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Course: Financial Accounting and Analysis

Answer 1:
Introduction: Cash Flow Statement
The Statement of Cash flow shows the inflow and outflow of cash for an enterprise/company over an
accounting period. Cash inflow represents generation of cash and cash outflow represents spending or
usage of cash. A company earning a good profit may not be able to meet its short term needs due to
shortage in inflow of Cash or Cash equivalents (short term, highly liquid investments).
Importance of Cash Flow Statement:
a) Helps the management in short term planning, keeping control of cash
b) Provide complete details about where the money is spent by the company
c) Helps in analysing how well the past cash planning worked out and what future changes must be
implemented in cash planning
d) Knowing the optimum level of cash balance and if surplus cash is available it can be used for
investing purposes

Concept and Application:

Cash Flow is categorized mainly into three:
 Operating Activities: Activities that are directly related to the core (revenue producing) business
operations. It reflects how much cash is generated from a company’s products or services.
Some examples for cash flow from Operating Activities are:
a) Receipts from sale of goods and services
b) Income tax payments
c) Rent Payments
d) Salary and wage payments to employees
e) Payments made to suppliers of goods and services used in production
f) Receipts from royalties, commissions and fees

 Investing Activities: Activities pertaining to investments that the company make for reaping benefits
at a later stage. It provides the details about the purchase and sale of the capital assets of the company
(assets having useful life more than one year).
Some examples for cash flow from Investing Activities are:
a) Purchase of tangible and intangible fixed assets
b) Purchase of investments
c) Dividend received
d) Interest received
e) Sale of fixed assets and investments
f) Receipts of (or Payments from) from Future, Forward, Option and Swap contracts except when
they are for trading purposes or classified as financing activities

 Financing Activities: It considers the stock purchase or sale by the company and any other proceeds
or payments with respect to the debt financing.
 Some examples for cash flow from Financing Activities are:
a) Proceeds from long term and short term borrowings
b) Proceeds from issue of share capital
c) Dividend paid
d) Interest and finance charges paid
e) Proceeds from issuing debentures, loans and bonds
Gaman Ltd
Net profit before tax Rs 269244
Loss on sale of asset Rs 95780
Dividend income Rs 26000
Interest Income Rs 35000
Finance cost paid on debentures Rs 12000
Gain on sale of investment Rs 45000
Depreciation on fixed assets Rs 85000
Amortisation expenses Rs 110000

Classification of the particulars in above table among the three cash flow activities:
 Operating Activities
a) Loss on sale of asset: Gain or Loss on sale of an asset is the difference between the cash received
by the company and the book value of the asset at the time of sale. Loss means the cash received
is less than the book value of the asset.
Example: The company Gaman Ltd sells its old machinery for Rs.2,00,000. Its original cost was
Rs.4,00,000 and its accumulated depreciation was 1,04,220 as of the date of sale. So its book
value was Rs.2,95,780 (Original cost – Accumulated depreciation). Since the cash received by
the company is less than its book value, there is loss of Rs.95780. This loss is incurred in a non-
operating activity but is a loss in investment. The proceedings from the sale of asset will be
shown as cash inflow from investing activity and the net loss amount will be added as
adjustment for calculating cash flow from operating activity (in Indirect method), since it is
already deducted from the revenue in P&L Statement.

b) Gain on sale of investment: It is the amount by which the proceeds from sale of investment is
greater than the book value of the investment that are sold. The proceedings from this sale will
be shown as cash inflow from investing activity and the net gain amount will be reduced as
adjustment for calculating cash flow from operating activity (in Indirect method)

c) Depreciation on fixed Assets(Operating): It is a non-cash item. Depreciation refers to the concept

where a tangible asset lose its value over time. Within accounting, depreciation is used to spread
the cost of a tangible asset over its useful life.
Example: If a machinery is purchased by a company for Rs. 850000 and the expected usage of
the machinery is 10 years, the business might depreciate the asset under depreciation expense as
Rs.85000 every year for a period of ten years. This 85000 rupees will be deducted from the
Revenue as expense but actually only the value of the machinery is depreciating by Rs.85000
and there is no cash outflow involved, that’s why it is referred as a non-cash item.
 While calculating the cash flow from operating activities by Indirect method this
depreciation amount would be added back as adjustment.

d) Amortization Expense: Amortization is used to spread the cost of an intangible asset over its
useful life. These expenses could be on assets like agreements, patents and trademarks, It is also
a non-cash item. This expense is also deducted from the Revenue in Profit and Loss Statement
but there is no actual cashflow for which it is adjusted in Operating Activities (in Indirect
method)

e) Interest Income: It is the interest received on investments and assets of the company. It is
considered as a cash inflow from investing activity, except for financial enterprises where
lending money and earning interest is there core business. Interest income will come under
operating activity for the financial sectors.

f) Dividend Income: Dividend is a portion of Company’s earnings distributed to shareholders. The

company (say Gaman Ltd) may have invested in many companies and is a shareholder of these
companies, so when dividends are declared by the latter the sum total dividend income is
represented as cash inflow from investing activity. For financial enterprises dividend income will
come under Operating activity.

g) Finance cost paid on debentures: