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Net Profit.doc Net Profit.doc Document Transcript

  • Chapter: 8 The Cash Flow Statement 1
  • LEARNING OBJECTIVES After you have studied this chapter, you should be able to understand the following • Need for a cash flow statement • Difference between profit and cash • Different types of cash flows • Meaning of cash from operating activities, cash from financing activities, cash from investing activities • Relationship between cash from operating activities and operating profit • Impact of changes in working capital on profit • Format for presenting cash flow statement 2
  • INTRODUCTION The basic objective of a cash flow statement (CFS) is to provide relevant information as regards cash receipts and cash payments of an enterprise during the accounting period. CFS shows the movement of cash of an enterprise. It records all cash flows occurred during a particular period. The Accounting Standard (AS)-3 is the relevant standard for preparing the cash flow statement. According to the AS-3, information about the cash flows of an enterprise is useful in providing users of financial statements with a basis to assess the ability of the enterprise to generate cash and cash equivalents and the needs of the enterprise to utilise those cash flows. The economic decisions that are taken by users require an evaluation of the ability of an enterprise to generate cash and cash equivalents and the timing and certainty of their generation. PROFIT ALONE NOT SUFFICIENT: In the previous chapter we saw that the profit is determined using the accrual concept and matching concept. So the profit earned during the period may not be same as the cash genereated during the period. Tabbl 8.1 shows cash from operations and the operating profit of some of the well known Indian companies. Table 8.1 Cash and Profit (2006) ( in crores) Operating Cash from Profit Operations Hindustan Petroleum Corpn. Ltd. -3306.33 521.09 Sun Pharmaceutical Inds. Ltd. -26.51 326.18 Suzlon Energy Ltd. 875.74 -267 Bajaj Auto Ltd. 995.11 1568.04 Tata Motors Ltd. 1224.73 217.48 Moreover, the income statement is influenced by the accounting assumptions. Whereas the cash flow is not influenced by the acounting assumptions. Example 8.1 Sales and other relevant financial information are as follows: • Purchased goods for cash = 10,000 • Purchased plant on credit = 50,000 • Sold goods for cash = 40,000 • Paid rent for the period = 5000 • Paid for advertisement = 5000 Table 8.2 shows the income statement and the cash flow statement. 3
  • Table – 8.2: Income Statement and Cash Flow Statement Income Statement Cash Flow Statement Assumption Assumption Assumption I II III Sales 40,000 40,000 40,000 Sales 40,000 COGS 10,000 10,000 10,000 Less Rent 5,000 5,000 5,000 Purchases 10,000 Depreciation 5,000 10000 16667 Rent 5,000 Advertisement 1000 1250 2500 Advertisement 5,000 21,000 26,250 34,167 Total Payment 20,000 Profit 19,000 13,750 5,833 CIH 20,000 Table Above examples shows that the profit decreased by more that 65% from assumption-I to assumption -III where as there was no change in the cash flows.. The change in profit is solely due to the change in the accounting treament of depreciation and amortisation of advertisement. • Assumption-I : life of the plant assumed to be ten years for depreciation. Advertisement cost amortised over five years • Assumption-II: life of the plant assumed to be five years for depreciation. Advertisement cost amortised over four years • Assumption-III: life of the plant assumed to be three years for depreciation. Advertisement cost amortised over two years Therefore, cash flow information together with the income statement help investors and other users to understand the ability of an enterprise to: • convert profit into cash; • meet its obligations; short term and long term; • pay dividend • make investments in the short run CASH FLOW STATEMENT Cash flow statement is prepared as the per AS-3. According to the AS-3, a company should prepare a cash flow statement and should present it for each period for which financial statements are presented. It captures all the cash transactions undertaken during a particular period. CFS records both revenue and capital items: Income statement shows only the revenue incomes and revenue expenses, balance sheet shows the capital receipts and expenditures, whereas, the cash flow statement shows all types of cash flows. The distinction between capital and revenue is not relevant while preparing CFS. For example: Salary paid (revenue expense), Purchased Plant (capital expense), Advertisement for launching a new product (deferred revenue expense) all are shown in the cash flow statement for the period. It records all cash flows even if it previous years, or future years. For example: Advance premium paid (relating to the next year), Arrear salary paid (relating to the previous year) both are recorded 4
  • in the cash flow statement. Table 8.3 shows some typical cash inflows (receipts) and cash outflows (payments). Cash and Cash Equivalents: The term cash and cash flows are not uniquely defined. Cash includes cash and cash equivalents. According to AS-3, Cash equivalents are held for the purpose of meeting short-term cash commitments rather than for investment or other purposes. For an investment to qualify as a cash equivalent, it must be readily convertible to a known amount of cash and be subject to an insignificant risk of changes in value. Therefore, an investment normally qualifies as a cash equivalent only when it has a short maturity of, say, three months or less from the date of acquisition. COMPONENTS OF CASH FLOW STATEMENT The cash flow statement should report cash flows during the period classified by operating, investing and financing activities. Cash flow statement explains the reasons for changes in cash and cash equivalents detailing out cash flow on various heads. Three are important components of the CFS are: • Cash flow from financing activities. • Cash flow from investing activities; • Cash flow from operating activities; Cash flow from financing activities (CFF) Financing activities are those activities that result in changes in the size and composition of the equity capital and borrowing of the enterprise. Cash inflows from financing activities include the following: • Proceeds from issuing equity instruments; • Proceeds from issuing bonds, mortgages, notes and from other short or long term borrowing. Cash outflows from financing activities include the following • Repayment of amount borrowed; • Capital element of finance lease payments; • Buyback of shares; • Payment of expenses or commissions on any issue of shares, debentures, loans, notes, bonds and other financing. Cash from financing activities may be negative or positive. Negative CFF means the company has paid off loans or redeemed capital or bought back capital or distributed dividend. Positive cash flows may be due to raising of funds in the form of capital or loans. 5
  • Exhibit 8.1 shows the cash from financing activities of NALCO Exhibit 8.1: (Rs. in crores) 2006 2005 S Source: Annual Report of NALCO It can be seen from the Exhibit 8.1 that during the year 2006, NALCO did not raise any funds from the market. However, during 2005, the company redeemed more than Rs. 650 crores. Negative cash from financing activities of NALCO was due to distribution of dividend. Example 8.1 ABC started business with capital of Rs. 10,000. It took 12% loan of Rs. 200,000; from IDBI bank . Used the funds to purchase stock of goods. Sold entire stock for 400,000. Interest for the year was fully paid. The company also paid 25,000 towards other expenses. Table 8.3 shows the cash from financing activities. Table 8.3 Cash Flow From Financing Activities Receipts Capital 100,000 12% Loan 200,000 Total Receipts 300,000 Payments Interest 24000 Total Payments 24000 CFF 276,000 Example 8.2 Assets and sources of ABC ltd as on 1st April 2006 were as follows: • Capital : 100,000 • 12% Loan: 200,000 • Cash: 50,000 • Other assets : 250,000 During the year, the company declared 20% dividdend and distributed the amount. At the beginning of the year (on 1st May) repaid 50% of loan. Interest on balance amount paid on time. Table 8.4 shows the cash from financing activities. 6
  • Table 8.4 Cash Flow From Financing Activities Receipts Total Receipts 0 Payments Loan repaid 100000 Interest 13000 Dividend paid 20000 Total Payments 133000 CFF -133,000 Cash flow from investing activities (CFI) Investing activities relate to the acquisition and disposal of long term assets and other investments not included in cash equivalents. Cash inflows from investing activities include the following: • Sale of shares of other companies • Sale of bonds and ,debentures of other companies • Dividend received • Interest received. • Receipts from sale of property, plant equipment and other productive assets; • Receipts from derivative transactions Cash outflows from investing activities include the following: • Purchase of shares of other companies • Purchase of bonds and ,debentures of other companies • Purchase of property, plant equipment and other productive assets; • Payments for derivative transactions Cash from investing activities may be negative or positive. Negative CFI means the company has paid for acquiring assets. Positive cash flows may be due to the sale of assets or due to the receipt of dividend and interest on the investments made. 7
  • Exhibit 8.2 shows the cash from investing activities of NALCO Exhibit-8.2: Rs. in crores 2005 2006 Exhibit 8.2 shows that NALCO increased continued to acquire fixed assets. During the last two years the company did not make any non-operating investment. The negative CFI in 2006 is exclusively due to the acquisition of fixed assets. Example 8. 3 On 1st April 2005, ABC started business with capital of Rs. 10,000. It took 12% loan of Rs. 200,000; from IDBI bank . Used the funds to purchase stock of goods for Rs. 50,000. It acquired plant costing 100,000 on credit and shares costing 100,000 for cash. Sold entire stock for 400,000. Interest for the year was fully paid. The company also paid 25,000 towards other expenses. Sold 50% of the shares at Rs. 60,000. During the year it also received Rs. Rs. 5000 as dividend. Table 8.5 shows the cash flow from investing activities (CFI). Table 8.5 Cash Flow From Investing Activities Receipts Sale of share 60000 Dividend received 5000 Total Receipts 65000 Payments Purchase of shares 100000 Total Payments 100000 CFI -35,000 8
  • Example 8. 4 Refer to the example 8.3.During 2006, company received dividend of Rs. 10,000. No other transactions. Table 8.6 shows the cash from investing activities (CFI). Table 8.6 Cash Flow From Investing Activities Receipts Dividend received 100000 Total Receipts 100000 Payments Purchase of shares 0 Total Payments 0 CFI 100,000 Example 8. 5 Transactions of ABC ltd for the year 2005 were as follows. • Started business with capital 100,000 • Took 12% loan on 1st July 200,000 • Purchased plant on credit 50,000 • Purchased stock for cash 50,000 • Purchased furniture for cash 10,000 • Purchased stock on credit from X 100,000 • Sold 50% stock for cash 200,000 • Rent per month 2,000 • Purchased 12% Bonds of Z ltd 25,000 • Rent paid 24,000 • Interest on bonds received 3000 • Dividend paid : 20,000 • Interest on loan paid 24,000 Table 8.7 shows cash flow from financing and cash from investing activities. 9
  • Table 8.7 Cash Flow From Investing Activities Cash Flow From Financing Activities Receipts Receipts Interest received on bonds 3,000 Capital received 100,000 12% Loan 200,000 Total Receipts 3,000 Total Receipts 300,000 Payments Payments Purchase of bonds 25,000 Interest paid 24,000 Purchase of furniture 10,000 Dividend paid 20,000 Total Payments 35,000 Total Payments 44,000 CFI -32,000 CFF 256,000 • Observe that interest received on bonds is cash from investing activities, whereas interest paid on loan is cash from financing activities. • Issues of shares is a financing activities, whereas purchase of shares of another company purchased is an investing activity. • Dividend paid is a financing activity, whereas dividend received is an investing activity. Cash flow from operating activities (CFO) Operating activities are principal revenue producing activities of the enterprise and other activities that are not investing or financing activities. Some example of cash flow from operating activities: • Cash receipts from the sale of goods and the rendering of services; • Cash receipts from royalties, fees, commissions and other revenue; • Cash receipts and payments from contracts held for dealing or trading purposes; • Cash payments to suppliers for goods and services; • Cash payment to and on behalf of employees; • Cash payments for income tax and refunds of income tax unless specifically identified with financing or investment activities. According to the AS-3, a company can prepare cash flows from operating activities using either: • the direct method, whereby major classes of gross cash receipts and gross cash payments are disclosed; or • the indirect method, whereby net profit or loss is adjusted for the effects of transactions of a non-cash nature, any deferrals or accruals of past or future operating cash receipts or payments, and items of income or expense associated with investing or financing cash flows. Direct approach – Under direct approach operating cash flow information is obtained from the cash book- cash receipts and payments can be classified and aggregated under the usual heads of accounts. 10
  • Cash from Operations : = (Cash Sales + Collections from Customers) less ( Payment for purchase of revenue goods and Payment towards revenue expenses) Example 8.6 Refer to the 8.5. Table 8.8 shows cash from operating activities using the direct method. Table 8.8 Cash Flow From Operating Activities Receipts Cash sales 200,000 Total Receipts 200,000 Payments for stock 50,000 Rent paid 24,000 Dividend paid 0 Total Payments 24,000 CFO 176,000 Example 8.7 Some of the transactions of ABC for the year ending March 2006 were as follows: • Started business with capital 100,000 • Purchased goods for cash 80,000 • Paid salaries 20,000 • Sold 20% of goods for cash 40,000 • Paid rent 8,000 Table 8.9 shows the cash from operating activities. Table 8.9 Cash Flow From Operating Activities Receipts Cash sales 40,000 Total Receipts 40,000 Payments for stock 80,000 Rent paid 8,000 Total Payments 88,000 CFO -48,000 Though the cash from operating activities is negative, profit for the period is positive as shown by the table 8.10. 11
  • Table 8.10 Income Statement Income Sales 40,000 Total Income 40,000 COGS 16,000 Rent paid 8,000 Total Expenses 24,000 Profit 16,000 Indirect Approach – Direct method is most appropriate for deriving operating cash flow because major heads of cash receipts and payments are disclosed. However, the SEBI has recently notified to follow indirect method only. Indirect method helps in reconciling the cash with profits. Table 8.11 shows cash from operating activity and profit before taxes. Table 8.11 Cash from Operations and Profit of NALCO (in crores) 2006 2005 Profit before Taxes 2753 2359 Cash from Operations 1965 1723 Why is Cash from operations different from profit? We had seen in the previous chapter that every receipt is not an income and every payment is not an expense. So profit, which is the excess of income over the expense, may not be equal to the cash in hand. Some of the reasons may be as follows: • Depreciation • Financing charges (interest) • Provisions • Change in Creditors/Debtors • Capital losses or profit (profit/loss on sale of assets ) Under indirect cash approach cash flow form operating activities can be derived as follows: • Net profit or loss • Add : Non-cash charge such as depreciation, provisions, deferred taxes, unrealized foreign exchange losses; • Add: Charges which are classified as part of investment or financing activities; • Less : Non-cash income such as depreciation and other write backs; • Less : Income which are classified as part of investment or financing activities. • Add/Less : Changes in inventories, operating receivables and payables. Exhibit 8.3 shows CFO of NALCO (Rs. in crores) 12
  • Source: Annual Report of NALCO In the indirect method effort is being made to reconcile profit with cash from operating activities. We had discussed in the chapter 7 that Profit is determined on the basis of the accrual concept and matching concept. Profit in the income statement also shows income and expense relating to other non-operating activities. Figure 8.1 shows the relationship between CFO and profit for the period. CFO = Profit + + Non cash Changes in or or items working - - capital Non-cash items: While preparing the income statement some non-cash items are also recorded. Some of the common non-cash items are: depreciation, amortisation, writing off research expenses, provisions for doubtful debts. Changes in working capital: Income statement is prepared on the basis of the accrual concept. So expenses due but not paid and incomes due but not received are also recorded in the income statement. Such items are reflected through current assets and current liabilities. Difference between current assets and current liabilities is called working capital. Example 8.8 13
  • Following are the assets and corresponding sources of ABC ltd.: Capital= 20,000; 12% loan = 50,000; Debtors = 30,000; and Furniture = 40,000 as on 1st April 2006. During the first quarter of 2006 the company had the following transactions: • Purchased stock on credit = Rs. 30,000 • Sold 50% of the stock for cash = Rs. 30,000 • Paid rent = Rs. 3,000 • Collection from the debtors = Rs.20,000 • Interest due but not paid Table 8.12 shows the profit for the first quarter and the corresponding cash from operating activities using the direct method. Table 8.12 Income Statement for the quarter CFO for the quarter Income Receipts Sales 30,000 Cash sales 30,000 Total Income 30,000 Collections 20,000 COGS 15,000 Total Receipts 50,000 Rent 3,000 Payments for stock 0 Depreciation 2000 Rent paid 3,000 Interest 1,500 Total Expenses 21,500 Total Payments 3,000 Profit 8,500 CFO 47,000 Now let us find CFO using the indirect method and reconcile profit with CFO. However, to determine the CFO through indirect method we the opening and closing balance sheet. Table 8.13 show the opening and closing balance sheet. Table 8.13 Balance sheet of ABC ltd. Opening Closing Capital 20,000 20,000 Loan 50,000 50,000 Profit 8,500 Creditors 30000 Outstanding Interest 1,500 70,000 110,000 Debtors 30,000 10,000 Furniture 40,000 38,000 Cash 47,000 Stock 15,000 70,000 110,000 We had discussed in the previous paragraph that the to determine CFO from profit, we have to find the determine the non-cash item, non-operating, and working capital changes. • Non cash items = Depreciation =Rs. 2,000 • Non operating items= Interest = 1,500 • Working capital change o Increase in creditors = 30,000 14
  • o Decrease in debtors = 20,000 o Increase in stock = 15,000 Non Changes in CFO = Profit 8,500 Non cash Operating working 47,000 + items + items + capital 2000 1500 35,000 Table 8.14 shows the CFO using the indirect method Table 8.14 • Cash Flow from Operating Activities Profit 8,500 • Depreciation is a non-cash item. Add Non Cash item While calculating profit, it has been Depreciation 2000 deducted so it has to added back to Add Non-Operating Item be profit to determine the cash from Interest 1,500 operating activities. Change in the working capital • Interest is a non-operating item. Add While calculating profit, interest has Increase in creditors 30,000 been deducted so it has to be added Decrease in debtors 20,000 back to profit to determine the cash Less from operating activities. Increase in stock 15,000 • Decrease in debtors. Debtors CFO 47,000 decreased from 30,000 to 10,000 due to collections. However, collection is not an income of the current year. It has not been shown while calculating the profit. So it has to be added to the profit to determine the cash flow. • Increase in creditors. COGS is shown as an expense. However, money had not been paid. Increase in creditors show that the company has purchased goods on credit. So it has to be added to the profit to determine the CFO. Increase in Current Assets reduces CFO Decrease in Current Asset increases CFO Decrease in Current Liabilities reduces CFO Increase in Current Liability increases CFO Example 8.9 Following are the relevant financial transactions of ABC ltd for the year ending March 2006.: • Started business with Capital 50000 • Took 12% loan 50000 • Purchased stock on credit 50000 15
  • • Sold 50% of stock for cash 50000 • Purchased furniture for cash 20000 • Purchased shares for cash 20000 • Depreciation on furniture 2000 • Expenses for the year 10000 • Expenses paid 6000 • Dividend received 10000 • Dividend distributed 5000 Table 8.15 shows different cash flows Table 8.15 Cash from Investing Activities Cash from Operating Cash from Financing (CFF) (CFI) Activities(CFO) Capital 50,000 Sales 50,000 12% Loan 50,000 Dividend 10,000 Total Receipts 100,000 Total Receipts 10,000 Total Receipts 50,000 Less Dividend distributed 5,000 Payment for furniture 20,000 Expenses 6,000 Payment for shares 20,000 Total Payments 5,000 Total Payments 40,000 Total Payments 6,000 -30,00 CFF 95,000 CFI 0 CFO 44,000 PATTERN OF CASH FLOWS Table 8.16 summarises the patterns of cash flows. Most of the financially strong companies will have positive CFO. Cash generated from operations can be used for reducing loan reduction or capital reduction. Table 8.16 Situation Situation Situation Situation Situation Situation 1 2 3 4 5 6 Cash from Operation (CFO) Negative Positive Positive Negative Positive Negative Cash from Financing (CFF) Positive Negative Negative Positive Positive Negative Cash from Investing (CFI) Positive Positive Negative Positive Positive Negative Which is the best combination and why? INTERRELATIONSHIP BETWEEN INCOME STATEMENT, CASH FLOW STATEMENT, AND BALANCE SHEET Cash flow statement, Income statement, and balance sheet are interrelated. Change in the balance sheet on two dates can be explained with the income statement and cash flow statement. Let us take the following transactions and see the impact on the financial statements: 16
  • • Capital: Increase or decrease: Will affect the cash flow statement • Expenses: Paid: affects cash flow statement and income statement • Expenses due but not paid: affect income statement and balance sheet. No effect on the cash flow statement • Income received: affects cash flow statement and income statement • Income due but not received: affects income statement and balance sheet • Purchase of asset for cash: affects cash flow statement and balance sheet • Purchase of assets on credit: affects balance sheet • Interest paid: affects income statement and cash flow statement • Interest due but not paid: affects income statement and balance sheet One can prepare the cash flow statement if the opening and closing balance sheet and the income statement for the period are given. Example 8.10 Balance sheet of ABC ltd is as follows: Balance Sheet 31st March 31st March 06 07 Capital 50,000 100,000 12% Loan 50,000 30,000 Profits 50,000 70,000 Creditors 50,000 50,000 200,000 250,000 Cash 50,000 40,000 Debtors 50,000 20,000 Plant 50,000 45,000 Shares 50,000 145,000 200,000 250,000 Several items of the balance sheet changed during the year. Income statement and cash flow statement can explain the change in the balance sheet. • Capital increased by 50,000: Cash flow item • Loan decreased by 20,000: Cash flow item • No change in creditors. No purchases or payment can be assumed. • Debtors decreased by 30,000: Cash flow item • Plant decreased by 5000: Expense or loss: Income statement item • Shares increased by 95,000: Cash flow item • Profit increased by 20,000: Income statement item. However, there is depreciation of Rs. 5000. so it can be assumed that the company earned an income (commission received, dividend received) of Rs. 25,000. Table 8.10 Income Statement Cash Flow Statement Dividend 25,000 Opening Balance 50,000 Dividend 25,000 Total Income 25,000 Capital 50,000 17
  • Collection 30,000 Depreciation 5,000 Total Receipts 155,000 Payment Total Expense 5,000 Loan 20,000 Shares 95,000 Total Payments 115,000 Profit 20,000 Closing Balance 40,000 Example 8.10 ABC ltd. lost several documents and reports due to fire. The accounts officer could put lay his hands on the opening and closing balance sheet as shown by table 8.10 Table 8.10 Balance Sheet of ABC ltd. Opening Closing Capital 50,000 70,000 Reserves 20,000 30,000 Loan 20,000 10,000 90,000 110,000 Fixed Assets 40,000 38,000 Stock 30,000 20,000 Cash 20,000 22,000 Debtors 30,000 90,000 110,000 He also collected the following data from his team members: • Sales 30,000 • Rent paid : 5000 • Interest paid: 1000 • Tax paid : 1000 The accounts office was asked to prepare the cash flow statement and income statement for the period. a. Capital o Opening Capital + Money Raised = Closing Capital o 50,000 + 20000 = 70,000 b. Loan o Opening Loan - Money Repaid = Closing Loan o 20,000 – 10,000 = 10,000 c. Reserves 18
  • o Opening Reserves + Current Profit = Closing Reserve o 20,000 + 10,000 = 30,000 d. Fixed Assets o Opening Assets - Depreciation = Closing Asset o 40,000 -2,000 = 38,000 e. Stock o Opening stock – COGS = Closing stock o 30,000 – 10,000 = 20,000 f. Cash o Opening + Receipts – Payments = Closing cash o 20,000 + 20,000 – 18,000 = 22,000 g. Debtors o Opening + Credit Sales – Receipts = Closing Cash o 0 + 30,000 – 0 = 30,000 Table 8.11 shows the relevant financial statements Table 8.11 Opening Balance Sheet Cash Flow Statement for the year Capital 50000 Receipts Reserves 20000 Capital 20000 Loan 20000 Total Receipt 20000 Total 90000 Loan 10000 Fixed Assets 40000 Rent 5000 Stock 30000 Interest 1000 Cash 20000 Tax 2000 Total Payments 18000 Total 90000 CIH 2000 Closing Balance Sheet Income Statement for the year Capital 70000 Sales 30000 Reserves 30000 COGS 10000 Loan 10000 Rent 5000 Total 110000 Depreciation 2000 Fixed Assets 38000 Interest 1000 Stock 20000 PBT 12000 Cash 22000 Tax 2000 Debtors 30000 Total 110000 PAT 10000 19
  • KEY TERMS Cash flow statement: Cash flow statement is prepared as the per AS-3. CFS shows all cash inflows and outflows for a particular period. CFS records both revenue and capital items: Income statement shows only the revenue incomes and revenue expenses, balance sheet shows the capital receipts and expenditures, whereas, the cash flow statement shows all types of cash flows. Cash equivalents: Cash equivalents are held for the purpose of meeting short-term cash commitments rather than for investment or other purposes. For an investment to qualify as a cash equivalent, it must be readily convertible to a known amount of cash and be subject to an insignificant risk of changes in value. Financing activities: Financing activities are those activities that result in changes in the size and composition of the equity capital and borrowing of the enterprise. Investment activities: Investing activities relate to the acquisition and disposal of long term assets and other investments not included in cash equivalents. Operating activities: Operating activities are principal revenue producing activities of the enterprise and other activities that are not investing or financing activities. Operating profit: Excess of operating income over the operating expenses is operating profit. Cash from financing activities(CFF): CFF is result of the financing activities. Cash from financing activities may be negative or positive. Negative CFF means the company has paid off loans or redeemed capital or bought back capital or distributed dividend. Positive cash flows may be due to raising of funds in the form of capital or loans. Cash from investing activities (CFI): CFI is the result of the investing activity of a company. Cash from investing activities may be negative or positive. Negative CFI means the company has paid for acquiring assets. Positive cash flows may be due to the sale of assets or due to the receipt of dividend and interest on the investments made. Cash from Operating activities (CFO): CFO is the result of the operating activity of a company. CFO depends profit generating ability of a company. CFO can be determined by direct method or by using indirect method. Direct method of determining CFO: Under direct approach operating cash flow information is obtained from the cash book- cash receipts and payments can be classified and aggregated under the usual heads of accounts. Indirect method of determining CFO: Under indirect method effort is being made to reconcile profit with cash from operating activities. Profit is adjusted for non-cash items, non-operating items and changes in the working capital 20
  • Theoretical Questions 1. What is cash equivalents? 2. Distinguish between cash and profit. 3. Classify the cash flows. 4. What is cash from operating activities (CFO)? 5. What is the treatment of dividend and interest received and paid? 6. Distinguish between cash from operating activities and operating profit. 7. Examine the relationship between profit and cash from operating activities. 8. Why is cash generated during the year generally not equal to profit for the year? 9. Briefly explain the provisions of the Accounting Standard (AS)-3 10. Examine the impact of the changes in the working capital on the cash from operating activities. 11. When will the cash from investing activities (CFI) be negative? 12. Explain with example the impact of depreciation on the cash from operating activities. 13. Examine the implications of having positive CFF, negative CFI, and negative CFO. 14. Can a company have positive profit and huge negative CFO? 15. Examine the implications of having negative CFF, negative CFI, and positive CFO. 16. A company having profit will always have positive cash from operating activities (CFO). Comment. 17. Changes in working capital will no effect on CFO. Comment. 18. Buy back of shares will increase the cash from financing activities (CFI). 19. Dividend paid and dividend received will affect the cash from financing activities (CFF). Comment. 20. Examine the impact of the following transaction of CFO: a. Paid salaries b. Purchased goods on credit c. Interest received d. Interest paid e. Profit on the sale of fixed assets f. Issued capital at a premium g. Collections from old debtors. h. Buy back of shares Numericals 1. Following are the transactions of XYZ ltd for the year ending March 2006: • Started business with capital = 200,000 • Issues shares to the public = 10000 shares of Rs. 10 at a premium of 50% • Took 10% loan = 100,000 • Purchased plant on credit = 50,000 • Purchased stock of goods for cash = 50,000 • Purchased shares of MN ltd. = 50,000 • Sold 50% of shares of MN ltd for Rs. 40,000 • Interest due but not paid = 10,0000 • Sold 50% of stock of goods for cash = 50,000 • Expenses for the period = 20,000 • Expenses paid = 15,000 Required: Cash flow statement. 21
  • 2. Following are the transactions of XYZ ltd for the year ending March 2006: • Issues shares to the public = 20000 shares of Rs. 10 at a premium of 50% • Took 10% loan = 200,000 • Purchased plant for cash = 50,000 • Purchased stock of goods on credit = 50,000 • Purchased shares of XY ltd. = 150,000 • Sold 50% of shares of MN ltd at a profit of 50% on cost • Interest paid = 10,0000 • Sold 50% of stock of goods for cash = 50,000 • Expenses for the period = 20,000 • Expenses paid = 15,000 • Depreciation = 10% Required: Cash from investing activities, cash from financing activites, and cash from operating activities. 3. Following transactions are entered into by A & Co. during January 2006. Prepare the necessary financial statements. Show the CFO, CFF, CFI. (i) Started business with furniture valued at Rs. 12,000 (ii) Owners introduced Rs. 100,000 in cash (iii) Issued 10000 shares of Rs.10 at a premium of Rs.50. (iv) Purchased goods for sale for Rs. 50,000 from B & Co. on credit (v) Purchased goods for cash: Rs.50,000 (vi) Sold goods costing Rs. 20,000, at Rs. 30,000 on cash basis (vii) Sold goods costing Rs. 40,000, to C & Co. for Rs. 75,000 on credit (viii) Paid Rs. 1,000 towards freight and paid Rs. 5,000 towards salary. (ix) Lost goods for sale for Rs. 10,000 due to fire. (x) Interest accrued but not due on 10% IDBI Loan: Rs. 1,000 (xi) Paid Rs. 12,000 towards annual insurance premium . (xii) Realized Rs. 47,000 from C & Co. in full and final settlement. (xiii) Charged depreciation on furniture Rs. 100 (xiv) Paid the money due to B&Co and received discount of Rs. 5,000 (xv) Conveyance charges paid to the staff Rs. 500 4. Following are the transactions of XYZ ltd. for the year ending March 2006: • Started business with Capital 50000 • Took 12% loan 50000 • Purchased stock on credit 50000 • Sold 50% of stock for cash 50000 • Purchased furniture for cash 20000 • Purchased shares for cash 20000 • Depreciation on furniture 2000 • Expenses for the year 10000 • Expenses paid 6000 • Dividend received 10000 • Dividend distributed 5000 Required: Cash from investing activities, cash from financing activites, and cash from operating activities. 22
  • 5. Following are the transactions of XYZ ltd. for the year ending March 2006: • Started business with Capital 150,000 • Took 12% loan 150,000 • Purchased stock on credit 150,000 • Sold 50% of stock for cash 150,000 • Purchased furniture for cash 20,000 • Purchased shares for cash 20,000 • Depreciation on furniture 2000 • Expenses for the year 10,000 • Expenses paid 20000 • Dividend received 10000 • Dividend distributed 5000 Required: a) Cash from investing activities (CFI), cash from financing activites (CFF), and cash from operating activities (CFO). b) Reconcile profit with cash from operating activities (CFO) 6. Following is the balance sheet of XYZ limited as on 31st March 2006: Balance Sheet Capital 100,000 12% loan 150,000 250,000 Stock 70,000 Debtors 80,000 Furniture 40,000 Plant 50,000 Cash 10,000 250,000 Transactions during the first quarter of 2006 are given below: • Purchased stock on credit 30,000 • Sold 50% of the stock for cash 80,000 • Paid rent 3,000 • Collection from the debtors 20,000 • Salaries for a month 2,000 • Salaries paid 24,000 • Insurance premium for the year paid 6,000 Required: • All Financial statements • CFO using indirect method 7. Share capital on 1.1. 99 = 200,000, Share capital on 1.1.2000 = 500,000 Bonus shares issued during the year = 50000 Debentures converted into share = 100,000 Buy back of share = Rs. 200,000 23
  • Find Cash from financing activities 8. ABC ltd. issued 10,000 shares of Rs. 10 at 25. Took 12% loan of Rs. 200,000. Money raised was used as follows: • 20% to buy stock of goods; • 30% to buy plant • 40% to shares of XYZ ltd. • Balance was retained as cash During the first quarter, sold the entire stock on credit for Rs. 80,000 and sold the shares of XYZ ltd. at a profit of 50% for cash. Depreciation for the year =10,000; Required: Cash flow statement 9. Net profit after depreciation and tax is Rs. 35000. Depreciation is 15000. A total sale was Rs. Rs. 1,00,000 of which 60% was on credit. Cost of the goods was 25% of the sales. Entire purchase was on credit. Find Cash from Operation. 10. Following are some of the financial statements of ABC ltd. Table Balance Sheet as on30th June 02 Sources Assets Share capital 500,000 550,000 Fixed assets 600,000 540,000 Reserves and surplus 250,000 127,500 Bonds 50,000 0 12% Long term borrowings 150,000 100,000 Stock 200,000 150,000 Outstanding Salary 20,000 Debtors 200,000 145,000 Accrued Interest 4,500 Advance Rent 0 12,000 Creditors 200,000 200,000 CIH 50,000 155,000 TOTAL 1,100,000 1,002,000 1,100,000 1,002,000 Cash Flow Statement for Apr- June 02 Receipts Amount Payments Amount Opening Cash 50,000 12% Long term borrowings 50,000 250,00 Cash Sales 0 Creditors 100,000 150,00 Collections from customers 0 Salaries 60,000 Dividend Received 2,000 Rent 36,000 Fixed Assets Fixed Assets 100,000 Interest on Bonds 5,000 Electricity Charges 6,000 Investments 60,000 Dividend Paid 10,000 CIH 155,000 517,00 0 517,000 24
  • The CEO of the company, Ms. K, is very happy as the cash position improved considerably. We have increased our cash by 3 times, whereas our competitor1 has lost cash. That's a big jump, she thought. She had big plans for expansion and is planning to approach her friends to sell the shares of the company. However, for further clarity she consulted Ms. J, the financial controller of her company. J gave her an enigmatic smile and said the devil is in the income statement, K. Bad Debts during the quarter were Rs.5000. Prepare the Income Statement and check whether you would be interested to buy the shares. You are also required to prepare CFS as per the AS-3. 1 25
  • 11. ABC is a sports equipment sales company. During 1999, the company replaced Rs. 18000 of its fully depreciated equipment with new equipment costing Rs. 23000. Although a mid year dividend of Rs. 5000 was paid, the company found it necessary to borrow Rs.5000 from its bank. Further borrowing may be needed since cash account is dangerously low at the year- end. The president of the company, Ms. Saha was not happy with the financial position. To get a clear picture of the business, she collected the following Income Statement and a rough statement of cash flows. Income Statement (1999-2000) Items Amount Sales 1,95,000 Cost of Goods Sold 1,40,000 Operating Expenses and taxes 49,700 Net Profit 5,300 Cash Flow (1999-2000) : Rough Statement Items Amount Cash Received : a) Net Income: 5,300 b) Depreciation: 5,000 Cash from Operation: 10,300 c) Loan from Bank 5,000 d) Debentures Raised 16,000 TOTAL CASH GENERATED 31,300 Cash Paid a) New Equipment 23,000 b) Dividends 5,000 TOTAL PAYMENT 28,000 INCREASE IN CASH 3,300 Ms. Saha seeks your help. Specifically, she wants to know why the cash flow statement shows net cash generated during the year as Rs. 3,300, when the cash balance decreased from Rs. 15,000 to Rs.500 during the year. Also, why is depreciation shown as cash received? She asked you to see the company’s balance sheet if required. 26
  • Balance Sheet Items Amount Amount Cash 500 15,000 Debtors 17,800 13,200 Stock 28,500 17,500 Prepaid Expenses 700 300 Equipment 40,000 35,000 Less Depreciation -11,000 -24,000 TOTAL ASSETS 76,500 57,000 Creditors 8,700 10,000 Outstanding Expenses 600 1,100 Bank Loan 5,000 - Debentures 16,000 - Share Capital 40,000 40,000 Retained Earnings 6,200 5,900 TOTAL LIABILITIES 76,500 57,000 Required: (a) Correct Cash Flow Statement showing why the company is having such a difficult time keeping sufficient cash on hand. (b) Answer the president’s questions. 12. Transactions of XYZ ltd for the year ending March 06: • Started business with capital 100,000 • Took 12% loan on 1st July 200,000 • Purchased plant on credit 50,000 • Purchased stock for cash 50,000 • Purchased furniture for cash 10,000 • Purchased stock on credit from X 100,000 • Sold 50% stock for cash200,000 • Rent per month 2,000 • Purchased 12% Bonds of Z ltd 25,000 • Rent paid 24,000 • Interest on bonds received 3000 • Dividend Paid 20000 • Interest on loan paid 24000 Required: Cash flow statement using the AS-3 27
  • 13. On 1st April 2006 A, B, and C floated a company “Buy N Sell” with own funds of Rs. 50,000 each and immediately issued 10,000 shares of Rs.100 issued at premium of 10% to their friends. The company purchased 100 shares of Microsys (@ Rs.2500) on 20th April and deposited the balance money in a Short Term (9 months) Deposit Scheme of Zltd. The rate of interest on the deposit is 18% per annum. Sold the shares on 15th June 01 @ Rs. 3650. Declared and distributed dividend of 10% Transactions for the first quarter of 2006 were as follows: • Purchased 10% bonds of XY ltd. for Rs. 1 lakhs and 10000 shares of SAIL @ Rs.4 • Purchased the right to buy a building by paying Rs. 100000 and sold the right within a week a hefty premium of 85%. • Gave short-term advance to another company: Rs. 50000. Collected Rs. 60000 after 15 days. • Bought two old maruti cars @ Rs. 2.5 lakhs from Delhi and sold one of them at profit of 25%. • Gave Rs. 20,000 to the MD of a company. MD became insolvent. Only 10% of the money given could be collected. • Commission paid to the agents: Rs.25000. Rent and other expense per month Rs.10000 • Purchased a piece of land at Rs.5 lakhs and sold the same to a housing company at a profit of 20% on the sales. Tax paid: 2% on the sales proceed. • Purchased 100 shares of Satyam at Rs. 250. • Sold all shares of SAIL @ Rs.6.50. • Purchased a car for office use: Rs.5 lakhs • A visited Singapore to explore new business avenues: Expenses incurred Rs.50000. • Sponsored the local cricket match: Rs.25000 • Purchased the right to sell tickets for the match for Rs. 100000. Expenses incurred for selling the tickets Rs.30000. Sale proceeds from the tickets Rs. 220000. • Paid Rs. 20 000 to an accountant to prepare the necessary financial statements. Required: Cash flow statement and Income statement 28
  • 1. You are given : The Balance Sheets of a company as on 31st Mar 01/ 31st Mar 02 and the Income Statement of the company for the year 2001-2002. Depreciation : Plant and Machinery 20%, Furniture 5%, Computer 20% Balance Sheet as on 31st March, 2001 Liabilities In Rs. Assets In Rs. Capital A 50,000 Plant & Machinery 50,000 Capital B 50,000 Furniture 5,000 Share Capital 1,50,000 Computer for office use 30,000 Loan from ICICI at 10% 60,000 Debtor C ltd. 19,000 Creditor X ltd. 20,000 Investment SAIL at 25% 50,000 Interest Accrued 6,000 Rent paid in advance 12,000 Outstanding Expenses 4,000 Stock 1,50,000 Profit 20,000 Cash in hand 44,000 Total 3,60,000 Total 3,60,000 Income Statement for 2001-2002 Expenses In Rs. Incomes In Rs. Cost of Goods sold 100,000 Sales 1,25,000 Depreciation : Interest (SAIL) 12,500 Plant & Machinery 10,000 Loss 1,750 Furniture 250 Computer 6,000 Bad debts 5,000 Rent 12,000 Interest (ICICI) 6,000 Total 1,39,250 Total 1,39,250 Balance Sheet as on 31st March, 2002 Liabilties In Rs. Assets In Rs. Capital A 50,000 Plant & Machinery (-Depr.) 40,000 Capital B 50,000 Furniture 4,750 Share Capital 2,00,000 Computer for office use 24,000 Share Premium 60,000 Investment SAIL at 25% 50,000 Loan from ICICI at 10% 60,000 Stock 50,000 Creditor X ltd. 20,000 Cash in hand 2,93,500 Outstanding Expenses 4,000 Profit 20,000 - Loss 1,750 Total 4,62,250 Total 4,62,250 29
  • Required: Cash Flow Statement for the year 2001-2002 From the following Balance Sheets And Income Statement of XYZ Ltd., prepare a Cash Flow Statement: Balance Sheet as on 31st March 2001 Sources Rs. Applications Rs. Share capital 239000 Fixed Assets 180000 Reserves and Surplus 32800 Investments 45900 Loan from IDBI 51300 Inventories 24000 Short term loans 8300 Debtors 62000 Creditors 6000 Cash and Bank 25500 337400 337400 Balance Sheet as on 31st March 2002 Sources Rs. Applications Rs. Share Capital 251000 Fixed Assets 210000 Reserves and Surplus 48450 Investments 64400 Loan from IDBI 56000 Inventories 24000 Short term loans 7750 Debtors 57500 Creditors 6500 Cash and Bank 16800 Salaries due but not paid 3000 372700 372700 Income Statement Expenses Rs. Incomes Rs. Opening Stock 24000 Sales: Purchases: Cash 148700 Cash 48000 Credit 32000 Credit 30400 Depreciation 24000 Income From Investments 5800 Interest 7500 Salary 35000 Rent 15500 Advertising Expenses 8500 Telephone Charges 1950 30
  • Profit 15650 186500 186500 1. Following are the balance sheet and income statement of Altd. Balance Sheet Sources Assets 2001 2002 2001 2002 Share Capital 100000 200000 Plant and Machinery 100000 120000 Debentures 70000 30000 Investments 30000 80000 Creditors 28000 82000 Debtors 10000 40000 Tax Payable 0 6000 Cash 40000 10000 Profit and Loss A/c 16000 20000 Prepaid Expenses 4000 8000 Stock 30000 80000 214000 338000 214000 338000 During the year debentures were converted into share Income Statement Sales 200000 Less COGS Other Expenses Opening Stock 30000 General Expenses 22000 Purchase 196000 Depreciation 16000 Closing Stock 80000 Taxes 8000 146000 Total Expenses 46000 Profit after Tax 8000 Dividend 4000 Required: Cash flow statement as per Accounting Standard-3 31
  • Real Life Questions 1. Satyam Computer Services Ltd. of Hyderabad was incorporated in 1987 as a private limited company. The company was set up with the objective of providing software development and consultancy services to large corporations. In 1991, it was converted into a public limited company. To become an end-to-end IT solutions player in the areas of consulting, systems integration, products, application development and maintenance services, Satyam Computers merged its three subsidiary companies. The merger was with effect from April 1, 1999. As on that date the assets and liabilities are as follows (Rs. Crore): a) Gross Fixed Asset = Rs. 338.17, Accumulated Depreciation = 93.30, b) Investments = Rs. 39.02 , Debtors = 132.24 c) Share Capital = 166.92, Reserves and Surplus = 140.90 d) Borrowings = 248.27, Creditors = 28.79 Following is the abstract of Income Statement and Cash Flow Statements of Satyam Computer Services Ltd. Income Statement 1st April 99 to 31st 2000 Cash Flow Statement 1st April 99 to 31st 2000 Items Amt. (Rs. crores) Items Amt. (Rs.crores) Sales 677.07 Opening 168.75 Other Incomes 1.94 Cash Salaries 269.82 Collection 524.49 Repairs Expenses 9.59 from Advertising 33.53 Customers Other Expenses 117.58 Raised Capital 58.24 Excise Duty 0.61 Raised Loans 46.60 Interest 40.88 Purchase of F. 94.82 Depreciation 71.02 Assets Tax 6.00 Purchase of 53.18 Profit After Tax 129.98 Investments Interest paid 39.78 Dividends 12.78 Tax paid 5.9 Dividend Tax 1.41 Dividend paid 12.24 Retained Profit 115.79 Closing Cash 592.16 Required: Balance sheet of Satyam Computer Services Ltd. as on 31st March 2000. 2. Following are the cash transactions and other relevant information of Nalco for year ended 31st March 2005: Source: http://www.nalcoindia.com a. Opening cash in hand: 98.34 crores b. Cash purchase of fixed assets = 126.72 32
  • c. Cash sale of investments = 200 d. Cash redemption of debentures= 214 e. Repayment of loans = 440 f. Interest income for the period: 12 g. Interest received = 21 h. Interest for the period = 60 i. Interest paid = 69 j. Increase in inventories = 61 k. Increase in debtors = 69 l. Decrease in creditors = 88 m. Dividend paid = 437 n. Tax paid = 636 o. Profit before tax (PBT) = 1870 p. Depreciation = 459 q. Non- cash expenses = 13 r. Loss on sale of assets = 1.0 Required : Cash Flow Statement 3. Cash Flows of some Indian companies: India Cements ACC Madras Cements Cash from Operation 85.74 84.22 66.77 Cash from Financing 419.17 -83.04 -64.54 Cash from Investing -584.13 -15.61 -44.09 Give your comments. 33
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