 18000

2000 1000

8/18/12 Cash from operation

Overall effect of current assets and liabilities can be shown as:

+ Decrease in debtors + Decrease in stock prepaid Expenses accrued income + Increase in creditors o/s expenses Cash from operation = Net profit debtors
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+ Decrease in + Decrease in

+ Increase in

- Increase in - Increase in

Summary of findings:

Increase in Current assets and Decrease in current liability Decrease in cash

Decrease in Current assets and Increase in current liabilities Increase in cash

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10000 12000 Debtors 15000 20000 Creditors 5000 7500 Bills receivable 5000 8000 O/s expenses 3000 5000 Bills payable Trading and Profit and Loss account 4000 2000 Particulars Amount Particulars Prepaid expenses To, Purchases By, Sales 1000 500 20000
To, Wages To, Gross profit 5000 5000 30000

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Amount
30000 30000

To, Salaries To, Rent To, Depreciation on plant To, Loss on sale of furniture To, Goodwill written off To, Net Profit

1000 1000 1000 500 1000 5500

By, Gross profit b/d By, Profit on sale of building Book value 10000 Sold for 15000

5000

5000

10000

10000

Sol: 1. Calculate fund from operation 8/18/12 2. Adjustments in fund amt to find out cash from operation

Fund from operation:

Net profit Add: Items that do not decrease the fund: Depreciation Loss on sale of furniture Goodwill written off 5500 1000 500 1000

2500 8000 5000 3000

Less: Items which do not increase the fund: Profit on sale of building Fund from operation

(Out of Net profit of Rs 5500, Fund from operation is only Rs. 3000)

Cash from operation:

Fund from operation as calculated Less: Increase in CA and decrease in CL: Increase in stock (12000- 10000) Increase in debtors (20000- 15000) Increase in BR (8000- 5000) Decrease in BP (4000- 2000)

8/18/12 3000

2000 5000 3000 2000

(12000) ( 9000)

Add: Decrease in CL and increase in CA: Decrease in prepaid expenses (1000-500) 500 Increase in O/S expenses (5000- 3000) 2000 Increase in creditors (7500- 5000) 2500 Cash from operation

5000 (4000)

Format of Cash Flow Statement (Direct Method)

Balance as on .. ---Cash balance Bank balance
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xxx

---Add: Sources of cash: Issue of shares --Long term loans --Sale of fixed assets --Short term borrowings --Cash from operation --(1)

xxx xxxx

Total cash available

Importance of cash flow analysis:

Helps in an efficient cash management Helps in internal financial management Discloses the movement of cash Discloses success or failure of cash planning

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Cash flow statement can not be equated with the income statement. The cash balance by CFS may not represent the real liquid position of the business Cash flow statement can not replace the income statement or the fund flow statement.

Limitations of Cash flow analysis

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Difference between CFS and FFS: Cash Flow Analysis

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Fund Flow Analysis

Concerned with change in working capital (which includes cash) position It shows the short term solvency of the business as it takes into a/c other liquid assets as well. Useful for short period as a tool for financial analysis Reverse is not necessarily true, i.e., sound cash position = sound fund position Sound cash position =/ sound fund position Decrease in current assets and increase in current liability = Decrease in working capital and vice versa

It is concerned only with change in cash position Records only cash receipts and disbursements and thus cant show the short term solvency of the business More useful in very short period for financial analysis Cash is a part of working capital and therefore improvement of cash position results in improvement in fund position Decrease in current assets and increase in current liability = Increase in cash position and vice versa