Paper: Cost Accounting Lesson: Cash Flow Statement Lesson Developer: Ms. Yasha Bothra, College/Dept: Assistant Professor in Commerce, Bharati College, University of Delhi
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Table of Contents: 1. 2. 3. 4. 5. 6. 7. 8.
Learning Outcomes Introduction Applicability of Cash Flow Statement Objectives of Cash Flow Statement Advantages of Cash Flow Statement Limitations of Cash Flow Statement Cash Flow Statement and Cash Book Classification of Cash Flow Activities 8.1. Operating Activities 8.1.1. Meaning 8.1.2. Calculating Cash Flow from Operating Activity 8.1.3. Purpose of Calculating Cash Flow from Operating Activity 8.2. Investing Activities 8.2.1. Meaning 8.2.2. Calculating Cash Flow from Investing Activity 8.2.3. Purpose of Calculating Cash Flow from Investing Activity 8.3. Financing Activities 8.3.1. Meaning 8.3.2. Calculating Cash Flow from Financing Activity 8.3.3. Purpose of Calculating Cash Flow from Financing Activity 9. Non Cash Investing and Financing Transactions 10. Complete Format of Cash Flow Statement Summary Glossary Exercises References
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1. Learning Outcomes: After going through this lesson, you should be able to: understand the concept of Cash Flow Statement; learn the objectives and needs of Cash Flow Statements; find out the advantages and disadvantages of making Cash Flow Statements; comprehend the different types of activity under Cash Flow Statements; appreciate the knowledge of cash and non cash items and their importance in Cash Flow Statements; learn to prepare Cash Flow Statement.
2. Introduction: Every business operating in this world wants to make some kind of benefit out of its activities. All business firms enter into a give and take relationship. They buy raw material and manufacture goods. Cash Flow Statement is a statement that tells about the inflow and outflow of cash and cash equivalents in an organization. Cash Flow Statement is also known as Statement of Cash Flows. It shows the changes in the cash position of an organization. In fact, it is statement which not only informs about the changes in the position of cash but also the reason for the change. At this point we must know the following: Cash: Cash can be understood as cash in hand and Demand Deposits with banks. Cash Equivalents: Cash equivalents are the short term but very liquid investments that can be easily and readily converted into cash. Thus, we understand that cash flows relates to inflows and outflows of cash and cash equivalents. Cash Flow Statement allows investors to understand how a company's operations are running, where its money is coming from, and how it is being spent.
Hello ITO I want to know why making cash flow is important.. as profits can be obtained from Financial Statements of the company.
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Knowledge of profits is not sufficient. A business firm must know about the availability of cash with it to meet its payment obligations. Suppose I bought goods of Rs 5000 from you on credit. You incurred cost of Rs 4000 to make these goods. Now your suppliers are asking you for payment .But you are not having money as you sold these goods to me on credit.
OK…….Now I understood. I made a profit of Rs1000 in this transaction. But there is no cash with me in spite of making profit.
Yes….Right, and just think how people or investors would value a company which has no cash to pay dividend or a very less amount of cash to meet its obligations. Thus, it is required to make Cash Flow Statement to know the position of cash. Now let us see who are required to make this Statement for Cash.
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3. Applicability of Cash Flow Statement: The Institute of Charted Accountants of India issued the Accounting Standard (AS-3) relating to the Cash Flow Statement. It states the format for the Cash Flow Statement for the period commencing on or after April 1, 2001. Preparation of Cash Flow Statement is mandatory for the following entities:
Enterprises having equity or debt securities listed whether in India or outside India; Enterprises which are in the process of listing their equity or debt securities as evidenced by the Board of Directors' Resolution in this regard; Banks (including Co-Operative Banks); Financial Institutions; Enterprises involved in insurance business; All commercial, industrial and business reporting enterprises, whose turnover for the immediately preceding accounting period on the basis of audited Financial Statements exceeds 50 crore . Turnover does not include 'Other Income'; All commercial, industrial and business reporting enterprises having borrowings, including public deposits, in excess of 10 crore at any time during the accounting period; Holding and subsidiary enterprises of any one of the above at any time during the accounting period.
4. Objectives of Making Cash Flow Statement: Cash Flow Statement is further information to the users of Financial Statements and investors. The statement shows the inward bound and outward bound of cash. The statement assesses the potential of the enterprise to generate cash and make the most of it. Following objectives are served by Cash Flow Statement: It tells about cash generated as well as used in various kinds of activities undertaken by the firm. It helps in planning of future use of cash, i.e. whether to buy an asset or not. Whether continuing a particular operation is viable or not. Banks and financial institutions mostly have a preference for Cash Flow Statement to analyze liquidity of the borrowing firm. Thus it helps in assessing the liquidity position of the firm. This statement helps to manage the cash in the most efficient and effective manner. It is very useful in the evaluation of cash position of a firm. It shows the inflows and outflow of cash separately from Investing, Financing and Operating activities.
Value Addition 1: Did You Know? Cash Flow Statement Cash Flow Statement is also known as “Where Got Where Gone Statement”.
5. Advantages of Cash Flow Statement: Following are the advantages of Cash Flow Statements:
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Cash Flow Statement provides information about the inflows and outflows of cash in the enterprise. It tells about the flow of cash from different activities namely: Operating, Investing and Financing. It gives an idea about the management’s efficiency regarding management of its cash resources. It tells about the liquidity and solvency position of an enterprise. It helps in preparation of future budget of the enterprise. It tells about the stronger and weaker activities of the enterprise.
6. Limitations of Cash Flow Statement: Cash Flow Statement suffers from the following limitations: There is no consideration of Non Cash Activities in the Cash Flow Statement. Since it is prepared after preparation of Financial Accounts, therefore it cannot rectify any errors that had already taken place in the accounts. It is not a substitute to Profit and Loss Account as it is based on only cash transactions. Cash Flow Statement is based on Cash Basis of Accounting and not Accrual Basis of Accounting.
7. Difference Statement:
between
Cash
Book
and
Cash
Flow
Cash Book is a Primary Book of entry for cash transactions whereas Cash Flow Statement shows sources and uses of cash. In Cash Book, an entry is passed for all cash transactions as well as it might have discount received or allowed column whereas in Cash Flow Statement only inflow or outflow of cash is recorded. Cash Book is prepared throughout the financial year as and when transaction relating to cash takes place whereas Cash Flow Statement is prepared at the end of the financial year. Cash Book gives information about balance of cash whereas Cash Flow Statement tells about inflow and outflow of cash. Cash Book doesn’t show cash flow from different activities separately whereas Cash Flow Statement shows inflow and outflow of cash from these activities separately. In cash Book, cash means cash at hand and cash at bank but in Cash Flow Statement cash and its equivalent means cash in hand, cash at bank and Short Term Marketable Securities.
Value Addition 2: Did You Know? Cash Flow Statement and Cash Budget Cash Flow Statement tells about changes in cash position in the past whereas Cash Budget forecasts the changes in cash position in the future
INTERACTIVE 1
8. Classification of Cash Flow Activities: Institute of Lifelong Learning, University of Delhi
As per AS-3 (Revised), issued by the Accounting Standards Board, Cash Flow Statement is divided on the basis of the three activities namely Operating Activities, Investing Activities and Financing Activities. Figure 1: Classification of Cash Flow Activities
Cash flow
Operating Activities
Investing Activities
Financing Activities
Value Addition 3: Image Examples of Operating, Investing and Financing Activities Click on the link below to view an image for cash flow activities. Source: http://images.flatworldknowledge.com/heisinger/heisinger-fig12_001.jpg
8.1. Operating Activities: The first activity which results in inflow and outflow of cash is operating activity. Let us understand about it: 8.1.1. Operating Activity-Meaning: It refers to the principal revenue generating activities of an enterprise. Operating activities are the core activities of the enterprise. In case of manufacturing concern these are manufacturing and selling of goods. In case of retail business these are buying and reselling of goods. For a service providing enterprise operating activities relates to selling and providing services. Every enterprise should focus on generating cash from such activities as these are the reason for which a business or an enterprise was buildup .following can be inflows and outflows of cash due to operating activities: cash receipts from the sale of goods and services by the enterprise; cash receipts from royalties, fees, commissions and other revenue; cash payments to suppliers for goods and services; cash payments to and on behalf of employees;
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cash receipts and cash payments of an insurance enterprise for premiums and claims, annuities and other policy benefits; cash payments or refunds of income taxes except they can be in particular identified with financing and investing activities and Cash receipts and payments relating to futures contracts, forward contracts, option contracts and swap contracts when the contracts are held for dealing or trading purposes.
8.1.2. Calculation of Cash Flow from Operating Activities: Cash Flow from Operating Activities can be calculated by two methods. Figure 3: Methods of Calculating Cash Flow from Operating Activities
a. Direct Method: In Direct Method, Cash Flow from Operating Activities are calculated by subtracting cash payments from cash received from activities of regular nature or those activities which are in nature of operating activity. The standard-setting bodies promote the use of the direct method, but it is infrequently used, for the first-rate basis that the information in it is hard to pull together; companies basically do not bring together and accumulate information in the way necessary for this format. Using the direct method may have need of that the chart of accounts be restructured in order to bring together different types of information. b. Indirect Method: The Indirect Method is the mostly used method for calculation of cash flow from operating activities. In this method, the net income figure from the Income Statement is used to calculate the amount of net cash flow from operating activities. The Profit and Loss Account Balance is taken from Balance Sheet. The difference between the figures of P & L Account is used to find the amount of profit generated. This difference is the beginning point in Indirect Method for calculation. However, it is adjusted for non cash expenses, non operating incomes/gains, non operating losses and adjustment for changes in working capital.
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Following is the format for calculating cash flow from operating activities by direct method and indirect method. a. Cash Flow from Operating Activities by Direct Method:
For the year Ended……………………. As per AS-3 (Revised)
Particulars (A) Cash Received from Operating Activities Cash Sales Cash Received from Customers Cash Received for Royalties Trading Commission Received
Amount
Amount
Xxxx
(B) Cash payments for Operating Activities Payment for Purchases in Cash Cash Paid to Suppliers Business Expense ,Office Expense or any Other Operating Expense
Xxxx
(C) Cash Generated from Operations (A-B) Less: (D) Income Tax Paid (Net of Tax Refund Received) Cash Flow before Extra Ordinary Item (E) Adjustment for Receipt and Payment for Extraordinary Item. (G) Net Cash from /Used in Operating Activities
Xxxx Xxxx Xxxx Xxxx Xxxx
b. Cash Flow from Operating Activities by Indirect Method: For the year Ended……………………. As per AS-3 (Revised) Particulars
Amount
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Amount
(A) Cash Flow from Operating Activities Net P& L A/c or difference between Closing and Opening Balance of P & L A/c A) Add: Profits Appropriated: Transfer to Reserve Proposed Dividend for the Current Year Interim Dividend Paid During the Year Provision for Tax Made During the Year Any Receipt from Extraordinary Item Less: Extraordinary Item, if any, Credited to P & L A/c Refund of Tax Credited to P& L A/c Net Profit Before Tax and Extraordinary Item B) Add: Non Operating Expenses Depreciation Preliminary Expenses Written Off Discount on Issue of Shares & Debentures Written Off Goodwill, Patents and Trademark Amortized Interest on Borrowings Interest on Debentures Loss on Sale of Fixed Assets C) Less: Non Operating Income Interest Income Dividend Received Rent Received (If it is of Non Operating Nature) Profit on Sale of Fixed Assets D) Operating Profit before Working Capital Changes(A+B-C) E)Add: Decrease in Current Assets & Increase in Current Liabilities F)Less: Increase in Current Assets and Decrease in Current Liabilities G)Cash Generated from Operations(D+E-F) H)Less: Income Tax Paid (Net of Tax Refund Received) J) Adjustment for Extraordinary Item K)Net Cash from or Used in Operating Activities
Following points should be kept in mind before making Cash Flow Statement: Profit or Loss on Sale of Fixed Assets: Many times firms make profit or loss when they sell fixed assets like plant or machinery, building etc. In case assets are sold at a price higher than their book values less depreciation, there is profit on such sale and vice versa. But we must know that the cash received by selling such asset comes under investing activities. But the profit or loss doesn’t result in any flow of cash thus we are required to make adjustments for such an amount in the net profit. Thus we are required to add the loss on sale and deduct profit on sale of such assets. But gain or loss on sale of short term marketable securities results in increase or decrease in cash flow from operating activities. Short term marketable securities are current assets. Purchase and Sale of Securities: In case the enterprise for which statement is to be made is a finance company then buying and selling of securities is part of their operating activity. Similarly cash advances and loans
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made by financial enterprises are also part of the operating activity for a finance company. In all other cases they are treated as financing activities. Extraordinary Items: Extraordinary items are the items which don’t occur regularly such as Insurance claims received for loss by fire, relief fund for natural disaster etc. Therefore any increase in profit due to extraordinary income is deducted and any reduction in profit due to extraordinary expense or loss is added back. Interest and Dividend Received or Paid: In case of financial institutions interest paid or received and dividend paid or received are part of their day to day activity therefore they are classified as operating activity. Cash flows from such activities are operating cash flows. In case of other enterprises Interest paid and dividend paid is a financing activity, whereas interest received and Dividend received is an investing activity. Payment of Interim Dividend: The amount of interim dividend paid during the year is added back to profits to calculate cash flow from operating activities and deducted from and then reduced from cash flow from financing activity Proposed Dividends: Proposed dividend is an appropriation of profit therefore they are added back to net profits to calculate cash generated from operating activities. Taxes on Income: Taxes paid will be classified as operating, investing or financial activity according to the purpose for which they are paid. For example income tax paid is of the nature of operating activity but capital gain tax on sale of fixed asset is a financing activity. Provision for Tax: Provision for tax is added back to profits as they are just an appropriation of profit. If there are two balances provided for the provision for cash i.e. the opening or last year’s provision and closing or current year’s provision. In such a case provision from last year is taken as tax paid and current year’s provision is added back to profits. Provision against Current Asset: There are various provisions against current assets such as Provision for bad and doubtful debts, provision for discount on debtors etc. These provisions actually affect the cash flow from operations there are two ways of treating them: Figure 4: Treatment of Provision against Current Assets
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Treatment of Provision against Current Asset
Deduct from Respective Asset
Treat Provision as Current Liability
1. Deduct from Respective Asset: In this method, the opening and closing balances of such provisions are deducted respectively from the opening and closing balances of the respective asset. And then the difference between the resulted values of asset is taken to know about changes in working capital. 2. Provision against Current Asset As Liability: The other way is to treat provision against current asset as current liability. Thus increase or decrease in the amount of such provision will affect cash flow from operations. INTERACTIVE 2 Illustration 1: From the following information compute cash flow from operating activities by direct method. Cash Sales Purchases(Cash) Operating Expenses Depreciation Income Tax Paid Differed Tax (Included in Income Tax Paid)
100000 50,000 20,000 5000 6000 3000
Solution 1:
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Cash flow from operating activities by Direct Method can be calculated as follows:
(A) Cash Flow from Operating Activities Cash Inflows Cash Sales Cash Outflows Purchases Operating Expenses Income Tax Paid (6000-3000) Net Cash Flow from Operating Activity Note:
Amount
Amount 100000
(50,000) (20,000) (3,000)
(73,000) 27000
1. Since depreciation is a non cash expense therefore it is not considered above. 2. Deferred tax has no cash flow implication for current period. Illustration 2: From the following information, calculate Cash Flow from Operating Activities by Indirect Method: Profit and Loss Account For the year ended 31st March………….. Particulars Depreciation Loss on Sale of Furniture Discount on Issue of Debentures Written Off Interest on Debentures
Amount 80,000 20,000
Goodwill Written Off General Expenses Transfer to Reserve
20,000 12000 20,000
Provision for Doubtful Debts Provision for Tax Proposed Dividend Interim Dividend Net Profit
6,000
12,000 20,000
Particulars Gross Profit Interest Investment Dividends
on
Amount 5,00,000 12,000 21,000
Profit on Sale of Machinery Rent of the Hall Claim for Loss of Fire Commission Receivable Refund of Tax
15,000
50,000
1,20,000
20,000 1,20,000 20,000 12000
50,000 1,10,000 35,000 3,35,000
Additional Information: Debtors
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Bills Receivable Creditors Stock Provision for Tax Accrued Commission Prepaid Expenses Provision for Doubtful Debts Outstanding Wages
10,000 20,000 1,50,000 40,000 13,000 15,000 14,000 15,000
15,000 60,000 1,25,000 50,000 20,000 20,000 20,000 20,000
Solution 2: Cash Flow Statement For the year ending 31 March,…….
(A) Cash Flow From Operating Activities Net Profit Transfer to General Reserve Provision for Tax Proposed Dividend Interim Dividend Less: Claim for Loss of Fire Refund of Tax Profit before Tax and Extraordinary Item Add: Depreciation Loss on Sale of Furniture Discount on Issue of Debentures Interest on Debentures Goodwill Written Off Provision for Doubtful Debts Less: Interest on Investment Dividend Received Profit on Sale of Land Rent Income Operating Profit Before Working Capital Changes Add: Decrease in Current Assets and Increase in Current Liabilities Increase in Creditors Outstanding Wages Decrease in Stock Less: Increase in Current Assets and Decrease in Current Liabilities Increase in Debtors Increase in Bills Receivables Accrued Commission
Amount 3,35,000 20,000 50,000 1,10,000 35,000 (1,20,000) (12000)
Amount
4,18,000 80,000 20,000 12,000 20,000 20,000 6,000 (12000) (21,000) (15,000) (20,000)
40,000 5,000 25000
(70,000) (5,000) (7,000)
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90,000 5,08,000
70,000
Increase in Prepaid Expenses Cash from Operating Activities Less: Income Tax Paid Net Cash From Operating Extraordinary Items Add: Extraordinary Items: Claim for Loss on Fire Return of Tax
(5,000)
Activities
(87,000) 4,91,000 (40,000) 4,51,000
Before
1,20,000 12,000
1,32,000 5,83,000
Working Notes: Provision for Tax Account: Particulars Bank Account Balance c/d
Amount 40,000 50,000 90,000
Particulars Balance b/d P & L Account
Amount 40,000 50,000 90,000
Value Addition 3: Did You Know? Cash Flow from Operating Activities All companies listed on any recognized Stock Exchange in India are required to prepare their Cash Flow Statement as per Accounting Standard- 3 using the indirect method. INTERACTIVE 3 8.1.3. Purpose of Calculating Cash Flow from Operating Activities: Cash flow from operating activities indicates the amount of profit generated by operations. It is very important for a firm to have positive cash flow from operations. A long time negative cash flow from operations will result in the downfall of firm’s capacity to meet short term requirements of the firm. A prolonged increase in non cash current assets such as debtors and stock will affect the firm’s short term liquidity position. It is also possible that such a firm faces difficulty to meet its short term obligations. Increase or decrease in profit also affects the dividend paying capability of firms. And no investor would like to invest in such a company. In the long run, a satisfactory return on asset, healthy capital structure, high dividends and positive rating and value of the firm in the market result from positive cash flow from operating activities.
8.2. Investing Activity:
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Many times investing activities are understood as those activities that are related to fixed assets of the company. Thus, buying a machine, selling any Plant and building comes under investing activity. Let us understand about it in detail.
8.2.1. Investing Activity: Meaning Investing activities are the activities that help in generation of future income or cashflows. According to AS-3 following are the examples of cash flow from investing activities: a. Cash payments made to a purchase fixed assets .Fixed assets can be tangible or intangible. It includes payment for those relating to capitalized research and development costs and self-constructed fixed assets; b. cash receipts from selling or discarding of fixed assets. Fixed assets can be tangible or intangible; c. As discussed above, any outflow of cash for buying shares, warrants or debt instruments of other enterprises and interests in joint ventures (other than payments for those instruments considered to be cash equivalents and those held for dealing or trading purposes is a financial activity; d. cash receipts from disposal of shares, warrants or debt instruments of other enterprises and interests in joint ventures (other than receipts from those instruments considered to be cash equivalents and those held for dealing or trading purposes); e. Cash advances and loans made to third parties (other than advances and loans made by a financial enterprise); f. cash receipts from the repayment of advances and loans made to third parties other than advances and loans of a financial enterprise); g. cash payments for futures contracts, forward contracts, option contracts and swap contracts except when the contracts are held for dealing or trading purposes, or the payments are classified as financing activities; and h. Cash receipts from futures contracts, forward contracts, option contracts and swap contracts except when the contracts are held for dealing or trading purposes, or the receipts are classified as financing activities. Note: 1. Loans given to third parties are an investing activity as firm will earn interest on it. So any amount received from such parties in repayment of principal or interest is an investing activity. 2. Rental Income is an investing activity. INTERACTIVE 4
8.2.2. Calculation of Cash Flow from Investing Activities: To calculate any cash flow, the basic thing that we have to keep in mind is to deduct cash outflow from cash inflow of respective activity. In case of investing activity any payment to acquire fixed assets is deducted from any cash received from sale of fixed asset. Following if the format to calculate cash flow from Investing activity. This format is applied just after the calculation of cash generated from or used in operating activity. (B) Cash Flow From Investing Activities Sale of Fixed Assets Like Plant and Machinery, Building, Etc Proceeds from Sale of Long Term Investments Proceeds from Sale of Patents ,Trademark and Copyrights
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xxxx Xxxx Xxxx
Receipt of Cash from Rental Income Cash Received as Dividend Interest Income Less: Purchase of Fixed Assets Like Plant and Machinery, Etc. Purchase of Long Term Investments Purchase of Patents , Trademark and Copyrights Net Cash Generated from or Used in Investing Activity
Xxxx Xxxx Xxxx (xxxx) (xxxx) (xxxx) xxxx
Illustration 3: ABC Ltd has the following opening balances taken from its Financial Accounts: Fixed Assets: 15,00,000 Depreciation: 2,00,000 Bank : 95,000 Other Current Assets: 6,25,000 Current Liabilities 3,00,000 It is also provided that the company a. Has acquired fixed assets of Rs 3,00,000. After selling one machine for 1,20,000, costing 2,00,0000 on which depreciation provided was 1,00,000. b. Net Profit after depreciation 1,75,000 c. Depreciation charged is 1,50,000 d. Increase on Current Assets 2,00,000 e. Increase in Current Liabilities 3,00,000. Calculate Cash Flow From Operating And Investing Activity. Solution 3: (A) Cash Flow From Operating Activities Net Profit After Depreciation Add: Depreciation Less: Profit on Sale of Machinery Operating Profit Before Working Capital Changes Add: Increase in Current Liabilities Less : Increase in Assets Net Cash from Operating Activities (B) Cash Flow from Investing Activities Sale of Machine Purchase of Machine Net Cash Used in Investing Activity
Amount 1,75,000 1,50,000 (20,000)
3,05,000 3,00,000 (2,00,000) 4,05,000 1,20,000 (3,00,000)
Working Notes: Cost of Machine = 2,00,000 Depreciation = -1,00,000 Current Value
Amount
= 1,00,000
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(1,80,000) 2,25,000
Profit on Sale of Machinery = 1,20,000 – 1,00,000 = 20,000 Note: While calculating Cash Flow From Investing Activity, one can have value of fixed assets given at written down value or at cost. There can be only following things that can happen with fixed assets. Purchase of an Asset; Sale of an Asset; Depreciation of an Asset. If fixed assets are shown at Written Down Value: Given any two figures, we can calculate the third one. Balancing figure on the debit side is purchase of an asset whereas balancing figure on credit side can be sale of an asset or depreciation on an asset. If fixed assets are shown at cost and accumulated depreciation (separately maintained in the accounts) or provision for depreciation. In such a case depreciation is not charged to assets account, it is ascertained from provision for depreciation account or accumulated depreciation account.
Illustration 4: From the following information, calculate the cash flow from Investing Activity: Particulars 31 March, 2014 31 March,2015 Machinery at Cost 6,00,000 6,50,000 Accumulated 1,00,000 1,50,000 Depreciation Patents and Copyrights 2,00,000 75,000 During the year the firm has sold a Machinery for Rs 50,000. The cost of Machine was Rs 60,000 with an Accumulated Depreciation of Rs 30,000. Solution 4: Machinery Account Particulars Bal b/d To Pal A/c – Profit on Sale
Amount 6,00,000 20,000
To Bank Account-Purchases
1,10,000 7,30,000
Particulars By Bank Account-Sale By Accumulated Depreciation(on Machine Sold) By Balance c/d
Amount 50,000 30,000 6,50,000 7,30,000
Accumulated Depreciation Account Particulars To Depreciation on
Amount 30,000
Particulars By Bal b/d
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Amount 1,00,000
Machinery Sold To Balance c/d
1,50,000
By P & L A/c (Balancing Figure)
1,80,000
80,000 1,80,000
Profit on Sale of Machine = Sale Price – Book Value = 50,000-(60,000-30,000) =20,000
Cash Flow From Investing Activity Proceeds from Sale of Machine Purchase of Machine Sale of Patents Net Cash From Investing Activity
50,000 (1,10,000) 1,25,000 65,000
8.2.3. Purpose of Calculating Cash Flow from Investing Activity: Cash flow from investing activities is very important. It indicates how much cash has been on assets that help in future income generation. Cash flow from investing activity is an indicator of firm’s decision about long term and noncurrent assets. A negative cash flow means more of purchases. This is good if it increases the productive capacity of firm. A positive cash flow indicates that the sale of asset is more than its purchases. If asset is discarded because of its reduced capacity then it is fine. But a mere sale of asset to earn cash for other purpose is not good.
8.3. Financing Activity: Financing activity shows the cash inflows and outflows related to transactions with the providers of finance i.e. the owners and the creditors of the company. 8.3.1. Financing Activity: Meaning Financing activities are those activities of an enterprise that results in the changes in the size and composition of the owner’s capital including preference share capital and the borrowed funds. Thus, cash flows from financing activities include the following basic components: Cash received by issuing Shares; Cash received by issuing Debentures; Redemption of Preference Shares; Repayments of Debentures; Buy back of Equity Shares; Payment for Dividends.
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Cash Flows from Financing Activities are a measure of the money that a company took in or paid out to finance its activities. It represents the flow of cash between a company and its owners and creditors. 8.3.2. Purpose of Calculating Cash Flow from Financing Activity: Cash flow from financing activity is the third and the final section of Cash Flow Statement. Cash Flow from financing activity can be calculated as follows: (C) Cash Flow From Financing Activity Proceeds from Issue of Share Capital Along with Premium Cash Received by Issuing Debentures Less: Redemption of Preference Shares Buyback of Equity Shares Redemption of Debentures Payment of Loans Taken(Long Term) Payment of Interest on Debentures Payment of Interest on Loans Payment of Interim Dividend Payment of Final Dividend Net Cash Used in Financing Activity
Xxxx Xxxx (xxxx) (xxxx) (xxxx) (xxxx) (xxxx) (xxxx) (xxxx) (xxxx)
Illustration 5: Following information is provided for a company. Calculate Cash Flow from Financing Activity. 31 March , 2014 31 March , 2015 Equity Share Capital 30,00,000 35,00,000 Securities Premium 4,00,000 Debentures 8,00,000 4,00,000 Proposed Dividend 8,00,000 10,0000
During the year the company paid an interim dividend of Rs 3,00,000. The company also declared a dividend of 10% on all shares. Interest on debentures paid during the year is 20,000. Solution 5: In this question since we have additional information about dividend therefore, we will make Proposed Dividend Account. Proposed Dividend Account Particulars To Bank A/C Balance c/d
Amount 6,50,000 10,00,000
Particulars Balance b/d By P & L A/C
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Amount 8,00,000 8,50,000
Dividend Paid = Interim Dividend +10% on Shares = 3,00,000 + 10% (35,00,000) = 3,00,000 + 3,50,000 = 6,50,000 Calculation of Cash Flow from Financing Activity (C) Cash Flow From Financing Activity Proceeds from Issue of Share Capital Along with Premium Securities Premium Less: Redemption of Debentures Payment of Interest on Debentures Payment of Interim Dividend Payment of Final Dividend Net Cash Used in Financing Activity
5,00,000 4,00,000 (4,00,000) (20,000) (3,00,000) (3,50,000) (1,70,000)
Value Addition 4: Know more Cash Flow from Financing Activities To know more about cash flow from financing activities click on the link below http://www.investopedia.com/video/play/cash-flow-financing-activities-cff/
8.3.3. Purpose of Calculating Cash Flow from Financing Activity: Cash flow from financing activity can be positive or negative. An inflow of cash indicates an increase in owner’s capital, Preference share capital or borrowed funds. By analyzing this section of statement one gets to know which source is company using in large amount to raise funds. This indicates or gives a signal about company’s ability to meet it financial obligation. More of debt financing means that the company is sure of earning so much of profit to meet its fixed interest obligation. One should also look for maturity schedule of debt raised. More of equity financing may be due to taking up of new project where minimum return can’t be predicted by company with surety. Equity capital is stable and long term capital. An outflow of cash can be due to repayment of capital or debt or due to payment of dividend. A dividend paying company is seen as more revenue generating firm. Cash flow from financing activity gives an insight to investors about how and in what amounts a company raises capital from debt and equity sources, as well as how it pays off these sources over time.
9. Non Cash Investing and Financing Transactions:
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Many times firms enter into transactions that do not result in any inflow or outflow of cash but it is of investing or financing activity in nature. These activities are not considered while making Cash Flow Statement as it doesn’t result in any inflow or outflow of tax. Following are some examples: Acquisition of Asset by Issuing Shares; Purchase of Asset on Credit; Conversion of Debt into Equity.
INTERACTIVE 5
Value Addition 5: Quiz Multiple Choice Questions Click on the link below to take a quiz on the concept of Cash Flow Statement. Source: http://www.accountingcoach.com/cash-flow-statement/quiz
10. Complete Format of Cash Flow Statement: At this point we have well understood the different kinds of activities that results in cash flows in an organization. thus now we will look at the complete format of a Cash Flow Statement. Once we calculate cash flows from all the three activities, then we will add all the cash flows to Calculate overall inflow or outflow of cash. And to this total opening balance of cash is added. It should be equal to closing cash balance. Particulars (A) Cash Flow From Operating Activities Net P & L A/C Or Difference Between Closing And Opening Balance Of P & L A/C A) Add: Profits Appropriated: Transfer To Reserve Proposed Dividend for the Current Year Interim Dividend Paid During the Year Provision for Tax Made During the Year Any Receipt from Extraordinary Item Less: Extraordinary Item, If Any, Credited to P& L A/C Refund of Tax Credited to P&L A/C Net Profit Before Tax and Extraordinary Item B) Add: Non Operating Expenses Depreciation Preliminary Expenses Written Off Discount on Issue of Shares & Debentures Written Off Goodwill, Patents and Trademark Amortized Interest on Borrowings Interest on Debentures Loss on Sale of Fixed Assets C) Less: Non Operating Income Interest Income Dividend Received Rent Received(If it is of Non Operating Nature) Profit on Sale of Fixed Assets.
Amount
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Amount
D) Operating Profit Before Working Capital Changes(A+B-C) E)Add: Decrease in Current Assets & Increase in Current Liabilities F)Less: Increase in Current Assets and Decrease in Current Liabilities G)Cash Generated from Operations(D+E-F) H)Less: Income Tax Paid (Net of Tax Refund Received) J) Adjustment for Extraordinary Item K)Net Cash from or Used in Operating Activities (B)Cash Flow from Investing Activities Sale of Fixed Assets Like Plant and Machinery, Building, Etc Proceeds from Sale of Long Term Investments Proceeds from Sale of Patents ,Trademark and Copyrights Receipt of Cash from Rental Income Cash Received as Dividend Interest Income Less: Purchase of Fixed Assets Like Plant and Machinery, etc. Purchase of Long Term Investments Purchase of Patents , Trademark and Copyrights Net Cash Generated from or Used in Investing Activity (C) Cash Flow from Financing Activity Proceeds from Issue of Share Capital along with Premium Cash Received by Issuing Debentures Less: Redemption of Preference Shares Buyback of Equity Shares Redemption of Debentures Payment of Loans Taken(Long Term) Payment of Interest on Debentures Payment of Interest on Loans Payment of Interim Dividend Payment of Final Dividend Net Cash Used in Financing Activity
xxxx Xxxx Xxxx Xxxx Xxxx Xxxx (xxxx) (xxxx) (xxxx) Xxxx
Xxxx Xxxx (xxxx) (xxxx) (xxxx) (xxxx) (xxxx) (xxxx) (xxxx) (xxxx)
Net Increase /Decrease in Cash and Cash Equivalents (A+B+C) Add: Opening Balance of Cash and Its Equivalent Less Opening Balance of Bank Overdraft
xxxx (xxxx)
Xxxx
Closing Balance of Cash and its Equivalent Less: Bank Overdraft
xxxx (xxxx)
Xxxx
Xxxx
Note: Bank borrowings are generally considered to be financing activities. However, where bank overdrafts which are repayable on demand form an integral part of an entity's cash management, bank overdrafts are included as a component of cash and cash equivalents. A characteristic of such banking arrangements is that the bank balance often fluctuates from being positive to overdrawn.”
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If Bank overdraft is treated as financing Activity then it should be shown under cash flow from Financing Activity.
Illustration 6: Following is the balance sheet of ABC Ltd. Prepare Cash Flow Statement on the basis of following information’s Particulars
Note No’s
1. EQUITY AND LIABILITIES 1. Shareholders Fund (A) Share Capital (B) Reserves and Surplus 2. Noncurrent Liabilities (A) Long Term Borrowings 3. Current Liabilities (A) Trade Payables (B) Provision for Tax Total 2. Assets 1. Noncurrent Assets (A) Land and Building (B) Machinery 2. Current Assets (A) Current Investments (B) Inventories (C) Trade Receivables (D) Cash and Cash Equivalents Total
Amount
Amount
5,00,000 3,78,000
6,00,000 3,56,000
2,70,000
-
1,34,000 61,000 13,02,000
1,68,000 95,000 12,19,000
4,00,000 60,000
4,80,000 50,000
18,000 2,30,000 4,55,000 1,80,000 13,43,000
20,000 2,60,000 2,79,000 1,30,000 12,19,000
Amount
Amount
3,00,000 78,000 3,78,000
3,10,000 46,000 3,56,000
Notes to Accounts: Particulars 1. Reserves and Surplus General Reserve Surplus
Additional Information: Machinery costing Rs 8000 were sold at Rs 8500 during the year. Provision for tax made during the year was Rs 50,000 During the year part of Land and building costing Rs 10,000 was sold for Rs 12,000 was and profit on sales was included in the statement of P&L A/C Interim dividend paid during the year amounted to Rs 40,000. Solution 6:
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In this question we have information about investments, Provision for Tax and fixed assets twice. Once in Balance Sheet and second as additional information therefore we will make their accounts in working notes to get information. Cash Flow Statement For the year ended 31,March………………
Amount (A) Cash Flow From Operating Activities Closing Balance of Surplus Less: Opening Balance of Surplus Add: Transfer to General Reserve Interim Dividend Provision for Tax Net Profit Before Tax and Extraordinary Item Add: Depreciation of Machinery Less: Profit on Sale of Investment Profit on Sale of Fixed Assets Profit Before Working Capital Changes Add: Decrease in Trade Receivables Increase in Trade Payables Less: Increase in Current Investments Increase in Inventories Cash Generated from Operations Less: Income Tax Paid Net Cash Generated from Operations
Amount
46,000 (78,000) (32,000) 10,000 40,000 50,000 68000 2,000 (500) (2,000) 67,500 1,76,000 34,000 (2,000) (30,000) 2,45,500 (16,000) 2,29,500
(B) Cash Flow From Investing Activities Sale of Machinery Sale of Land and Building Purchase of Land and Building Net Cash Generated from Operations
8,500 12,000 (90,000)
(C) Cash Flow from Financing Activities Increase in Share Capital Payment of Borrowings Interim Dividend Paid Net Cash Generated from Financing Activity
1,00,000 (2,70,000) (40,000)
(69,500)
Net Decrease in Cash and Cash Equivalents (A+B+C) Add: Opening Balance of Cash and Cash Equivalents Closing Balance of Cash and Cash Equivalent
Working Notes: Provision for Tax Account
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(2,10,000) (50,000) 1,80,000 1,30,000
Particulars To Bank-Tax Paid(Balancing Figure)
Amount 16,000
Balance c/d
95,000 1,11,000
Particulars Balance b/d
Amount 61,000
By P&L A/c - Provision made
50,000 1,11,000
Machinery Account Particulars Balance b/d Profit on Sale of Investment
Amount 60000 500
Particulars By Bank- Sale Depreciation
Amount 8500 2000
Balance c/d
50,000 60,500
60,500
Land and Building Account Particulars Balance b/d To Profit on Sale To Bank-Purchases(Balancing Figure)
Amount 4,00,000 2,000 90,000
Particulars By Bank-Sale
Amount 12,000
Balance c/d
4,80,000
4,92,000
4,92,000
Value Addition 6: Quiz Multiple Choice Questions Click on the link below to take a quiz on Cash Flow State ment. Source:http://highered.mheducation.com/sites/0072994029/student_view0/chapter21/mu ltiple_choice_quiz.html
Summary:
Cash Flow Statement indicates sources of cash inflows and outflows resulting from transactions during a year. Cash Flow Statement portrays the long term financial position of an enterprise Cash Flow Statement is not same as Cash Account. It highlights the firm’s Operating, Investing and Financing Activities. Net profit of a firm doesn’t mean that firm has generated same amount of cash. There are many non cash transactions. Operating Activities are regularly occurring or day to day activity of a firm. Investing Activities are the activities related to fixed and long term assets of the firm. Financing Activities are the one which relates to rising of capital, changes in owner’s or borrowed funds. It also includes dividend and interest payments for the same.
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Interest paid and received and dividend received is usually classified as cash flow from operating activity for a financial institution.
Glossary:
Deferred Tax: Deferring Tax Liability to the future years is referred to as deferred taxes. Cash Book: It is a book which records cash transactions in chronological order. It fulfills the purpose of a journal and a ledger. Accounting Standards: They are the guidelines regarding how a firm should prepare and present its financial statement. Cash Inflow: Receipt of cash is called as cash Inflow. Cash Outflow: If money goes out of the firm then it is a cash outflow. Accrual Basis of Accounting: Revenues are recognized when they are earned, not when cash is received. Similarly expenses are matched to matching revenues when they are incurred not when cash is paid.
Exercises: I. Objective Type Questions: A. State True or False: 1. 2. 3. 4. 5. 6. 7.
Sale of furniture results in inflow of cash Cash Flow Statement is based on accrual basis of accounting. Payment of Income tax is an operating activity. Inflow from cash is always equal to outflow of cash Cash equivalents include short term securities. Cash Flow Statement is optional in case of listed companies AS-3 relates to Cash Flow Statement
B. Fill in the Blanks: 1. Cash Flow Statement is also called as …………………………………… . 2. Cash Flow Statement has ……………………….. , ……………………………… and ……………….. activities. 3. …………………………. and…………………….. method can be used to calculate cash flow from Operating Activities 4. Bank Overdraft is generally regarded as ……………………… activity. 5. Receipt from sale of goods and services is regarded as …………………….
II. Theoretical Questions:
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1. 2. 3. 4. 5. 6. 7. 8. 9.
What is a Cash Flow Statement? What are the uses of Cash Flow Statements? Distinguish between Cash Flow Statement and Cash Book. Write any three operating activities. Depreciation reduces the value of an asset; still it is added to profit in Cash Flow Statement. Why? Explain the two methods of calculating cash flow from operating activity. Explain the meaning of financial activities. What are investing activities? Explain cash and cash equivalents.
III. Numerical Questions: 1. Following is the brief information from The Balance Sheet of ABC Ltd: Profit for the year 2014 was 1,35,000 whereas it stood at Rs 1,65,000 in the year 2015. The amount of Plant and Machinery stood at Rs 2,50,000 in the previous Balance Sheet. However, it is at Rs 4,15,000 in the year 2015. Investments (Long Term) in the year 2014 were 75,000. The same amounted to Rs 1,50,000 in the next year. Show how you will show these items in Cash Flow Statement in the following situations: 1. If no other information is given; 2. If opening investments were sold at a profit of 10% on 31st March,2015; 3. If opening investments were sold at a loss of 15% on 31st March,2015; 4. If investments costing Rs 2,00,000 were purchased during the year and some were sold at a profit of 20% on 31st March,2015. 2. Calculate Cash Flow From Operating Activities from the following information, provided: Profits earned during the year is 50,000; Transfer to Reserves is Rs 40,000; Depreciation provided is 20,000; Profit on Sale of Furniture is Rs 15,000; Loss on Sale of Machine is Rs 20,000; Interim Dividend Paid is Rs 40,000; Following information is also provided;
Debtors Trade Receivables Trade Payables Stock Outstanding Expenses Creditors Prepaid Expenses
31 March,2014 40,000 60,000 45,000 57,000 92,000 60,000 25,000
31 March,2015 39,000 72,000 50,000 53,000 76,000 58,000 30,000
3. From the following information prepare Cash Flow Statement. Note No’s
Amount 31 March,2014
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Amount 31 March,2015
1. EQUITY AND LIABILITIES 1. Shareholders Fund (A) Share Capital (B) Reserves and Surplus 2. Noncurrent Liabilities (A) Long Term Borrowings 3. Current Liabilities (A) Trade Payables (B) Provision for Tax Total 2. Assets 1. Noncurrent Assets (A) Tangible Assets 2. Current Assets (A) Trade Receivables (B) Cash and Cash Equivalents Total
2,00,000 5,00,000
3,00,000 7,00,000
2,70,000
3,00,000
2
2,80,000 3,00,000 15,50,000
3,97,000 4,00,000 20,97,000
3
10,00,000
15,89,000
4,50,000 1,00,000 15,50,000
3,00,000 2,08,000 20,97,000
1
Notes to Accounts:
1. Reserves and Surplus General Reserve Surplus 2. Trade Payables Creditors Bills Payables 3.Tangible Assets Building Plant and Machinery
Amount
Amount
3,00,000 2,00,000 5,00,000
4,00,ooo 3,00,000 7,00,000
2,00,000 80,000 2,80,000
2,97,000 1,00,000 3,97,000
6,00,000 4,00,000 10,00,000
7,50,000 8,39,000 15,89,000
Additional Information: Interim Dividend of Rs. 50,000 was paid during the year. Answers to Objective Type Questions: A. 1. True; 2.False; 3.True; 4. False; 5. True; 6. False; 7.True. B. 1. where got where gone statement; 2. operating, investing and financing; 3. Direct and Indirect; 4. Financial; 5. Operating Activity.
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References: 1. Work Cited and Suggested Readings:
Monga J.R (2014).,Fundamentals of Corporate Accounting,Paperbacks,Delhi Khan & Jain(2008), Financial Management,Tata Mac Graw-Hill Corporations. Rao Peddina Mohana,Financial Statement Analysis and Reporting,PHI Learning Pvt.Ltd. Goyal V.K., Goyal Ruchi, Corporate Accounting,PHI Learning Pvt. Ltd,New Delhi. V.Rajasekran, R.Lalitha, Corporate Accounting, Pearson Education India. Dr. R.K. Mittal, Dr. Shagun Ahuja,Corporate Accounting,VK Publications,New Delhi
2. Video Links:
Visit
this
link
to
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more
about
Cash
Flow
Statement
https://www.youtube.com/watch?v=mh-eTgiUO0s
Visit
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more
about
operating
activity
http://www.investopedia.com/video/play/cash-flow-operating-activities/
Visit
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given
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the
purpose
of
Cash
Flow
Statement
http://study.com/academy/lesson/the-statement-of-cash-flows-purpose-format-examples.html
3. Web Links: Visit the following link to know more about operating activities http://news.morningstar.com/classroom2/course.asp?docId=145092&page=3 Visit the given link to understand investing activities http://www.accountingcoach.com/blog/investing-activities-cash-flow-statement Visit the following link to understand financing activities http://www.accountingformanagement.org/financing-activities-section/. Visit the URL
http://wps.prenhall.com/bp_fraser_financial_10/217/55796/14284025.cw/content/index.html to take a quiz on the concept of cash flow statement. Visit the URL http://www.theglobeandmail.com/report-on-business/small-business/sb-money/cashflow/the-importance-of-operating-cash-flow-for-small-businesses/article15134561/ to know the importance of cash flow for a small business.
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