Chapter 4:

Cash Flow Statement

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 Introduction
 In business Cash is referred to as the trump card for any business
 Cash Flow Statement is the cash summary
 All the cash inflows and outflows in a business are stated and
registered.
 Cash Flow Statement gives the position and flow of the cash inside a
company.
 A statement that presents the flow of cash to and from an organization
in a given accounting period, is known as the cash flow statement.
 This information summary on the varied type of cash flow transactions
is segregated under three activities: operating, investing and financing.

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 Three Activities of a Cash
Flow Statement

Amount
(A)Cash flows from operating activities XXXX
(A)Cash flows from investing activities XXXX
(A)Cash flows from financing activities XXXX
Net increase (decrease) in cash and cash equivalents (A + B + XXXX
C)
Add: Cash and cash equivalents at the beginning XXXX
= Cash and cash equivalents at the end XXXXX

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 Cash and Cash
Equivalents
 Cash equivalents means all the short-term
investments which can converted into cash,
without any reduction in their value.
 Cash equivalents are often held for the purpose
of meeting short-term cash commitments rather
than for investment or other purposes.
 Cash, as we understand in general terms
 Demand deposits with the bank
 Short term, highly liquid investments that can be
readily converted to cash

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 Preparing a Cash Flow Statement
Using Direct Method

 All the cash flow activities are required to be segregated under three
activities viz., operating, investing and financing

 The sum of these activities reflects the net increase or decrease in

the cash and cash equivalents

 Here, by cash we mean both cash in hand and bank demand

deposits, similarly cash equivalents means all the short-term
investments which can be readily converted into cash without decline
in its value
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 Operating Activities

 It is the principle revenue generating activities of an entity

 Two ways of calculating it
 Direct method
 We independently analyze the changes that cash
transactions cause in each balance sheet non-cash account
 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”

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 Illustration –
Jamuna Tudu Enterprises
Jamuna Tudu Enterprises
Profit & loss Account
For the Year ending 31st March 20X1
(all figures in Rs. Million)
Purchase for the year 800 Sales 1,650
Direct Expenses 200
Gross Profit 650
1,650 1,650
Rent 80 Gross Profit B/d 650
Profit on sale of old
Salary 200 machinery 130
Depreciation 150
Provision for Bad Debts 50
Proposed Dividends
( Withdrawals) 100
Provision for Taxes 25
Preliminary Expenses
written off 15
Net Profit 160
780 780
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 Solution – Direct Method

Jamuna Tudu Enterprises

Cash Flow Statement for the Year ending
31st March 20X1
(all figures in Rs. Million)
Cash flow from Operating Activities:
Cash Received on account of sale of
goods 1,650
Less: Payment made on account of
Purchase of goods (800)
Direct Expenses (200)
Salary Paid (200)
Rent Paid (80)
(1,280)
Cash Inflow 370

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 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
company’s shares and debentures
 Examples of investment activities include cash payments or receipts to
acquire or dispose fixed assets, shares, warrants, debt instrument,
etc.

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 Illustration –
Jamuna Tudu Enterprises

 The following transactions occur at Jamuna

Tudu Enterprises:

Item (all figures in Rs. Million)

Purchased a machinery for 1,500
Sold investment in shares worth 2,000
Received interest on debentures
purchased earlier 100

Received dividend on shares held 200

Sold old machinery 500

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 Solution
Jamuna Tudu Enterprises Cash Flow Statement
31st March 20X1

Cash Flow from Investing Activities: (all figures in Rs.

Million)

Sale of Shares
2,000
Interest received
100
Sale proceeds of old machinery
500
Dividend received
200

2,800
Less: Outflow on account of machine purchase
(1,500)

Cash flow from Investing Activities

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1,300
 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 Jamuna Tudu Enterprises has taken a
loan of Rs 1,500 millon and paid an interest of Rs 150 million
thereon, the cash flow from financing activities for the year comes to
Rs 1,350 million (i.e., 1,500 - 150)

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 Jamuna Tudu Enterprises
Cash Flow Statement for the Year ending
31st March 20X1
Cash flows from operating activities
Cash receipts from customers 1,650
Cash paid to suppliers (800)
Direct Expenses (200)
Cash paid to employees (200)
Indirect Expenses (Rent) (80)
Cash generated from operations 370
Income taxes paid -
Net cash from operating activities (A) 370

Cash flows from investing activities

Proceeds from sale of shares 2,000
Interest received 100
Proceeds from sale of machinery 500
Dividend received 200
Outflow on account of machine purchase (1,500)
Net cash from investing activities (B) 1,300

Cash flows from financing activities

Proceeds from long-term borrowings 1,500
Interest Paid (150)
Net cash from financing activities (C) 1,350

Net increase in cash and cash equivalents (A+B+C) 3,020

Cash and cash equivalents at beginning of period -
Cash and cash
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by McGraw Hill Education endPrivate
of period
Limited 3,020
 Illustration – John Bhengra Enterprises

Profit & loss Account

For the period ending 31-03-20X1
(all figures in Rs millions)

Purchases (all cash purchases) 750 Sales (includes 50% 1,000

Salaries 50 credit sales)
Wages 30 Total 1,000
Office Expenses 10
Selling & Distribution Expenses 12
Depreciation 8
Net Profit. 140
Total 1,000

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 Observations

 There is a profit of 140 million but assuming all purchases to be

cash purchases there is a net cash outgo of 352 million during the
period

 Since, the total cash inflow for the period is 500 million (i.e., 50%
of the total sales) and the total cash outflow is Rs 852 million (i.e.,
all the expenses other than depreciation)

 In the same way there can be a business loss for the period but
still can result in a positive cash flow due to the non-cash
expenses like depreciation
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 Flow of Funds

 There is a continuous movement of resources into the business,

within the business and out of the business
 The funds flow takes place only when there is a movement in the
current assets or the current liabilities during the accounting period
 Funds flow is used to refer to changes in or movement of current
assets and current liabilities
 Example: If land is purchased out of a long-term loan, there is no
flow of funds. But if financed by a short-term loan or cash, there is
an outflow of funds as working capital is reduced

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 Working Capital

 Working Capital = Current Assets – Current Liabilities

 All the assets held by the business with the objective of conversion to
cash during an operating cycle of the business
 Part of the assets is financed by short-term credits or borrowing
which are to be met or repaid during the operating cycle – these
are current liabilities

 Fund implies amount of resources invested in current assets

from sources of finance other than current liabilities

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 Funds Flow Statement

 Based on a fundamental equation:

 Sources of Funds – Application of Funds = Change in
Working Capital
 A statement that depicts the ways and reasons for movement in the
funds of an entity for a given accounting period
 It is not mandatory under any law, there is no prescribed format or
rules that govern this statement
 It is also called a Statement of Sources and Application of Fund or
How come Where Gone Statement

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 Need for Working Capital - Illustration

 Ramsons, a retail outlet, the investment in the showroom,

display counters, furniture fixtures and so on was Rs 6,00,000.
Ram follows straight-line depreciation of fixed assets at the rate
of 10 percent per annum.

 Estimated sales was Rs 1,50,000 per month: Rs 50,000 cash

sales and Rs 1,00,000 on credit to be collected in four equal
monthly installments, with the first installment collected at the
time of sale. All sales were made on 25 percent margin on selling
price

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 Additional Information

 Supply and sales constraints would warrant carrying three months

sales requirement in the form of inventory. Similarly a month’s cash
expense requirements had to be held in cash balance

 Initial inventory was to be bought for cash and replenishment

purchases will receive a month’s credit from suppliers

 Average monthly cash requirement for meeting operating expenses

other than payment for purchases amounted to Rs 26,000. Ram
needed to withdraw Rs 4,000 per month for his personal needs

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 Pertinent Questions

 How much working capital will Ramsons require to start

operations?

 Will he need any addition to working capital during the first four
months? Or will he have surplus working capital during the first
four months?

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 Schedule of Cash Payments
Month Explanation Amount Rs. Total Rs.
January Operating expenses 26,000
Withdrawals 4,000
30,000
February January purchases 112,500
Operating expenses 26,000
Withdrawals 4,000
142,500
March February purchases 112,500
Operating expenses 26,000
Withdrawals 4,000
142,500
April March purchases 112,500
Operating expenses 26,000
Withdrawals 4,000
142,500

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 Schedule of Cash Receipts
Month Explanation Amount Rs. Total Rs.
January Cash Sales 50,000
Credit sales of the month first installment 25,000
75,000
February Cash Sales 50,000
Credit sales of the month first installment 25,000
January sales second installment 25,000
100,000
March Cash Sales 50,000
Credit sales of the month first installment 25,000
January sales - third installment 25,000
February sales second installment 25,000
125,000
April Cash Sales 50,000
Credit sales of the month first installment 25,000
January sales - fourth installment 25,000
February sales - third installment 25,000
March sales second installment 25,000
150,000

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 P/L Account for the Period

RAMSONS
Profit & loss Account for the month ending…
31 January 28 February 31 March 30 April

Total Sales 150,000 150,000 1,50,000 150,000

Less: Cost of Sales 112,500 112,500 112,500 112,500

Other Expenses 26,000 26,000 26,000 26,000

Depreciation 5,000 5,000 5,000 5,000
Total Expenses 143,500 143,500 143,500 143,500
Net Profit 6,500 6,500 6,500 6,500
Less: Drawings 4,000 4,000 4,000 4,000
Profit Retained 2,500 2,500 2,500 2,500

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 Balance Sheet

RAMSONS
Balance Sheet as of 1st January
Assets Rs. Liabilities and Rs.
Capital
Fixed Assets 600,000 Capital 967,500
Inventory 337,500
Cash 30,000
967,500 967,500

Assumption: The entire asset requirements at the first instance are financed by Ram’s
own capital

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 Schedule of Cash Balances

RAMSONS
Schedule of Cash Balances
January February March April
Opening Balance 30,000 75,000 32,500 15,000
Cash receipts 75,000 100,000 125,000 150,000
Total Cash available 105,000 175,000 157,500 165,000
Less: Cash payments 30,000 142,500 142,500 142,500
Cash Balance 75,000 32,500 15,000 22,500

Less than the required cash of Rs 30,000

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 Balance Sheet (Assets)

RAMSONS
Balance Sheet as at the end of..

Assets 1 Jan 31 Jan 28 Feb 31 Mar 30 Apr

Fixed Assets 600,000 600,000 600,000 600,000 600,000
Less: Depreciation 5,000 10,000 15,000 20,000
Net Fixed Assets 600,000 595,000 590,000 585,000 580,000
Inventory 337,500 337,500 337,500 337,500 337,500
Receivable 75,000 125,000 150,000 150,000
Cash 30,000 75,000 32,500 15,000 22,500
Current Assets 367,500 487,500 495,000 502,500 510,000
967,500 1,082,500 1,085,000 1,087,500 1,090,000

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 Balance Sheet (Liabilities)

RAMSONS
Balance Sheet as at the end of
Liabilities & Capital 1 Jan 31 Jan 28 Feb 31 Mar 30 Apr
Capital 967,500 967,500 967,500 967,500 967,500
Add: Ret. Earnings 2,500 5,000 7,500 10,000
Owners Equity 967,500 970,000 972,500 975,000 977,500
Accounts Payable 112,500 112,500 112,500 112,500
Liabilities & Capital 967,500 1,082,500 1,085,000 1,087,500 1,090,000

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 Changes in Working Capital and the
Possible Sources of their Funding
RAMSONS
Schedule of Working Capital
Assets 31 January 28 February 31 March 30 April
Current assets 487,500 495,000 502,500 510,000
Less. Current Liabilities 112,500 112,500 112,500 112,500
Working Capital 375,000 382,500 390,000 397,500
Funds From Operation
Net Profit 6,500 6,500 6,500 6,500
Add: Depreciation 5,000 5,000 5,000 5,000
Total Funds generated from operations 11,500 11,500 11,500 11,500
Less withdrawals 4,000 4,000 4,000 4,000
Net additions to Working Capital 7,500 7,500 7,500 7,500

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 Capital Invested in Business

 Ramson’s Objective: “Invest money to make money”

 This investment of profits is known as ‘retained earnings’

 The balance sheet(s) of the business shows us how Ramsons

has utilized the money

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  The changes in fixed assets is represented by accumulated
depreciation only
 There were no additions to fixed assets
 Reduction in fixed assets due to depreciation is a non-cash
transaction
 On the liability side also there was no transaction involving long-term
liabilities or capital
 Only change in the long-term items is the increase in retained
earnings
 All changes are in working capital

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 Further…

 The net change in working capital is an increase of Rs 7,500 per

period

 This points to changes in current assets and current liabilities

 Changes in cash and receivable
 Only item of current liability to change is the accounts
payable during the first period, which is maintained later on
 The increase in receivable needed funds to finance it and it
was provided in part by the increase in payable

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 (Continued from previous slide)

 If an increase in current assets is offset by an equal increase in current

liabilities, the net impact on working capital is zero
 This leaves us with the only other item, which could have financed the
change in working capital  funds generated by operations
 The operations provided a profit of Rs 6,500 during each period
 An expiration of fixed assets in the amount of Rs 5,000 per month
 Thus operations generated is Rs 11,500 per period
 The owner regularly withdrew cash of Rs 4,000 per period leaving in
business additional resources of Rs 7,500 per period, which is the
change in working capital

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 Changes in Working Capital

1 Jan 31 Jan 28 Feb 31 March 30 April

Working 367,500 375,000 382,500 390,000 397,500
Capital

We could summarize the normal uses of funds (working capital) as follows:

1. Acquisition of new non-current assets
2. Repayment of non-current debt
3. Profit distribution to owners
4. Increase in the balance of working capital (current assets - current liabilities)

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 Cash and Receivables

 Cash as an investment!
 Amount which is required to be kept on hand to meet day-to-day requirement
of cash
 This amount is determined by (a) the regularity and uncertainties related to
cash inflows and outflows; and (b) need for investment in other assets
 Receivables as investment!
 Granting credit to customers implies ‘financing the cost of materials for the
duration of such credit’
 Financing only to the extent of cost of goods sold
 Opportunity aspect of credit granted is that one is deferring receipt to the extent
of receivable amount

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 Inventory, Supplies, Prepaid Expenses

 Inventory is held whenever there is a time lag between procurement

and use of inventory of materials and supplies

 Quantum on inventory depends on:

 Availability and regularity of supply
 Lead-time for delivery
 Credit allowed by supplier and terms of sale
 Storage Capacity, etc.
 Expenses that are to be paid before services are used, such as rent,
insurance, etc. in order to ensure smooth operations

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 Fixed or Non-current Assets

 We cannot expand our business beyond a certain capacity that is limited

by the facilities created by fixed assets; an additional investment is
required
 Need for fixed asset investment and current asset investment will vary
from business to business
 A trading company requires very little investment in fixed assets
and very large investment in current assets
 A complex manufacturing unit may need large investment in factory
and equipment
 Capital requirements will also be determined by specific firms at
given volumes of their activity
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 Future Capital Requirements

Need for Additional Capital

For financing additional For financing additional

fixed assets working capital

Increased holding Increased Increased cash

of inventory credit to holding
customers requirement

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 Internal Sources

Use of existing Surplus

Funds generated from Working Capital
operations
(Revenue less Expenses
First Internal Source
involving use of funds during Internal
the period) Sources

Sale of Non-Current Assets

Not a regular and continuing source of
funds
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 External Sources

 Two external sources:

 Owners contributing additional capital, i.e. by raising more
capital
 Increased long-term borrowing

 Short-term borrowing will not increase working capital

 Working capital represents long-term investment in
current assets

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 Sources of Working Capital

Working capital is required to finance that portion of current

assets, which are not financed by current liabilities

Working Capital Sources

Internal External

Operations Non-current Surplus Further Increased

Asset Sale Working Raising of Long-term
Capital use Capital Borrowing

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 Illustration
 A firm carries an average balance of Rs 10,000 accounts payable,
payable in 30 days and an average accounts receivable of Rs
15,000 receivable in 45 days.
 The firm will have to keep a net working capital for the differences
of receipts from customers and fund required meeting payable as
follows:

Fund required to meet payable due within 30 days Rs 10,000

Less: Funds received from customers within 30 days: Rs 10,000
Received in 45 days, that is, Rs 15,000 x 30/45
Fund required in the form of additional net working capital NIL

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 Illustration (contd.)

 Assuming the time taken for collection of receivable is 90 days the situation will be:

Fund required to meet payable due within 30 days Rs 10,000

Less: Funds received from customers within 30 days: Rs 5,000
Received in 45 days, that is, Rs 15,000 x 30/90
Fund required in the form of additional net working capital Rs 5,000

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Preparing a Cash Flow Statement
Using Indirect Method

 The cash effects of the balance sheet changes

between the start period and end period
statements

 the cash effects of income statement for that

period would simpler wherein revenue accounts
are sources of cash and expense accounts are
uses of cash.

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 Effect of Balance Sheet changes in Cash Flow Statement

Cash Inflow Cash Outflow

Operating
↓ Current Assets items ↑ Current Assets items
Activities
Operating Current Liability Current Liability
↑ ↓
Activities items items

Investing Non-Current Asset Non-Current Asset

↓ ↑
Activities items items

Financing Non-Current Liability Non-Current Liability

↑ ↓
Activities items items

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 Presentation format for Cash Flow Statement Using Indirect Method
Profit before taxation and extraordinary items XXXX
Add:
Adjustment (non-cash & non-operating items)
Depreciation XXXX
Interest Expense XXXX
Interest Income (XXXX)
Dividend income (XXXX)
Operating Profit before Working Capital changes XXXX
Add: Decrease in Current Assets (sources) XXXX
Increase in Current Liability (sources) XXXX
Less: Increase in Current Assets (application) (XXXX)
Decrease in Current Liability (application) (XXXX)
Cash Generated from operations XXXX
Less: Income Taxes paid (XXXX)
Cash Flow from Operating Activities (A) XXXX
Cash Flow from Investing Activities
Proceeds from sale of Fixed Assets XXXX
Purchase of Fixed Assets and Investments (XXXX)
Dividend Received XXXX
Interest received XXXX
Cash Flow from Investing Activities (B) XXXX
Proceeds from borrowings XXXX
Proceeds from issue of shares XXXX
Payment of long term borrowings (XXXX)
Payment of dividends (XXXX)
Cash Flow from Financing Activities (C) XXXX
Net Cash Flow during the year = (A+B+C) XXXX
Add: Copyright
Opening Balance
©2020 ofEducation
by McGraw Hill Cash (India)
andPrivate
Cash Equivalent
Limited XXXX
Closing Balance of Cash XXXX
 Accounting Standard on
Cash Flow Statement
 IFRS have International Accounting Standard 7, i.e., known as IAS 7
to deal with the cash flow statement
 Government of India in 2015 issued Indian AS 7, i.e., known as Ind
AS 7 to deal with the cash flow Statement
 Ind AS differs from IAS on only one aspect.
 On almost all other aspects, it is in sync with the IFRS.
 Few transactions that create confusion while separating various
items into their activities are:
 interest received
 Interest paid
 Dividend received
 Dividend paid.

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Suggestions to Avoid Confusion

Operating Activity Investing Financing

Activity Activity
Interest • Short Term • Long Term
Received Investment Investment
• Trade Advance
• Operating
Receivable
• Interest Received by
Financing
Institutions
Interest Paid • Loans and Debts Loans and
Debts
Dividend • Received by • Received
Received Financial Enterprise by Other
Enterprise

Dividend Paid Always classified as Financing Activity

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 Accounting Standards on Cash Flow
Statement: IFRS and Ind AS

Topic IFRS Indian AS

Item IAS 7- Statement of Indian AS 7- Statement of Cash
Cash Flows Flows
Bank overdrafts Included as cash and Similar to IFRS
cash equivalents
Interest and May be classified as For Financial enterprises:
Dividend operating, investing Interest paid and interest and
or financing activities dividend received are to be
in a manner classified as operating activities.
consistent from period Dividend paid is to be classified
to period. as financing classified.

For other enterprises:

Interest and dividends received
are required to be classified as
investing activities. Interest and
dividends paid are required to be
classified as financing activities.

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