Cash Flow Statement

Objectives Of Cash Flow Statement

The Cash Flow Statement is one of the primary financial statements that provides information about the cash receipts (inflows) and cash payments (outflows) of an enterprise during a specific period. It is prepared in accordance with a prescribed accounting standard, such as Ind AS 7 (Statement of Cash Flows) in India.

The main objectives of preparing a Cash Flow Statement are:

1. To Provide Information about Cash Flows

The fundamental objective is to provide detailed information about the sources and uses of cash and cash equivalents during the reporting period. It answers questions like "Where did the cash come from?" and "Where did the cash go?".

2. To Assess Ability to Generate Cash Flows

The statement helps users evaluate the entity's ability to generate positive future cash flows. This is crucial for assessing the company's sustainability and capacity for growth.

3. To Assess Ability to Meet Obligations

It helps in assessing the company's ability to meet its financial obligations (like paying suppliers, employees, lenders) and pay dividends to shareholders.

4. To Explain the Difference Between Profit and Cash

Often, a company may report significant net profit, but still face a cash crunch, or vice versa. The Cash Flow Statement explains the reasons for the difference between net profit (as per the Statement of Profit and Loss, which is based on the accrual concept) and the net change in cash and cash equivalents during the period. This difference arises primarily due to non-cash expenses/income (like depreciation, write-offs) and changes in working capital (like debtors, creditors, inventory).

5. To Enhance Comparability

By providing information on cash flows from different activities, the statement enhances the comparability of operating performance among different enterprises, as it removes the effects of using different accounting treatments for the same transactions (e.g., different depreciation methods, inventory valuation methods).

6. To Facilitate Prediction of Future Cash Flows

Historical cash flow information is often used as an indicator of the amount, timing, and certainty of future cash flows.

Benefits Of Cash Flow Statement

The preparation and analysis of a Cash Flow Statement offer several benefits to various stakeholders:

1. Provides Insights into Liquidity and Solvency

The statement provides a clear picture of the company's ability to generate enough cash to meet its short-term needs (liquidity) and long-term obligations (solvency). Unlike accrual-based statements, it focuses on actual cash movements.

2. Useful for Cash Management and Planning

Management uses the Cash Flow Statement to plan for future cash requirements, identify potential cash surpluses or deficits, and manage working capital efficiently.

3. Aids Investment and Credit Decisions

Investors can better evaluate a company's ability to pay dividends and reinvest for growth based on its cash flows. Lenders assess the company's capacity to repay loans and interest.

4. Helps Evaluate Financing and Investing Activities

The segregation of cash flows into different activities allows users to understand how the company finances its operations (e.g., through borrowings, share issue) and where it is investing its funds (e.g., in fixed assets, other companies).

5. Explains Changes in Cash Balance

It provides a comprehensive reconciliation of the opening and closing balances of cash and cash equivalents, explaining all the movements during the period.

In essence, the Cash Flow Statement provides a dynamic view of the business by tracking the movement of cash, which is vital for the survival and growth of any enterprise.

Cash And Cash Equivalents

For the purpose of a Cash Flow Statement, Cash and Cash Equivalents are treated together as a single category. The statement explains the change in the balance of this combined category from the beginning to the end of the period.

Cash: Comprises cash on hand and demand deposits with banks.
Cash Equivalents: These are defined as short-term, highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value.

An investment normally qualifies as a cash equivalent only when it has a short maturity, generally considered to be **three months or less** from the date of acquisition.

Movements within the items constituting cash or cash equivalents are not considered cash flows. For example, transferring money from a bank account to a cash box, or investing surplus cash in a short-term deposit maturing in one month, are not reported as cash flows from operating, investing, or financing activities; they are simply movements within Cash and Cash Equivalents.

Bank Overdrafts: As per Ind AS 7, bank overdrafts that are repayable on demand and form an integral part of an entity's cash management are included as a component of cash and cash equivalents. However, other types of bank borrowings are treated as financing activities.

Cash Flows

Cash flows are defined as the inflows and outflows of cash and cash equivalents.

Inflows: Cash receipts. These represent the sources from which cash and cash equivalents are generated during the period.
Outflows: Cash payments. These represent the uses to which cash and cash equivalents are applied during the period.

The Cash Flow Statement analyses and presents these cash flows by classifying them into three main categories: Operating Activities, Investing Activities, and Financing Activities.

Non-cash transactions, such as the acquisition of assets by assuming directly related liabilities or by means of a finance lease, or the conversion of debentures into shares, are **excluded** from the Cash Flow Statement because they do not involve cash flows. These transactions are disclosed elsewhere in the financial statements.

Classification Of Activities For The Preparation Of Cash Flow Statement

The preparation of a Cash Flow Statement involves classifying cash receipts and payments into three major categories:

Cash Flows From Operating Activities

These are the cash flows from the principal revenue-producing activities of the enterprise and other activities that are not investing or financing activities. They generally result from the transactions and other events that determine the net profit or loss of the enterprise.

Examples of cash flows 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 payments to suppliers for goods and services.
Cash payments to employees and on behalf of employees.
Cash receipts and 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 from contracts held for dealing or trading purposes.

Operating cash flows are important because they indicate the extent to which the operations of the enterprise have generated sufficient cash flows to repay loans, maintain the operating capability of the enterprise, pay dividends, and make new investments without recourse to external financing.

Cash Flows From Investing Activities

These are cash flows arising from the acquisition and disposal of long-term assets and other investments not included in cash equivalents.

Examples of cash flows from investing activities:

Cash payments to acquire property, plant and equipment, intangibles, and other long-term assets.
Cash receipts from the sale of property, plant and equipment, intangibles, and other long-term assets.
Cash payments to acquire equity or debt instruments of other entities and interests in joint ventures (other than payments for those instruments considered to be cash equivalents or held for dealing or trading).
Cash receipts from the sale of equity or debt instruments of other entities and interests in joint ventures (other than receipts for those instruments considered to be cash equivalents or held for dealing or trading).
Cash advances and loans made to other parties (other than advances and loans made by a financial institution).
Cash receipts from the repayment of advances and loans made to other parties.

Investing cash flows represent the extent to which cash outlays have been made for resources intended to generate future income and cash flows.

Cash Flows From Financing Activities

These are cash flows that result in changes in the size and composition of the contributed equity and borrowings of the enterprise.

Examples of cash flows from financing activities:

Cash receipts from issuing shares or other equity instruments.
Cash payments to owners to acquire or redeem the enterprise's shares (e.g., share buyback).
Cash receipts from issuing debentures, loans, notes, bonds, mortgages, and other short or long-term borrowings.
Cash payments in settlement of amounts borrowed.
Cash payments by a lessee for the reduction of the outstanding liability relating to a finance lease.

Financing cash flows are important as they predict claims on future cash flows by providers of capital to the enterprise.

Treatment Of Some Peculiar Items

Certain items might fall into different categories depending on the nature of the business or the specific transaction:

Interest and Dividends

Interest Paid: Usually classified as operating cash flows (as it's a cost of obtaining resources used in operations). However, it can also be classified as financing cash flows (as it's a cost of borrowed funds). Consistency is key.
Interest Received: Usually classified as operating cash flows (part of revenue generation). However, it can also be classified as investing cash flows (return on investments). Consistency is key.
Dividends Paid: Usually classified as financing cash flows (distribution to owners).
Dividends Received: Usually classified as operating cash flows (part of revenue). However, it can also be classified as investing cash flows (return on investments). Consistency is key.

Financial institutions usually classify interest and dividends received and paid as operating cash flows, as these are part of their core activities.

Taxes on Income

Cash flows arising from taxes on income are normally classified as operating cash flows unless they can be specifically identified with financing and investing activities (e.g., tax implications on capital gains from sale of investments). When tax cash flows are allocated to investing or financing activities, the total amount of taxes paid is disclosed in the notes.

Extraordinary Items

Cash flows associated with extraordinary items are classified as arising from operating, investing, or financing activities, as appropriate, and are disclosed separately.

Ascertaining Cash Flow From Operating Activities

Cash flows from operating activities can be presented using two methods:

Direct Method: Shows major classes of gross cash receipts and gross cash payments. For example, cash received from customers, cash paid to suppliers and employees.
Indirect Method: Starts with net profit or loss from the Statement of Profit and Loss and adjusts it for non-cash items, non-operating items (related to investing or financing activities), and changes in working capital.

Both methods arrive at the same net cash flow figure from operating activities. Ind AS 7 encourages the use of the direct method, but the indirect method is more commonly used in practice.

Indirect Method

The indirect method adjusts net profit or loss for the effects of:

Changes during the period in inventories and operating receivables and payables.
Non-cash items such as depreciation, provisions, deferred taxes, unrealised foreign currency gains and losses, undistributed profits of associates, and minority interests.
All other items for which the cash effects are investing or financing cash flows.

Format (Indirect Method):

$ \begin{array}{|l|l|} \hline \textbf{Particulars} & \textbf{Amount (₹)} \\ \hline \text{Net Profit/(Loss) before Tax and Extraordinary Items} & \text{XXX} \\ \hline \text{Add: Non-cash and Non-operating Expenses} & \\ \quad \text{Depreciation and Amortisation} & \text{XXX} \\ \quad \text{Interest on Borrowings (Finance Costs)} & \text{XXX} \\ \quad \text{Loss on Sale of Fixed Assets / Investments} & \text{XXX} \\ \quad \text{Discount/Loss on Issue of Debentures Written Off} & \text{XXX} \\ \quad \text{Increase in Provisions (e.g., Provision for Doubtful Debts)} & \text{XXX} \\ \quad \text{Goodwill Written Off} & \text{XXX} \\ \quad \text{Preliminary Expenses Written Off} & \text{XXX} \\ \quad \text{Operating Expenses paid in advance (Decrease in Prepaid Expenses)} & \text{XXX} \\ \quad \text{Operating Income received in advance (Increase in Unearned Income)} & \text{XXX} \\ \quad \text{Outstanding Operating Expenses (Increase in Outstanding Expenses)} & \text{XXX} \\ \quad \text{Accrued Operating Income (Decrease in Accrued Income)} & \text{XXX} \\ \quad \dots & \dots \\ \hline \text{Less: Non-operating Income} & \\ \quad \text{Interest Received} & \text{(XXX)} \\ \quad \text{Dividend Received} & \text{(XXX)} \\ \quad \text{Profit on Sale of Fixed Assets / Investments} & \text{(XXX)} \\ \quad \text{Decrease in Provisions} & \text{(XXX)} \\ \quad \text{Operating Expenses paid in advance (Increase in Prepaid Expenses)} & \text{(XXX)} \\ \quad \text{Operating Income received in advance (Decrease in Unearned Income)} & \text{(XXX)} \\ \quad \text{Outstanding Operating Expenses (Decrease in Outstanding Expenses)} & \text{(XXX)} \\ \quad \text{Accrued Operating Income (Increase in Accrued Income)} & \text{(XXX)} \\ \quad \dots & \dots \\ \hline \text{Operating Profit before Working Capital Changes} & \text{XXX} \\ \hline \text{Add: Decrease in Current Assets (except Cash \& Cash Eq.)} & \\ \quad \text{Decrease in Inventories} & \text{XXX} \\ \quad \text{Decrease in Trade Receivables} & \text{XXX} \\ \quad \text{Decrease in Other Current Assets (operating nature)} & \text{XXX} \\ \quad \dots & \dots \\ \hline \text{Add: Increase in Current Liabilities (operating nature)} & \\ \quad \text{Increase in Trade Payables} & \text{XXX} \\ \quad \text{Increase in Other Current Liabilities (operating nature)} & \text{XXX} \\ \quad \dots & \dots \\ \hline \text{Less: Increase in Current Assets (except Cash \& Cash Eq.)} & \\ \quad \text{Increase in Inventories} & \text{(XXX)} \\ \quad \text{Increase in Trade Receivables} & \text{(XXX)} \\ \quad \text{Increase in Other Current Assets (operating nature)} & \text{(XXX)} \\ \quad \dots & \dots \\ \hline \text{Less: Decrease in Current Liabilities (operating nature)} & \\ \quad \text{Decrease in Trade Payables} & \text{(XXX)} \\ \quad \text{Decrease in Other Current Liabilities (operating nature)} & \text{(XXX)} \\ \quad \dots & \dots \\ \hline \text{Cash Generated from Operations} & \text{XXX} \\ \hline \text{Less: Income Tax Paid} & \text{(XXX)} \\ \hline \text{Cash Flows before Extraordinary Items} & \text{XXX} \\ \hline \text{Add/(Less): Cash Flows from Extraordinary Items} & \text{XXX/(XXX)} \\ \hline \textbf{Net Cash from / (used in) Operating Activities} & \underline{\underline{\textbf{XXX}}} \\ \hline \end{array} $

Notes: Preference dividend is deducted to arrive at profit available for equity shareholders, but for CFS, we start with Profit/Loss before Tax, so preference dividend is not deducted here. If tax is included in PBT, then Net Profit/Loss after Tax is taken, and Tax Expense is added back. Income Tax Paid is shown as a deduction.

Ascertainment Of Cash Flow From Investing And Financing Activities

Cash flows from investing and financing activities are generally ascertained by analysing the changes in relevant non-current asset, non-current liability, and shareholders' equity accounts between the opening and closing balance sheets, combined with information from the Statement of Profit and Loss and notes.

These sections are typically prepared using a direct approach, listing each significant cash inflow and outflow.

Cash Flows From Investing Activities

Focuses on cash movements related to acquiring and disposing of long-term assets and investments.

Examples of analysis:

Compare opening and closing balances of Property, Plant and Equipment (net of depreciation). An increase usually means purchases (outflow), a decrease means sales (inflow). Check notes for additions, disposals, and depreciation.
Cash paid for purchase of PPE = Closing Balance (Gross Block) + Opening Depreciation/Accumulated Depreciation - Closing Depreciation/Accumulated Depreciation - Opening Balance (Gross Block) - Any Asset Disposed (Gross Block).

Cash received from Sale of Asset = Sale Proceeds (from P&L or notes) - Any Book Value of Asset Sold.
Compare opening and closing balances of Non-current Investments. Increase indicates purchase (outflow), decrease indicates sale (inflow). Check P&L for profit/loss on sale.
Compare opening and closing balances of Long-term Loans and Advances given. Increase means more loans given (outflow), decrease means repayment received (inflow).
Interest Received and Dividend Received on investments are also part of investing activities (though often classified as operating as discussed earlier, consistency is important).

Cash Flows From Financing Activities

Focuses on cash movements related to changes in owners' equity and borrowings.

Examples of analysis:

Compare opening and closing balances of Share Capital and Securities Premium. An increase indicates issue of shares (inflow). Check notes for details of issues.
Compare opening and closing balances of Long-term Borrowings (Debentures, Term Loans, etc.). An increase suggests borrowings (inflow), a decrease suggests repayments (outflow). Check notes for details.
Compare opening and closing balances of Short-term Borrowings (if not considered part of cash equivalents). An increase suggests borrowings (inflow), a decrease suggests repayments (outflow).
Dividend Paid (including preference and equity) is an outflow. Check appropriation of profits in P&L or Statement of Changes in Equity and notes.
Redemption of Preference Shares or Debentures is an outflow. Check notes.
Buyback of Equity Shares is an outflow. Check notes.
Interest Paid on borrowings is also part of financing activities (though often classified as operating).

Preparation Of Cash Flow Statement

The Cash Flow Statement is prepared by systematically arranging and presenting the cash flows derived from the three categories of activities.

Standard Format (as per Ind AS 7 / AS 3 (Revised)):

$ \begin{array}{|l|l|l|} \hline \textbf{Particulars} & \textbf{Amount (₹)} & \textbf{Amount (₹)} \\ \hline \textbf{I. Cash Flows from Operating Activities} & & \\ \quad \text{Cash generated from Operations (calculated from PBIT adjusted for W.C. changes)} & \text{XXX} & \\ \quad \text{Less: Income Tax Paid} & \text{(XXX)} & \\ \quad \text{Cash flows from Extraordinary Items (Operating)} & \text{XXX/(XXX)} & \\ \quad \textbf{Net Cash from / (used in) Operating Activities} & & \underline{\text{XXX}} \\ \hline \textbf{II. Cash Flows from Investing Activities} & & \\ \quad \text{Purchase of Property, Plant and Equipment} & \text{(XXX)} & \\ \quad \text{Proceeds from Sale of Property, Plant and Equipment} & \text{XXX} & \\ \quad \text{Purchase of Investments} & \text{(XXX)} & \\ \quad \text{Proceeds from Sale of Investments} & \text{XXX} & \\ \quad \text{Loans and Advances granted} & \text{(XXX)} & \\ \quad \text{Repayment of Loans and Advances received} & \text{XXX} & \\ \quad \text{Interest Received} & \text{XXX} & \\ \quad \text{Dividends Received} & \text{XXX} & \\ \quad \text{Cash flows from Extraordinary Items (Investing)} & \text{XXX/(XXX)} & \\ \quad \textbf{Net Cash from / (used in) Investing Activities} & & \underline{\text{XXX}} \\ \hline \textbf{III. Cash Flows from Financing Activities} & & \\ \quad \text{Proceeds from Issue of Share Capital} & \text{XXX} & \\ \quad \text{Proceeds from Issue of Debentures / Borrowings} & \text{XXX} & \\ \quad \text{Repayment of Borrowings} & \text{(XXX)} & \\ \quad \text{Redemption of Preference Shares / Debentures} & \text{(XXX)} & \\ \quad \text{Buyback of Equity Shares} & \text{(XXX)} & \\ \quad \text{Interest Paid} & \text{(XXX)} & \\ \quad \text{Dividends Paid} & \text{(XXX)} & \\ \quad \text{Cash flows from Extraordinary Items (Financing)} & \text{XXX/(XXX)} & \\ \quad \textbf{Net Cash from / (used in) Financing Activities} & & \underline{\text{XXX}} \\ \hline \textbf{IV. Net Increase / (Decrease) in Cash and Cash Equivalents (I + II + III)} & & \textbf{XXX} \\ \hline \textbf{V. Cash and Cash Equivalents at the beginning of the period} & & \textbf{XXX} \\ \hline \textbf{VI. Cash and Cash Equivalents at the end of the period (IV + V)} & & \underline{\underline{\textbf{XXX}}} \\ \hline \end{array} $

The closing balance of cash and cash equivalents must match the corresponding figure in the Balance Sheet at the end of the period.

The Cash Flow Statement is a valuable tool for understanding the sources and uses of cash, which is the lifeblood of a business, providing insights into the company's financial health beyond what is presented by the accrual-based profit figure alone.