Cash Flow Statement

Session Four

Rationale
Profit alone is not sufficient.
accrual & matching concept accounting assumptions

Cash Flow Statement

A statement that presents the inflows and outflows of cash to and from an organization due to various transactions in a given accounting period. Helps assess the ability of an enterprise to generate cash & cash equivalents and to utilize the same. Also helps to assess the liquidity and solvency of the entity. AS 3 issued by the ICAI guides the preparation of cash flow statement in India. SEBI Clause 32 of the listing agreement of stock exchanges

Basic Elements
Cash flow from operating activities: Principal revenue producing activities of the enterprise Cash flow from investing activities: Acquisition and disposal of long term assets and investments (other than those considered in cash equivalents) Cash flow from financing activities: Activities that result in change in size and composition of owners capital (equity) and borrowings of the enterprise

Cash Flow Statement Format

Cash Flows from Operating Activities [A] Cash flows from Investing Activities [B] Cash Flows from Financing Activities [C] Net increase/(decrease) in cash and cash equivalents [A+B+C] [D] Opening balance of cash and cash equivalents [E] Closing balance of cash and cash equivalents F =[D+E]

Operating Activities
It is the principle revenue generating activities of an entity Two ways of calculating it Direct method major classes of gross cash receipts and gross cash payments are disclosed -changes that cash transactions cause in revenue & expense accounts are analyzed. Indirect method The Profit and Loss Account is adjusted for the effects of transactions of non-cash and non-operating nature Also known as Reconciliation to Net Income

Cash flow from Operating Activities: Indirect Method

A. Start with Profit before tax from P&L a/c B. Adjust for Non cash items:
Add Non cash expenses -Depreciation & other non cash amortizations, provisions for liabilities

C. Adjust for Non operating items

Add Non operating expenses - Interest costs and other non operating expenses Deduct Non operating income Deduct Non recurring income Deduct Actual cash tax paid

D. Operating Profit before working capital adjustment (Adjusting A B & C) E. Working capital adjustments
Changes in current assets and current liabilities (other than cash and cash equivalents)

Cash flow from operating activities (D +/- E)

Illustration KK Ent.
Profit & Loss Account For the Year ending 31st March 20X9 Particulars Purchases for the Year Direct Expenses Gross Profit Total Rent Salary Provision for tax Net Profit Rs. Particulars Rs. 1,65,000

80,000 Sales 20,000 65,000 1,65,000 Total 8,000 20,000 Gross Profit B/d 2,000 35,000

1,65,000 65,000

Solution Direct Method

Kk Enterprises Cash Flow Statement For the Year ending 31st March 20X9(all figures in Rs)

Cash Flow From Operating Activities:

Cash received on account of sale of goods Less: Payment made on account of Purchases of goods Freight and Cartage Salary Paid Rent Paid Tax paid during the year Cash Inflow 1,65,000 80,000 20,000 20,000 8,000 2,000 1,30,000 35,000

Illustration KK Ent.
Profit & Loss Account For the Year ending 31st March 20X9 Particulars Rs. Particulars Purchases for the Year Direct Expenses Gross Profit Total Rent Salary Depreciation Provision for Bad Debts Proposed Dividends Interest on debt Preliminary Exp. written off Profit before taxes Provision for taxes Profit after taxes 80,000 Sales 20,000 65,000 1,65,000 Total 8,000 20,000 15,000 5,000 Gross Profit B/d 10,000 Profit on sale of old 2,500 machinery 1,500 16,000 2,000 14,000

Rs. 1,65,000

1,65,000

65,000 13,000

Solution Direct Method

Kk Enterprises Cash Flow Statement For the Year ending 31st March 20X9 (all figures in Rs)

Cash Flow From Operating Activities:

Cash received on account of sale of goods Less: Payment made on account of Purchases of goods Freight and Cartage Salary Paid Rent Paid
Tax paid

1,65,000 80,000 20,000 20,000 8,000

2,000

Cash Inflow

35,000

Solution Indirect Method

Kk Enterprises

Cash Flow Statement For the Year ending 31st March 20X9 (all figures in Rs)
Cash Flow From Operating Activities: PBT as per Profit & loss Account 16,000 Add: Non-cash transaction Provision for Bad Debts 5,000 Depreciation 15,000 Proposed Dividends 10,000 Interest on debt 2,500 34,000 Preliminary Expenses written off 1,500 Less: Non-operation incomes Profit on sale of machinery 13, 000 Tax paid during the year 2,000 Cash Inflow before working capital changes 35,000 Working capital changes NIL Operating Cash Flow 35,000

Illustration KK Ent.
Profit & Loss Account For the Year ending 31st March 20X9 Particulars Purchases for the Year (cash 60000, credit 20000) Direct Expenses (Cash 12000, due 8000) Gross Profit Total Rent Salary (Paid 15000,Due - 5000) Depreciation Provision for Bad Debts Proposed Dividends Interest on debt Preliminary Exp. written off PBT Provision for taxes Profit after taxes Rs. Particulars Rs. 1,65,000

80,000 Sales (Cash 100000 20,000 Credit 65000) 65,000 1,65,000 Total 8,000 20,000 15,000 5,000 Gross Profit B/d 10,000 Profit on sale of old 2,500 machinery 1,500 16,000 2,000 14,000

1,65,000

65,000 13,000

Solution Direct Method

Kk Enterprises Cash Flow Statement For the Year ending 31st March 20X9 (all figures in Rs)

Cash Flow From Operating Activities:

Cash received on account of sale of goods Less: Payment made on account of Purchases of goods 60,000 Freight and Cartage 12,000 Salary Paid 15,000 Rent Paid 8,000 Tax paid 2,000 Cash Inflow 1,00,000

3,000

Solution Indirect Method

Kk Enterprises

Cash Flow From Operating Activities: PBT as per Profit & loss Account 16,000 Add: Non-cash transaction Provision for Bad Debts 5,000 Depreciation 15,000 Proposed Dividends 10,000 Interest on debt 2,500 Preliminary Expenses written off 1,500 34,000 Less: Non-operation incomes Profit on sale of machinery 13,000 Tax paid 2,000 Cash Inflow before working capital changes 35,000 Increase in Debtors (outflow) - 65,000 Increase in Creditors (Inflow) + 20,000 Increase in Accruals (Inflow) + 8,000 Increase in Accs-salary (Inflow) + 5,000 32,000 Operating Cash Flow 3,000

Investing Activities
Activities related to acquisition and disposal of long-term assets and other investments, which are not taken into consideration under the cash equivalents head are investing activities Also includes investments made by business entities in other companys shares and debentures Examples of investment activities include cash payments or receipts to acquire or dispose fixed assets, shares, debt instrument, etc.

Illustration - Kanishk
The following transactions occur at Kk Enterprises:

Particulars
Purchased a machinery for Sold shares worth Received interest on debentures purchased earlier Received dividend on shares held Sold old machinery (including profit on sale 13,000)

Amount (Rs.) 1,50,000 2,00,000 10,000 20,000 50,000

Solution
Kk Enterprises Cash Flow Statement
Cash Flow from Investing Activities: Sale of Shares Interest received Sale proceeds of old machinery Dividend received Less: Outflow on a/c of machine purchase Cash flow from Investing Activities

2,00,000 10,000 50,000 20,000 2,80,000 1,50,000 1,30,000

Financing Activities
The activities that result in the change in size and composition of the long-term capital employed in the firm are known as financing activities Includes both owner(s) capital and long-term borrowing of the entity Example: cash received from issue of share capital, issue of loans and cash payment on dividend, redemption, etc. Supposing during the year Kk Enterprises has taken a loan of Rs 1,50,000 and paid an interest of Rs 2,500 thereon, the cash flow from financing activities for the year comes to Rs 1,47,500 (i.e., 1,50,000 - 2,500) Thus Net Cash Flow for Kk Ent. = CFO (3,000) + CFI (1,30,000) + CFF (1,47,500) = 2,80,500 Adjusting for Opening cash balance say Rs 5,000 would give closing cash balance of Rs 2,85,500

Recap
Proceeds from the sale of equipment used in the business A/B/C or supplemental info The loss on sale of equipment as above Declaration and payment of dividends on company's stock An increase in the balance in retailer's merchandise Retirement of long term bonds payable The amortization of the cost of an intangible asset The exchange/conversion of long-term bonds into common stock

Recap
A corporation reported the following information for the past year:

Net Income $200,000 Depreciation Expense 30,000 Gain on Sale of Truck 5,000 Proceeds from Sale of Truck 8,000 Decrease in Accounts Receivable 10,000
Assuming these are the only facts, what amount will the corporation report as the Cash Provided by
Assuming these are the only facts, what amount will the corporation report as the CFO on the cash flow statement?

Items that do not figure in cash flow statement

The following transactions have no impact on cash flow:
Issue of bonus shares Conversion of loan to equity Acquisition of business with shares Purchase of Fixed assets on credit

All the above items have no immediate cash impact

Issues
Interest received on long-term investments vis-vis interest received on short-term investments (including interest on trade advances and operating receivables) Interest paid on loans and debts vis--vis interest paid on working capital loan Dividend received in case of financial enterprises vis--vis dividends received by any other type of enterprise Dividend paid is always classified as financing activity

Cash Flow statement: A simple illustration

Balance Sheet as on SOURCES OF FUNDS: Paid up share capital Share premium General reserve Profit & Loss Account Loans TOTAL SOURCES 31/03/07 300 50 200 75 275 900 31/03/06 250 0 150 50 200 650 700 -350 350 150 100 50 650

APPLICATION OF FUNDS: Gross block 900 Less: Accumulated Depn. -425 Net Block 475 Investments 100 Net current assets 250 (excl. cash and bank balances) Cash and bank balances 75 TOTAL APPLICATION 900 Investments are sold at a profit of Rs. 25 Interim dividend paid Rs.20

Pattern of cash flows

Most of the financially strong companies will have positive CFO

Cash flow statement: How to interpret?

Identify the major sources of cash inflows and cash outflows. Compare capital expenditure with depreciation number. See how operating cash flows are being utilized. Find out whether the enterprise is growing. If yes, whether organically or inorganically.