Purpose of Case Flow Analysis

425
Section I
CASH FLOW STATEMENT

E A R N I N G O B J E C T I V E S

the study of this chapter, you should be able to:

pleting
'nderstand the nature and importance of cash flow statement.
of cash flow analysis.
Explain the purposes
Define cash flows.

Distinguishbetween a funds tlow and a cash flow statement.

items of cash inflows and outflowws.

State the
status of cash flow statement in India.
Explain the present
per Accounting Standard 3
Enumerate the mandatory disclosure requirements
as

(AS-3).

139 IMPORTANCE AND NATURE OF CASH FLOW STATEMENT

The importance of cash in the entire economic life of a firm can hardly be exaggerated. A
im may operate profitably, yet it may find it difficult to meet its commitments, including
payment of wages, taxes, dividends, etc. This may be because either the amount of cash
alable may be far less than the profit earned during the period or the cash may have been
Vsed f some other purposes. Again, at times, cash may be flowing in a much faster rate than
ing disbursed. So, during periods of temporary cash accumulation, the Finance Manager
eK Some oudet for these funds (temporary investments). The opposite of this sinuation
fat requires the arangement of the required amount from appropriate sources. Thus, the
TMana_
tmust know the movement of cash during a period for efficiently running its
i A cash flow analysis is considered to be the tool in the hands of the management

terostatement shows the changes in the financial position of a firm on cash basis.
words, it
n cash and the net effects of the various transactions of a firm during a period
t shows Ses of changes in the cash position of a firm between two balance
eel explains the causes
dates.tof is caled the
pications 'cash flow statement' because it shows the various sources
and
cash during period and their net impact on the cash balance.
The ng a

bank deposscash
cash' is used in its literal
sense, viz. it includes state and bank money in hand
withdrawable by cheques on demand.

13.10
PURPOSE OF CASH FLOW ANALYSIS
pimary purpose4cash
of a flow statement is to provide information about the cash receipts
426 Chapter 13: Changes in Financial Position

and cash payments of the firm during a period, and their impact on the ending cash
More specifically, a cash flow statement helps to assess the firm's ability to:
ing cash balance
1. generate cash flows from operating, financing and investing activities:
2 meet its obligations (e.g. payment of wages, expenses, trade creditors, taxes in
and pay dividends; erest)
3. determine the net increase or decrease in cash during any period and,
and, conse
consequently,
the amount of the ending cash balance; and
4. explain the difference between the net profit and the net cash flows from
perations
A cash flow statement also gives information about the non-cash investing and finanei
activities. It, thus, gives a true picture of a fim's liquidity and solvency position. ncing
A cash flow analysis based on past figures, however, has limited usefulness. A proicced
Cash flow statement helps the management in the area of financial planning and control
It may be mentioned that for both investment and financing decisions, the amount and
the period involved are two important pieces of information that the management should know
well in advance. A projected cash flow statement can provide both of them.
The usefulness of a cash flow statement to the users of published accounts hardly need
any emphasis. For example, prospective creditors will find this statement extremely useful for
determining the liquidity position. A prospective investor should also consult thisstatement not
only for determining the profitability of the firm but also for ensuring that his or her
investmentwould get regular return (cash dividend) in future. Banks do insist on, among other
things, projected cash flow statement while considering the applications from fims for term
loans or cash credit. Likewise, the income tax department may also require this statemen
under certain circumstances.
As the cash fow and funds flow statements are useful to the management and the users
of accounts, it is desirable that these statements do accompany the conventional profit and loss
account, and balance sheet. It is true that, at present, the law does not require both these
be to conventional financial statements. But there is no
embargo on their
statements to annexed
inclusion. A cash flow statement has been made mandatory for listed companies and
specified organizations with effect from 1 April 2001 pursuant to revised Accounting Standaru
otNc
(AS-3). Inchusion of the cash flow statement further enhances he utility of financial statements
to various user groups.

13.11 MEANING OF CASH FLOWS

A cash flow statement is alents'. Cash compr
prepared on the basis of 'cash and cash equivalents'. Casn quid
cash in hand and in bank, and demand
deposits.
Cash equivalents are short-term, hign Tht Thes
investments that held for the
are
purpose of meeting short-term cash commitme f cash,
short-term, highly liquid investments are: (i) readily convertible into known
and (ii) subject to insignificant risk of amou
changes in value. can
be
Cash equivalents are defined as which
short-term, highly liquid investments
nents
uhiect t
converted into cash within three months from the date of which ac
acquisition and
insignificant risk (AS-3).
 Preparation of Cash Flow Statement: Procedure
427
FUNDS FLOW VERSUS CASH FLOW
13.12

Aow and cash flow statements are both prepared to show the changes in the
Tthe f u n
sition of a firm during a particular period. They can be used as tools in the hands
financial p o s i t

f the
aacement for planning and control. For preparation of both the statements, relevant
m a n a g e m e n t

those in the profit and loss account for and certain

figures in the the balance sheets and As the funds
a period,
a matter and of fact, flow cash flow statements
information, are
necessary.
c o m p l e m e n t a .
to each other and should be prepared simultaneously to facilitate an in-
the
Te
analysis of the financial position of the firm during any particular period. Yet
depth
distinctiorn may be made between the two:
following
may be prepared the basis of any of the alternative
1.A funds flow
statement on
concepts of funds (e.g. cash, working capital, total financial resources amonng

others), though theworking capital concept is more popular and widely used. A cash
flow statement can be prepared on 'cash' concept only. Thus, the latter statement
uses the narrower concept of fund while analysing the financial position of a firm
during a period.
flow
2. A cash flow statement is based on the 'cash basis' of accounting while a funds
statement is based on the 'accrual basis' of accounting. That is why, while preparing
the cash flow statement, the operating profit or loss as per the accrual system needds
some adjustment in order to arrive at the cash operating profit.
3. A funds flow statement is generally accompanied by a statement showing changes in
the working capital during the period under consideration. A cash flow statement
does not accompany any such statement.
4. Although both can be used for planning and control purposes,. a funds flow statement
1S generally used for intermediate and long-range planning while a cash flow
statement may be used for both short- and long-range planning.

0.1 PREPARATION OF CASH FLOW STATEMENT: PROCEDURE

shflow statement shows the impact of various transactions on the cash position of a firm.
For pre the profit and
à cash flow statement, one has to take the help of balance sheets,
a cunt, and certain other relevant information. More precisely, it starts with the opening
B d bank balance; cash from operations or cash trading profit and receipts from other
the Cahadded to the opening cash and bank balance. From the aggregate figure as above,
ash outflows are deducted. The resultant figure will be the closing cash and bank balance.
er
he words, the with the cash intlows during the period should equal
pening
ope cash along
actualgregate of Cash outflows and the closing balance. When the closing balance is given
or esu cash
the cash e
flo
d figure), a reconciliation between the two, i.e. the closing balance as per

and that as per the balance sheet, may be made.

dtementatement
The cash may be prepared either in vertical torm or in T-fornm. A pro
TIna cash flov flow sta
OW
statement is shown in Table 13.6.
 Financial Position
Changes in
428 Chapter 13:
Forms
Statement-Alternative

Table 13.6 Cash Flow

Statement (Using Vertical Form)

(a) Pro forma Cash Flow
XX
Opening cash and bank balance
Additions during the year:
XX
Cash operating profit
(or cash from operations)
XX
etc.
Sale of fixed assets, investments, XX
Issue of share capital
Long-term loan (debentures,
XX
institutional loan, etc.)
Non-trading income, if any
XX XX
XX
Total
Less: Applications during the year:
Cash used in operations (loss), if any XX
Purchase of fixed assets,
XX
investments, etc.
XX
Redemption of preference shares XXX
Repayment of long-term loan XX
Repayment of dividend, tax, etc.
AA
XX
Closing cash and bank balance

(b) Pro forma Cash Flow Statement (Using T-form)

Opening balance XX Cash applications or outflows:

Purchase of fixed assets XX
Add: cash inflows:
Cash Trading Profit or cash from Redemption of preference shares XX
XX Repayment of loan XX
operations
XX
Sale of fixed assets, etc. XX Payment of dividend, tax, etc.
XX Closing balance XX
Share capital
Long-term loan, etc. XX
Non-trading income, if any XX
XX XX
Total

While either of the two alternative methods of presentation may be used for the purpose
the vertical form is a presentation as it focuses attention
better method of 'on the flow of casn
in a more prominent way. It is, therefore, widely used in practice.

13.13.1 Items of Cash Inflows and Outflows (other than Cash from
Operations)
wo
Some of the items can be determined directly by simply comparing the relevant figures a
balance sheet dates. For example, i fthe share capital as at the beginning of the period i ,
 Preparation of Cash Flow Statement: Procedure
429
sa
stands at 75,000 at the end of the period, unless otherwise stated,
the
W h i l e

4 p a r e n tt h a t d u during the period under consideration there has been cash inflow to the
0
o0 on account of the 1SSe ot share capital. But in a majority of the cases.
ofR 15, have to be checked for finding out the amount of the cash inflow or
e r accounts will

iow on various
e procedure to be followed in this respect is similar to what has
explained in Section I of this chapter.

Cash from Operations

313.2
but operating or trading profit on cash basis. Therefore, when details of cash
s is nothing

uons. e.g. sales, purchases, expenses are availabie, the cash trading profit can be easily
as in
Table 13.7.
gertained
Table 13.7 Profit and Loss Account (Cash Basis)

Cash purchases XX By Cash sales XX

and salaries paid XX Misc. income received (trading) XX
Wages
Expenses paid XX
Cash rading profit
(or cash from operations) X
balancing figure
XX XX
Alternatively, one may start with the net profit or loss and make necessary adjustments
Bth respect to the non-cash and non-trading items which have been debited (e.g. outstanding
gs and salaries, depreciation, provisions for bad and doubtrul debts and inventory losses,
IC-ofTs, loss on sale of fixed assets.) or credited (e.g. dividend, commission received, profit
e of fixed assets), to profit and loss account as well as to the changes in current assets

t liabilities. A pro forma statement showing the determination of cash operating

pott is shown in Table 13.8.

Table 13.8 Statement Showing Cash from Operations

.Ot1) as
per profit and loss account XX
Non-cash and non--trading items debited
to
profit and loss a/c:
Qutstanding wages, salarnes, ec XX
Depreciation
Frovision for
XX
XX
bad and doubtful debts
Alowance for inventory lossS XX
Goodwillwritten of XX
reliminary penses written off
LOSS on
XX
sale of fixed XX
assets
XX
 Chapier 13 Changes in Financial Po_ition
430
like dividend,
miscellaneous
XX
Less: () Non-trading receipts
income eredited to and loss a/c
profit
before adjustment
of working capital changes XY
Operating/Trading profit
Adjustments for working capital changes XX
(i) Decrease in current assets
balances)
(other than cash and bank
Increase in current liabilities XX
XX
assets
XX
(1) Increase in current
balances)
(other than cash and bank
Decrease in current iabilities XX
the period
Cash operating proit or cash from operations during XX

llustration 13.7
From the profit and loss account for the year ended 31 December 20x2. of a company and
the balance sheets as on 31 December 20x1 and 31 December 20x2, respectively, prepare a
cash flow statement for 20x2.

Profit and Loss a/c for the year ended 31 December, 20x2

To Cost of materials consumed 162,000 By Sales 200,000

20,000 Profit on sale of plant 5,000
Expenses
5,000 Miscellaneous income 10,000
Depreciation
Deferred expense 2,000
Net profit c/d 26,000
215,000 215,000
Dividend 8,000
Balance c/d 18,000 Net profit b/d 26,000
26,000 26,000

Balance Sheets as on 31 December 20x2

20x1 20x2 20x1 2012

(
) 40,000 56,000
Share capital 80,000 90,000 Fixed assets
14,000
Profit and loss a/c 30,000 48,000 Inventories 20,000
90,000
Trade payables 20,000 30,000 Trade receivables 60,000
14,000
Liabilities for expenses 6,000 10,000 Cash and bank balance 10,000 4
4,000
Advance income received 4,000 2,000 Prepaid expenses 6,000
2,000
Deferred expenses 4,000
180,000
140,000 180,000 140,000

An old plant has been sold for 10,000.

 Preparation of Cash Flow
Statement: Procedure 431
Cash Flow Statement for
20x2

Opening cash
and bank balance
the year: 10,000
during
Additions profit (note 1)
Cash operating 18,000
fixed a s s e t s
Sale of 10.000
share capital
Issue of 10,000
Total
38,000
the year: 48,000
Aoplications during
Fixed assets (note 2)
26.000
Dividend
8,000
and bank balance 34,000
Closing cash 14,000

Workings:
Cash operating profit is arrived at as follows:
Net profit as per profit and loss alc
26,000
Add: (i) Non-cash item of debit
Depreciation 5,000
Deferred expenses w/o
2,000
ii) Changes in curent assets and liabilities:
7,000
Decrease in current assets:
Inventories 6,000
Prepaid expenses 2,000
8,000
Increase in current liabilities:
Trade payables 10,000
Expenses 4,000
14,000
22,000
29,000
Deduct. (i) 55,000
Non-trading item:
Profit on sale of plant 5,000
(1) Changes in curent assets and Habilitües:
Increase in trade receivables 30,000
Decrease in income received 2.000
32,000 37,000
Cash from operations 18,000
accour
unt on
Alternat
d vely, cash from operations may be ascertained by preparing the profit and loss
a
cash basis as follows:
 Present Status of Cash Flow Statement
437
Table 13.10 Cash Fiow Statement under Direct Method (AS-3)

Pro forma Cash Flow Statement

(According to AS-3)

activities:*
from operating
ch lows
Cash inflows (a):

Cash
received for goods/services sold XX
Cash outflows (b):
Payment for materials/inventory
Wages and salaries
XX
Expenses XX
Taxes XX
Net cash provided (used) by operating
XX
acivities (a - b)
XXX
activities
Cash flows from investing
Cash inflows (a):
Sale of fixed assets and investments XX
Collection of principal on loans to other companies XX
Interest and dividend received
XX
XX
Cash outflows (b):
Purchase of fixed assets and investuments XX
Inter-company loans
Net cash provided (used)
XX
activities (a - b)
by investingB XX
XX
Cash flows from
financing activities:
Cash inflows (a):
5Sue of share capital, debentures and long-term loan
XX
Cash outflows (b):
OEmption of debenture, preference share capital XX
Interest on debt
capital
Dividends to shareholders XX
XX
Net XX
Se mereasecash(decrease)
provided (used) by financing activities (a-b) XX
in cash (1 + 2 3)
Add: Cash
+ XX
theat
Cash
at the end
beginning XX
cash XX
investüng
List individual and financing activities
items) XX
XX
XX
i
s format
is
Marginallyappin respect
n o a company other than a financing company. The format for a financing company,
respec of reatment of interest paid, and inerest and dividend receiv as stated earlier
 Financial Position
438 Chapier 13: Changes in
Table 13.11 gives a pro forma cash flow statement for an ente
other
financial enterprise (AS-3) showing cash flows from the operating activitiriseother
method. under inhandirecta
Table 13.11 Cash Flow Statement Showing Cash Flows from Operatino
under the Indirect Method ctivities
Pro forma cash flow statement (AS-3)
Cash flows from operating activities:
Net profit before taxation and extraordinary item
Adjustuments for: XX
(+) Depreciation XX
(+) Foreign exchange loss XX
(-) Interest income XX
(Dividend income XX
(+) Interest expense XX
Operating profit before the working capital changes
XX
Adjustments for changes in the working capital:
(+) Decrease in current assets XX
(+) Increase in current liabilities XX
XX
(-)Increase in current assets XX
( Decrease in current liabilities XX XX
Cash generated/used from operations: XX
(Income tax paid XX
Cash flow before extraordinary item XX
() Extraordinary item XX
Net cash flows from operating activities XX
XX
Cash flows fror vesting activities
(see Figure 5.3 for details)
Cash flows from financing activities XX
(see Figure 5.3 for details)
XX
Net increase in cash and cash equivalents
XX
Cash and cash equivalents at the beginning of the period
Cash and cash equivalents at the end of the period
taken
Under the indirect method, the net profit or loss asper the income statement items
cash
non-c
as the staring point and adjustments to net profit are made in respect
of nt liabilities
appearing in the income statement and changes in the current assets and rivities
aC w i t h
during consis
the year to reconcile the net profit to net ash provided by operating
direct method shows operating cash receipts and payments. I t is, thus, more
dard Board (FAS,
ltuing
the objective of the cash flow statement. The Financial Accounting Stanaaaverwhee
a nhandful(25
of the USA has expressed preference for the direct method. But, in practice
*
in the USA ony
majority of the firms (97.5%) use the indirect method and
 Chapter 13: Changes in Financial Position
448
Cash Flow from Financing Activities (C):
Issue of equity shares 200,000
Redemption of debentures (105,000
Interest on debentures (14,000
Net cash flow during the year (D) (A + B + C)
Opening cash balance (E)
81,000
S5,000
Closing cash balance (F) (D + E)
125.00
Debenture redeemed: 100,000+ Premium 5,000) from Security Premiu 180.00
mium Account.
PROBLEM 13.7: Cash flow statement
From the following summarized balance sheets of S. Ltd. and other
relevant infs
prepare a cash flow statement. ation,
Liabilities 2013 2014 Assets
2013
Share capital 2014
500,000 700,000 Land and building
Securities premium 45,000 500,000 650,000
55,000 Plant and machinery
General reserve 100,000 45,000 Stock
205,000 215,500
Capital reserve 98,000 95.000
15,000 Trade receivables
Profit and loss account 70,000 102,000 118,200
67,500 Cash 62,500
8% Debentures 100,000 85,000 Prepaid expenses 68,700
Provision for taxation 15,700 8.900
35,000 45,000
Proposed dividend 50,000 70,000
Trade payables 73,000 61,100
Outstanding expenses 10,200 12,700
983,200 1,156,300
983,200 1,156,300
Additional information:
(a) A plant costing 50,000 (WDV 735,200) has been sold
40,000. Profit on sale has been transferred to during 2013-14 tor
(b) A piece of land has been sold for capital reserve account.
sale of such land has also been 770,000 during the year 2013-14. The pront
on

transferred to capital reserve

(C) Balance of capital reserve on account
31.3.14 consists of profit on sale of plant and land
only
(d) During the year 2013-14, bonus
shares of 100,000 has been issued out or neral

reserve. g
(e) Debentures were redeemed
at a
transferred to premium of 10%; premium on redemption
profit
and loss account.
(f Amount
appropriated during
For proposed dividend: 7 2013-14
70,000
For taxation: 7
40,000
(g) Depreciation provided during 2013-14:
On plant and
On machinery: 32,800
building: 7 22,500
B.Com. (Hons.) CU
 Sotved Problems 449

Cash Flow Statement for the Year 2013-14

Amount () Amount ( )

activities (AA):
from operating
rsh ow
Trading profit
217,300
iDecrease i n stock 3,000
prepaid expenses 6,800
it
Decrease
in outstanding
expenses 2,500
se
229,600
in Trade receivables -16,200
increase
Decrease in Trade payables -11,900
201,500
iast Tax paid 30,000
operating activities 171,500
casih flow from

Cash fow from investing activities (B):

Saie of land and building 70,000
Sait of piant and machinery 40,000
110,000
Purchase oí land and building (-)232.300
Purchase of plant and machinery (-)78,500
cash fiow from investing activities 200,800
Cast flew from financing activities (C):
se of share capital including securities premium 110,000
SHesenption of debentures (-16,500
(-8,000
Deventure interest paid
(-)50,000
D:vidend paid
Caah fiow from financing activities 35,500
6,200
cashand cash equivalents (A +B C )
Add. pening cash 62,500
68,700

ow'kings Account
Land and Building
Amount (7) Amount ()

500.000 By Bank alc- sale proceeds 70,000

apota vewrve alc -pro. on saie 10.200 Profit and loss a/c
Eaik
alt purchaed in casi 232.30 Depreciation 22,500
Balance c/d 650,000
742.5()D 742,500
 in Financial Pasition
Chapter 13 Changes
450
Account
Plant and Machinery
Amount)
By Bank a/c - sale proceeds
Amount
205,000
To Balance bld
sale 4,800 Profit and loss a/c 40,000
Capital reserve a'c -

profit on

purchased in cash 78.500 Depreciation

Ban ac -

Balance c/d 32,800

215 500
288,300
288.300
Capital Reserve Account

Amount )
Amount )
By Balance b/d
Plant and machinery alc -
profit on sale
4,800
To Balance cd 15,000 Land and building
profit on sale (balancing figure) 10,200
15.000 15.000

Share Capital Acount

Amount (R) Amount ()
By Balance b/d 500,000
General reserve a/c
To Balance cid 700,000 Bonus issue 100.000
Bank a/c - fresh issue 100,000
700.000 700.000

General Reserve Account

Amount () Amount (
To Share capital a/c -

bonus issue 100,000 By Balance b/d 100,000

Balance c/d 45.000 Profit and loss a/c - transfer 45,000

145,000
145,000

Provision for Taxation Account

Amount
Amount R)
To Bank alc t a 35,000

paid 30,000 By Balance b/d

Balance cl 40,000
45,000 Profit and loss a/c -

75,0
75,000
 Solved Problems
451
Proposed Dividend Account
Amount () Amount ()
a/c
-

dividend paid 50,000 By Balance b/d 50,000

ToBank
Balance c/d 70,000 Profit and loss a/c -

provision 70,000
120,000 120,000
Adjusted Profit and Loss Account
Amount ) Amount ()
ToDepreciation Plant and mnachinery 32,800 By Balance b/d 70,000
Depreciation Building 22,500 Fund from operation
Transfer to reserve 45,000 (balancing figure) 217,300
Premium on redemnption of debentures 1,500
(15,000 x 10/100)
Provision for taxatioon 40,000
Proposed dividend - provision 70,000
Debenture interest 8,000
Balance c/d 67,500
287,300 287,300

PROBLEM 13.8: CFS-direct and indirect methods

rOit and loss account (extract) of AB Ltd. for the year ended 31 March 20x2.

(a) Income
Sales 114,000
400
Interest
Gain on sale of investments
1,400
I15,800
(b) Expenses
89,000
Cost of goods sold
17,800
Depreciation 9,200
Administration and selling 2,800
Interest 600
LOSS on sale of plant and machinery
119,400
(c) Profit before item 3,600
tax and extraordinary
d) Income tax
e) Extraordinary item 3,600
Net profit