Cash Flow Statements- Meaning

CFS is a statement which indicates sources of cash inflows and transactions of cash outflows of a firm during an accounting period. The activities /transactions which generate cash inflows are known as sources of cash and activities which cause cash outflows are known as uses of cash. It is appropriately termed as Where Got Where Gone Statement

USEFULLNESS OF CASH FLOW STATEMENT

CFS is very useful to the management for short term planning due to following reasons: Predicts future Cash Flows Determines ability to pay dividends and other commitments Shows the relationship of net income to changes in the business cash Efficiency in cash Management Discloses movement of cash Discloses success and failure of cash planning Evaluate management decisions Enhances comparability of report

Present Status of CFS

CFS are prepared in accordance with AS-3 AS-3 is mandatory for accounting periods commencing on or after 1st April 2001 in respect of the following: Listed companies or companies whose shares and debentures are in the process of enlisting on a recognized stock exchange in India All other commercial, industrial and business enterprises whose turnover for accounting period exceeds Rs.50 crores

 As per AS-3 a cash flow statement is to be classified into three heads. These include the following: 1. Operating Activities: Operating activities involve the cash effects of transactions that enter into the determination of net income, such as cash receipts from sales of goods and services and cash payments to suppliers and employees for acquisition of inventory and expenses

2. Investing Activities:
Investing activities generally involve long term assets and include (a) making and collecting loans (b) acquiring and disposing of investments and productive long term assets. 3. Financing Activities: Financing activities involve liability and stockholder's equity items and include obtaining cash from creditors and repaying the amounts borrowed and obtaining capital from owners and providing them with a return on, and a return of, their investment.

Sections of CFS
Operating Activities: Cash inflows: Cash Received for goods and services sold Cash outflows: Payment for materials & Inventory Wages and salaries Expanses Taxes Investing Activities: Cash inflow: From sale of property, plant and equipment. From sale of debt or equity securities of other entities. From collection of principles on loans to other entities. Cash Outflows: To purchase property, plant and equipment. To purchase debt or equity securities of other entities. To make loans to other entities. Financing Activities: Cash inflows: Issue of equity securities & preference shares Issuance of debentures and long term loans Cash outflows: Dividends to shareholders Interest on Debt Capital Redemption of debenture & preference share capital Income Statement Items

Generally Long Term Asset Items

Generally Long term Liability and Equity Items

Preparing Cash Flow Statements

Unlike the major financial statements, cash flow statement is not prepared from the adjusted trial balance. The information to prepare this statement usually comes from three sources: Comparative balance sheets provide the amount of the changes in assets, liabilities, and equities from the beginning to the end of the period. Current income statement data help the reader determine the amount of cash provided by or used by operations during the period. Selected transaction data from the general ledger provide additional detailed information needed to determine how cash was provided or used during the period

Steps in Preparing CFS

Preparing the cash flow statement from the data sources above involves three major steps: Step1.Determine the change in cash: This procedure is straight forward because the difference between the beginning and the ending cash balance can be easily computed from an examination of the comparative balance sheet. Step 2. Determine the net cash flow from operating activities: This procedure is complex. It involves analyzing not only the current year's income statement but also comparative balance sheets and selected transitions data. Step 3. Determine net cash flows from investing and financing activities: All other changes in the balance sheet accounts must be analyzed to determine their effects on cash.

Calculating Cash from Operating Activities

Operating Activities section of cash flow statement is converted from an accrual basis to cash basis. Conversion can be done by the following: Direct Method Indirect Method

Calculating Cash from operations Direct Method

It is also called as income statement method. Reports cash receipts and cash disbursements from operating activities. The difference between these two amounts in the net cash flow from operating activates. In other words, the direct method deducts from operating cash receipts the operating cash disbursements. The direct method results in the presentation of a condensed cash receipts and cash disbursements statement

 Under Direct method ,the information about major classes of gross cash receipts and gross cash payments may be obtained either : i. From accounting records of the company ii. By adjusting sales and other items in the profit & loss account for : a.Other non cash items such as Credit purchases outstanding expanses , income received in advance etc. b.Other items for which cash effect are investing or financing cash flows.

Calculating Cash from operations Indirect Method

Under Indirect Method , the net profit as per income statement is taken as the staring point and adjustments to net Profit are made in respect of non cash items appearing in the income statement and changes in the current assets and current liabilities to reconcile the net profit to net cash provided by operating activities. In India most of the listed companies use indirect method of preparing the CFS for two reasons (i) Simple & easy to prepare (ii) focuses on the difference between net profit and net cash flow from operations.

CFS showing Cash Flows from Operating Activities Indirect Method

Cash Flow from Operating Activities Net Profit before taxation and Extraordinary Items Add Depreciation Amortization Loss on sale of Fixed Assets, Investments etc. Non Operating Expanses Transfers to Provisions Decrease in Current Assets Increase in Current Liabilities Deduct Excess Depreciation Excess amortization Profit on sale of fixed asset, Investments etc. Non Operating Receipts Excess Provisions Increase in Current Assets Decrease in Current Liabilities XX XX XX XX XX XX XX XX XX XX XX XX XX XX XXXXX

Cash Flow Statement Example:

Tax Consultants Inc. Comparative Balance Sheets Assets Cash Accounts receivable Total Dec. 31, 2003 $49,000 $36,000 ----------$85,000 ====== Jan. 1, 2003 $-0$-0--------$-0===== Change Increase/Decrease $49,000 increase $36,000 increase

Liabilities and Stockholder's Equity Accounts payable Common stock Retained earnings Total

$ 5,000 $60,000 $20,000 --------$85,000 =======

$-0$-0$-0------$-0=====

$ 5,000 increase $60,000 increase $20,000 increase

Tax Consultants Inc. Income Statement for the year ended December 31, 2003 Revenue Operating expenses Income before income taxes Income tax expenses Net income $125,000 $ 85,000 --------$ 40,000 $ 6,000 ---------$ 34,000 =======

Tax Consultants Inc. Cash flow statement-Indirect Method For the year ended December 31, 2003 Cash Flows From Operating Activities: Net income Adjustments Increase in accounts receivable Increase in accounts payable Net cash provided by operating activities ash Flows From Financing Activities: Issuance of common stock Payment of cash dividend Net cash provided by financing activities $34,000 $(36,000) $ 5,000 ---------------

($31,000) ------------$ 3,000

$60,000 $(14,000) ----------

$46,000 ----------49,000

Net increase in cash Cash, January 1, 2003 Cash, December 31, 2003 -0---------$49,000 =======