1.CHAPTER 5: CASH FLOW STATEMENT - INTRODUCTION

LEARNING OUTCOMES:

MEANING OF CASH FLOW STATEMENT

OBJECTIVES OF CASH FLOW STATEMENT

IMPORTANCE OR USES OF CASH FLOW STATEMENT

LIMITATIONS OF CASH FLOW STATEMENT

                                  CASH FLOW STATEMENTS

Cash flow statement 

It is a financial statement which shows the inflow and outflow of cash and cash equivalents from the various activities (operating activities, investing activities and financing activities) of an enterprise during an accounting period.

Cash and cash equivalents 

.As for AS- 3, 'Cash' comprises cash in hand and demand deposits with banks.

 'Cash Equivalents' means short term highly liquid investments that are readily convertible into known amounts of cash and which are subject to an insignificant risk of changes in value.

Examples of cash equivalents

 Preference shares of a company acquired shortly before the specific redemption date, s

Short term marketable securities.

*Current investments are to be taken as marketable securities unless otherwise specified.

*'Cash flows' implies movement of cash and cash equivalents ( in and out) due to some non- cash items.

*Non cash items are the items other than cash and cash equivalents example machinery, share capital etc.

Objectives of cash flow statement 

1. To provide useful information about cash flows of an enterprise during a particular period under various heads operating ,investing financing.

2. To assess the ability of the enterprise to generate cash and cash equivalent and the needs of the enterprise to utilise those cash flows.

Exercise 1

State giving reasons whether the following transactions will result in inflow, outflow or no flow of cash or cash equivalents

1. Sale of fixed asset (book value 100000) at a loss of 5,000. I

2. Purchase of stock in trade for cash. O
3. Cash received from debtors. I
4. Cash deposited in bank / short term deposits in banks. N
5. Cash withdrawn from Bank. N
6. Sale of marketable securities for cash at par. N
7. Proposed dividend. N
8. Dividend / interest paid. O
9. Interest received on debentures held as investment. I
10. Discount received on making payment to suppliers . N
11. Old furniture written off. N
12. Purchase of fixed assets on long term deferred payment. N

13. Charging of depreciation on furniture. N 

14. Payment of cash to creditors. O

15. Goodwill written off. 

16. Refund of tax. I 

17. Provision for tax. N


HINTS ARE GIVEN TO SOLVE THE EXERCISE. 
(Cash flows' implies movement of cash and cash equivalents ( in and out) due to some non- cash items.)

*Non cash items are the items other than cash and cash equivalents example machinery, share capital etc.

Benefits / advantages of cash flow statement 

1. It enables users to evaluate changes in net assets of an enterprise, its financial structure including its liquidity and solvency.

2. It is useful in assessing the ability of an enterprise to generate cash and cash equivalents.

3. It enhances the compatibility of the operating performance by different enterprises.

4. It is helpful in checking the accuracy of past assessments estimates of future cash flows and in examining the relationship between profitability and impact of changing prices.

Cash flows from operating activities

Operating activities are the principal revenue generating activities (or the primary or main activities) of the enterprise.

Significance

It indicates the internal solvency level of the company and is regarded as the key indicator of the extent to which the operations of the enterprise have generated sufficient cash flows to maintain the operating capabilities of the enterprise paying dividends making of new investments and repaying of loans without the recourse to external source of financing.

Examples of cash inflows from operating activities

*cash received from sale of goods and the rendering of services to customers 

*cash received from royalties, fees, commissions and other revenues.

Examples of cash outflows from operating activities

*Cash payment to suppliers for goods and services purchased.

*Payment of employees benefit expenses 

*Cash payments of operating expenses 

*Cash payment to an insurance enterprise for premiums and claims.

* Cash payment of income taxes.

Cash flows from investing activity

 Investing activities are the acquisition and disposal of long term assets and long term Investments.

Examples of cash outflows from investing activities 

*Cash payments to acquire fixed
assets.
*Cash payment to acquire shares, warrants or debt instruments of other enterprises.

*Cash advances and loans made to third party by non financial enterprises ( since advances and loans made by a financial enterprise is classified as operating activities).

Examples of cash inflows from investing activities

* Cash received from sale of fixed assets 

* Cash receipt from payment of advances of loans made to third parties

* Cash receipts from sale of shares warrants or debt instruments of other enterprises (except those held for trading purposes) 

* Interest received in cash from loans and advances made to third parties.

* Dividend received from investments in other enterprises.

Cash flows from financing activities

 It result in change in the size and composition of the owner's capital including preference share capital in case of a company and borrowing of the enterprise.

                                                   Or,

 It relates to long-term funds or capital of an enterprise, eg., cash proceeds from issue of equity shares, debentures, raising long-term bank loan, repayment of bank loan etc.

Examples of cash inflows from financing activities
*Cash proceeds from issuing shares

* Cash proceeds from issuing debentures ,loans bonds and other short term borrowings / long term borrowings.

Examples of cash outflows from financing activities 

*Cash payments of amount borrowed example redemption of debentures or preference shares, buy back of equity shares, repayment of long term debts etc.
*Interest paid on debentures and long-term debts
* Dividends paid (both final dividend and interim dividend)

Extraordinary items are not the regular phenomenon, that is, non recurring in nature.

Examples 

*Loss due to theft or earthquake or flood

*Insurance proceeds from the famine settlement / earthquake disaster settlement.
Interest and dividend

In case of a non financial enterprise

*Payment of interest and dividend are classified as cash outflows from financing activities
*Receipt of interest and dividend are classified as cash inflows from investing activities.

In case of financial enterprise (whose main business is lending and borrowing)

* Interest paid, interest received and dividend received are classified as operating activities 

* Dividend paid is a cash outflow from financing activities...

Examples of investing activity for every type of enterprise

*Purchase of goodwill ,purchase of fixed asset, sale of fixed assets.

Examples of activities which are a financing activity for every type of enterprise

*Dividend paid, issue of shares, redemption of preference shares, buyback of shares, issue of debentures, redemption of debentures, obtaining long term loans, repayment of long term loans.

Taxes

*Income tax that is tax on normal profit for operating profit is cash outflow from Operating activities

* Capital gains tax that is capital tax on capital profits example gain on sale of land and building is cash outflow from Investing activities

* Dividend tax that is tax on the amount distributed as dividend to shareholders is cash flow from Financing activities.

Non cash transactions

Investing and Financing transactions that do not require the use of cash or cash equivalents are termed as non cash transactions. 

They should be excluded from a cash flow statement since there is no inflow or outflow of cash and cash equivalents. 

Examples of non cash transactions

 *Issue of shares and debentures to the vendors for the purchase of fixed assets

*Redemption of debentures by converting them into equity shares

* Issue of fully paid bonus shares.