A Statement prepared from the historical data (Income Statement
and Balance Sheet) showing sources and uses of cash is called cash flow
statement. It reveals the inflow and outflow of cash during the particular
period. Cash flow statement can be prepared for a year, half year, and
quarter of for any other duration.
Cash: Cash means all cash + cash equitable + marketable securities + bank
Flow: Flow means flow of cash from business to economy and economy to
business i.e. cash inflows and cash outflows.
Statement : Statement is a performa prescribed by Charted Accountant
•To show the causes of changes in cash balance between two balance sheet dates.
•To indicate the factors contributing to the reduction of cash balance
inspite of increase in profits and vice versa.
A cash flow statement summarizes the causes of changes in cash
position of a business enterprise between dates of two balance sheets. A
statement a cash flows reveals the movements of cash of a business enterprise
for the given accounting period indicating specifically how the cash was
generated. Statement of cash flow is required for short range financial
The cash flow statement simultaneously provides an explanation of why a
firm’s cash position has changed between successive balance sheet dates and
explains changes that have taken place in the firm’s noncash asset, liability, and
stockholders’ equity accounts over the same time period.
The cash flow statement explains the reasons for low cash balance
inspite of huge profits or large cash balance inspite of low profits.
It helps in short-term financial decision relating to liquidity.
It shows the major sources and uses of cash. The management with the aid
or projected cash flow statement can know
1. How much cash will be needed
2. From which sources it can be obtained
3. How much can be generated internally
4. How much could be obtained from outside.
It helps the management in planning the repayment of loans, replacement
of assets, credit arrangements etc.
It is also significant for capital budgeting decisions.
On the basis of past years cash flow statement projections can be made for
the future. The projected cash flow statement helps in planning for the
investment of surplus or meeting the deficit. A Comparison of actual cash flow
statement with the projected cash flow statement helps in understanding the
variations and control of cash expenditure
SIGNIFICANCE AND USES OF CASH FLOW STATEMENT:
Opening of Accounts for Non Current items
Preparation of Adjusted Profit and Loss Account
Comparison of Current Items to Determine Inflow and Outflow of Cash
Preparation of Cash Flow Statement.
PROCEDURE FOR THE PREPARATION OF CASH FLOW STATEMENT:
THREE COMPONENTS OF CASH FLOW STATEMENT…
Cash Flow form Operating Activities
Cash from financing Activities
Cash from investing Activities
Operating activities are the principle revenue producing activities of
the enterprise and other activities that are not investing and financing
activities. Hence, these are the results of those transactions and events that
determines the net profit or loss.
Cash Flow form Operating Activities
• Operating Activities:
The cash flow from operating activities section of a cash flow statement
can be presented using the direct format or the indirect format. The bottom line is
the same, but the two begin at different points. Companies are free to use either
format. Below is an example of both formats.
Direct method: shows how much cash came in for sales and how much cash went out
for inventory and other operating expenditures.
Indirect method: starts with net income as a figure that summarizes most of the cash
transactions for operating activities in a firm. However, net income also includes
transactions that ere not cash, so we must eliminate the non-cash transactions from
the net income figure to arrive at an accurate presentation of cash flow from
Cash Flow From Operating Activities
From sales of goods or services
From interest and dividend income
To pay suppliers for inventory
To pay employees for services
To pay lenders (interest)
To pay government for taxes
To pay other suppliers for other operating expenses
This section of the cash flow statement reports the
company's net income and then converts it from the accrual basis to the
cash basis by using the changes in the balances of current asset and
current liability accounts, such as
Other Current Assets
Notes Payable (generally due within one year)
Payroll Taxes Payable
Income Taxes Payable
Other Current Liabilities
In addition to using the changes in current assets and current
liabilities, the operating activities section has adjustments for depreciation
expense and for the gains and losses on the sale of long-term assets.
Cash receipts from the sale of goods and the rendering of services
Cash receipts from royalties, fees, commissions and other revenues
Cash payments to suppliers of goods and services
Cash payments to and on behalf of employees
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 unless they can be specifically
identified with financing and investing activities
Cash receipts and payments relating to future contracts, forward
contracts, option contracts and swap contracts when the contracts
are held for dealing or trading purposes.
Investing activities include the acquisition and disposal of
long-term assets and other investments not included in cash
equivalents. The separate disclosure of cash flows arising from
investing activities is important.
Cash Flow from Investing Activities:
An item on the cash flow statement that reports the
aggregate change in a company's cash position resulting from any
gains (or losses) from investments in the financial markets and
operating subsidiaries, and changes resulting from amounts spent on
investments in capital assets such as plant and equipment.
If fixed assets and investments increased, it means, there is
application of cash
If fixed assets & investments reduced, it means there is source of
cash and so cash from investing should increase.
Cash Flow From Investing Activities
From sale of fixed assets (property, plant, equipment)
From sale of debt or equity securities
(other than common equity) of other entities
To acquire fixed assets (property, plant, equipment)
To purchase debt or equity securities
(other than common equity) of other entities
This section of the cash flow statement reports changes in the
balances of long-term asset accounts, such as
Furniture & Fixtures
In short, investing activities involve the purchase and/or
sale of long-term investments and property, plant, and equipment.
WHAT TO ADD TO PROFIT (INDIRECT METHOD)?
Loss on sale of fixed assets
Amortisation of intangible assets
Interest (it will go to cash from investing or cash fro financing
(all other non – cash expenses/ provisions).
WHAT TO DEDUCT FROM PROFIT (INDIRECT METHOD)
Profit on sale of fixed assets
Cash payments to acquire fixed assets (including intangibles)
Cash receipts from disposal of fixed assets (including intangibles)
Cash payments to acquire and cash receipts from disposal of
shares, warrants or debt instruments of other enterprises and
interests in joint ventures.
Cash advances and loans made to 3rd parties
Cash payments and receipts for future 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
The separate disclosure of cash flows arising from financing
activities is important because it is useful in predicting claims of future cash
flows by providers of funds (both capital and loan)to the enterprise.
Financing activities are activities that result in changes in the size and
composition of the owners capital (including preference share capital in
the case of a company) and borrowings of the enterprise.
Cash Flow from Financing Activities:
Accounts for external activities such as issuing cash dividends,
adding or changing loans, or issuing and selling more stock. The formula
for cash flow from financing activities is as follows:
Cash Received from Issuing Stock or Debt - Cash Paid as
Dividends and for Re-Acquisition of Debt/Stock
Cash Flow From Financing Activities
From the sale of the firm’s own equity securities
To repay amounts borrowed
To repurchase the firm’s own equity securities
To pay shareholders dividends
This section of the cash flow statement reports changes in
balances of the long-term liability and stockholders' equity accounts, such
Notes Payable (generally due after one year)
Deferred Income Taxes
Paid-in Capital in Excess of Par-Preferred Stock
Paid-in Capital in Excess of Par-Common Stock
Paid-in Capital from Treasury Stock
In short, financing activities involve the issuance and/or
the repurchase of a company's own bonds or stock. Dividend
payments are also reported in this section.
Cash proceeds from issuing shares or other similar instruments
Cash proceeds from issuing debentures, loans, notes, bonds and
other short or long term borrowings, and
Cash repayments of amounts borrowed such as redemption of
dentures, bonds, preference shares.
Statement of Cash Flows
Cash Flow from Operating Activities
Net Income XXX,XXX
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization XX,XXX
Changes in other accounts affecting operations:
(Increase)/decrease in accounts receivable X,XXX
(Increase)/decrease in inventories X,XXX
(Increase)/decrease in prepaid expenses X,XXX
Increase/(decrease) in accounts payable X,XXX
Increase/(decrease) in taxes payable X,XXX
Net cash provided by operating activities XXX,XXX
Format : 2
Cash Flow from Investing Activities
Capital expenditures (XXX,XXX)
Proceeds from sales of equipment XX,XXX
Proceeds from sales of investments XX,XXX
Investments in subsidiary (XXX,XXX)
Net cash provided by investing activities (XXX,XXX)
Cash Flow from Financing Activities
Payments of long-term debt (XX,XXX)
Proceeds from issuance of long-term debt XX,XXX
Proceeds from issuance of common stock XXX,XXX
Dividends paid (XX,XXX)
Purchase of treasury stock (XX,XXX)
Net cash provided by financing activities (XX,XXX)
Increase (Decrease) in Cash XX,XXX
METHOD USED TO ANALYZE THE CASH FLOW
Scan the big picture
Check the power of the cash flow engine
Pinpoint the good news and the bad news
Put the puzzle together
STEP 1: SCANNING THE BIG PICTURE
First, place your company in context in terms of its age, industry, and size.
(Mature companies have different cash flows from start-up companies. And
service industries look different from heavy manufacturing industries.)
Flip through the annual report and other accounting records to determine
how management believes the year progressed. Was it a good year? Perhaps a
record-breaking year in terms of revenue or net income? Or is management
explaining how the company has had some rough times?
Look at net income. Does it show income or losses over the past few years? Is
income (or loss) shrinking or growing?
STEP 2: CHECKING THE POWER OF THE CASH FLOW ENGINE
The cash flow from operating activities section is the cash flow engine of
the company. When this engine is working effectively, it provides the cash
flows to cover the cash needs of operations.
To check the cash flow check if the cash flow from operating activities is
greater than zero. Also check whether it is growing or shrinking. Assuming it
is positive, the next question is can it cover important, routine expenditures?
An exception is start-up companies often have negative cash flow from
operating activities because they had to spend a lot to get the company
started and their cash flow engines are not yet up to speed.
Examine the operating working capital accounts. Inventories, receivables,
and accounts payable usually grow in expanding companies.
STEP 3: PINPOINTING THE GOOD NEWS AND THE BAD NEWS
Begin with cash flow from investing activities. One systematic observation
is to check whether the company is generating or using cash in its investing
activities. A healthy company invests continually in more plant, equipment,
land, and other fixed assets to replace the assets that have been used up or
have become technologically obsolete.
You must look at the entire package to evaluate whether your cash flows
from financing are in the “good news” or “bad news” categories. One
systematic way to begin is to compare borrowing and payments on debt with
each other across the years and note the trends. Another way in uncovering
the news in this section is to check the activities in the stock accounts.
STEP 4: PUTTING THE PUZZLE TOGETHER
It would be rare to find a company in which all of the evidence is positive,
or in which all of the evidence is negative.
To make a balanced evaluation, you must use both the good news and
the bad news identified in each section of the statement.
Sometimes there are unusual or unknown items that may need further
looked into (possibly by a professional).
A CHANGE IN THIS BALANCE SHEET
CHANGES REPORTED IN THIS SECTION
OF THE CASH FLOW STATEMENT
Current Assets Other than Cash Operating Activities
Current Liabilities Operating Activities
Long-term Assets Investing Activities
Long-term Liabilities Financing Activities
Stockholders' Equity Financing Activities