CASH FLOW STATEMENT

MEANING OF CASH FLOW AND CASH FLOW STATEMENT

Cash Flows are inflows and outflows, i.e., the movement of cash and cash
equivalents.

The Cash Flow Statement is prepared according to Revised Accounting Standard-3

on cash flow statement. The standard requires that cash flow be classified and
shown in the cash flow statement under three heads, namely:

1. Cash Flow from Operating Activities

2. Cash Flow from Investing Activities ; and
3. Cash Flow from Financing Activities.

OBJECTIVES OF CASH FLOW STATEMENT

The objectives of cash flow statement are:

 To ascertain the sources from activities (i.e., operating/investing/financing

activities) from which cash and cash equivalents were generated by an
enterprise.

 To ascertain the uses by activities (i.e., operating/investing/financing

activities) for which cash and cash equivalents were used by an enterprise.

 To ascertain the net change in cash or cash equivalents indicating the

difference between sources and uses from or by the three activities
between the dates of two Balance Sheets.

IMPORTANT DEFINITIONS AS PER ACCOUNTING STANDARD-3 (REVISED)

I. Cash comprises of cash in hand and demand deposits with banks.

II. Cash Equivalents are short-term, highly liquid investments that are
readily convertible into known amount of cash and which are subject to an
insignificant risk of change in value.
An investment normally qualifies as cash equivalent only when it has a
short maturity of, say (a) treasury bills,(b) commercial paper,(c)money
market funds and (d)investments in preference shares and redeemable
within three months can also be taken as cash equivalents if there is no
risk of the failure of the company.

III. Cash Flows are inflows and outflows of cash and cash equivalents.AS-3
requires a cash flow statement to be prepared and presented in a manner
that it shows cash flows from business transactions during a period
classifying the into:
(I)Operating Activities; (ii) Investing Activities; (III) Financing Activities.

IV. Operating Activities: operating activities are the principal revenue

producing activities of the enterprise and other activities that are not
investing or financing activities.
V. Investing Activities: Investing activities are the acquisition and disposal
of long-term assets and other investments not included in cash
equivalents. These activities include transactions involving purchase and
sale of long term productive assets like machinery, land, etc., which are
not held for resale.

VI. Financing Activities: Financing activities are the activities that result in
change in the size and composition of the owner’s capital (including
preference share capital in the case of a company) and borrowing of the
enterprise.

OPERATING ACTIVITIES

CASH INFLOW CASH OUTFLOW

 Cash Sales Cash purchase

 Cash received from Debtors
 Cash received from commission
and Fees
 Royalty.
In the case of financial companies
 Cash received for Interest and
Dividends
 Sale of Securities
Payment to creditors
Cash operating expenses
Payment of Wages
Income Tax
In the case of financial companies
Cash paid for interest
Purchase of Securities

INVESTING ACTIVITIES

Cash Inflow Cash Outflow

 Sale of Fixed Assets Purchase of Fixed Assets

 Sale of Investments Purchase of Investments
 Interest received
 Dividends received

FINANCING ACTIVITIES

Cash Inflow Cash Outflow

1. Issue of shares in Cash Payment of Loans
2. Issue of Debentures in Redemption of preference shares
Cash Buy-back of Equity shares
3. Proceeds from Long-term Payment of Dividend
Borrowings Payment of Interest
How the amount of Income Tax is paid determined?

If the amount of tax paid is not given, it is calculated by preparing the provision for
Tax Account:

Dr. PROVISION FOR TAX ACCOUNT Cr.

Particulars Rs. Particulars Rs.

To Bank A/c (Tax Paid) …….. By Balance b/d …….

To Balance c/d …….. By Profit and loss A/c
(provision made during the ……..
year)

………….. ..……..

NOTE:
If only the provision for tax is given in the two Balance Sheets and no information
about tax paid is given, the amount in the previous year’s Balance sheet is
treated as tax paid during the current year. It involves an Outflow of cash.

The current year’s provision for tax represents the amount of tax provided for the
current year. It is added back to the current year’s profits to calculate net profit
before tax and extraordinary items (under the indirect method). It is merely a
book entry and does not involve outflow of cash.

The provision for Tax Account provides information about the tax paid during the
current year as well as the tax provided for the current year.

Indirect Method of calculating the Cash Flow from Operating Activities.

Under this method, net cash flow from operating activities is calculated by
employing the information contained in the Profit and Loss Account and
Balance Sheet.

The amount being net profit before tax is the starting point for calculation. It can
be calculated as:

Difference between the Closing Balance and the Opening Balance of Profit and Loss A/c

Add: The Proposed Dividend for the current year

Add: The Interim Dividend paid during the year

Add: Transfer to Reserve

Add: The Provision for tax made during the year

Less: Refund for tax credited to the Profit and Loss A/c

Less: Extraordinary items, if any, credited to the Profit and Loss A/c

Net profits before tax and extraordinary items

After having computed the Net Profit before tax and extraordinary items, it is
further adjusted to arrive at the net Cash Flow from Operating Activities. These
adjustments are classified into two categories:

1. Adjustments for Non-Cash and Non-Operating Items:

Non-Cash and non-operating items (such as depreciation, interest on long
term borrowings, discount on issue of shares or debentures written off,
goodwill/patents/copyright amortized, loss on sale on assets or
investments, premium payable on redemption of debentures or preferential
shares, etc) are added back and non-operating incomes and gains (such as
profit on sale on fixed assets and investments, interest, rent or dividend
received, etc) are deducted.

2. Adjustments for Changes in the Current Assets and Current Liabilities

Related to Operating Activities:
(e.g., debtors, bills receivable, stock, prepaid expenses, creditors, bills
payable, outstanding expenses, etc)
A decrease in current assets (excluding cash and cash equivalents) and
increase in current liabilities (excluding bank overdraft) is added and an
increase in current assets and a decrease in current liabilities is deducted
from operating profit before working capital changes to arrive at cash
generated from operation.

After that tax paid (the net of refund of tax) is deducted from cash generated
from operations to arrive at the cash flow from operating activities before
extraordinary items. After that we add or subtract the proceeds of
extraordinary item(s) to get Net cash from (used in) operating activities.

EFFECT OF CHANGE IN CURRENT ASSETS AND CURRENT

LIABILITIES.

Current Assets

1) Stock: Change in the level of stock must be considered for

calculating the cash flow from operating activities. A decrease in
stock will increase the cash inflow from operating activities
whereas an increase in stock will decrease the cash inflow from
operating activities.

2) Debtors and Bills Receivable: A decrease in debtors or bills will

receivable will increase the cash inflow from operating activities,
whereas an increase in debtors or bills receivable will decrease the
cash inflow from operating activities.

3) Prepaid Expenses: A decrease in the prepaid expenses will

increase the cash inflow from operating activities. Conversely, an
increase in the prepaid expenses will decrease the cash inflow
from operating activities.
Current Liabilities

1) Creditors and Bills Payable: A decrease in creditors and bills payable

will reduce cash. Conversely, an increase in creditors/bills payable will
effectively increase the cash available to the enterprise.

2) Outstanding Expenses: A decrease in outstanding expenses will reduce

cash. Similarly, an increase in outstanding expenses will increase the
cash available to the enterprise.

The general rules that develop from the above discussion are:

1. An increase in current assets leads to decrease in cash.

2. A decrease in current assets leads to an increase in cash.
3. An increase in current liabilities leads to an increase in cash.
4. A decrease in current liabilities leads to a decrease in cash.

Preparation of Fixed Assets Account

1. Fixed Asset Account (on Original Cost Basis): If the Balance

Sheet contains an item of provision for depreciation or accumulated
depreciation, it means that the fixed assets are shown in the balance
sheet at their original cost. In such cases, fixed assets fixed assets and
provision for depreciation account should be prepared.
Fixed asset account will disclose the purchase and sale of the fixes asset
during the year and by preparing provision for depreciation account the
amount of depreciation charged during the year will be found out.

2. Fixed Asset Account (on the Written Down Value Basis):

When the Balance sheet does not contain the item of provision for
depreciation or accumulated depreciation for both the years, it means
that the fixed assets are shown in the Balance sheet at their written
down value (after depreciation) and hence the fixed asset account will be
prepared on the written down value basis.
In this case the amount of current year’s depreciation should be
credited to the Asset Account.

Treatment of Depreciation

At the time of calculating profit/loss, depreciation is debited to profit

and loss account. It does not involve cash but is a book entry. Therefore,
depreciation is to be added back to net profit before tax for
calculating cash flow.
 Treatment of profit or loss on sale of Fixed Assets

For calculating net profit/loss, loss on sale of fixed assets is debited to

profit and loss account. Similarly, profit on sale of fixes assets is
credited to profit and loss account. It does not involve cash. Rather cash
is involved on sale of fixed assets. Profit or loss is a result of sale.
Therefore, loss on sale of fixed assets is added back and profit on
sale of fixed assets is deducted from net profit before tax for
arriving at the cash flow from operating activities.

Sale proceeds of fixed assets will, of course, result in a cash inflow but this inflow
will be shown in the cash flow statement under cash flow from investing activities.

CASH FLOW FROM INVESTING ACTIVITIES

Investing activities of an enterprise are acquisition and disposal of

the long term assets and other investments not included in cash
equivalents. Accordingly, the cash inflow and outflow relating to the
fixed assets, shares and debt instruments of other enterprises,
interests in joint ventures, advances and loans to third parties and
also their repayments are shown under investing activities in the
cash flow statement.

Cash flow from investing activities is ascertained by analyzing the

changes in fixed assets and long term investments in the beginning
and at the end of the year.

For getting the missing figure regarding purchase/sale of fixed assets

and depreciation, fixed assets account and provision for depreciation
account is prepared.

Ascertaining Missing Amounts regarding Fixed Assets or

Depreciation.

CASE 1: When the Fixed Asset is shown at the Written down Value.

Under this case, depreciation is charged to the Asset Account and the
balance of the Asset Account shows the written down value of the
asset, which is also called the book value.
Dr. FIXED ASSETS ACCOUNT (AT WRITTEN DOWN VALUE) Cr.

Particulars Rs. Particulars Rs.

To Balance b/d By Bank A/c (sale of Fixed Asset) ……

To Bank A/c (purchases) By Profit & loss A/c ……
To Profit & loss A/c (Loss on sale of Fixed Asset)

(Profit on sale of Fixed Asset) By Depreciation A/c

……
By Balance c/d

NOTES:
1) Generally, the purchase of fixed assets is a balancing amount on the debit
side of the account and depreciation or the sale of fixed assets on the
credit side of the account.
2) Information regarding depreciation is generally given in the question.
Students are required find out only the sale or purchase of asset.
3) If the sale and depreciation are not given, then assume it is either sale or
depreciation and give your assumptions.
In case of land, it should be assumed sale as depreciation is not charged
on land. In case of patents/goodwill/trade marks, it should be assumed
that the amount is written off.

CASE 2: When the fixed assets are shown at their original cost and
accumulated depreciation (provision for depreciation) is separately
maintained.
Under this case, (in contrast to the above case), depreciation is not directly
charged to the Asset Account. The depreciation for the period is debited to the
depreciation account (transferred to P&L A/c) and credited to Accumulated
Depreciation Account.
In the Balance Sheet, asset appears at its original cost and the accumulated
depreciation is shown either by deducting from Fixed Asset Account or on the
liability side of Balance sheet. In such cases, we prepare separate accounts for
fixed assets and accumulated depreciation. Depreciation for the year can be
ascertained from provision for depreciation account.
Dr. FIXED ASSET ACCOUNT (AT COST) Cr.

Particulars Rs. Particulars Rs.

To Balance b/d …. By Bank A/c (Sale of Fixed Asset) ….

To Profit & loss A/c …. By Accumulated Dep. A/c ….
(Profit on sale of Fixed asset) (Accumulated Dep. On fixed asset sold)
To Bank A/c ….. By Profit & loss A/c …..
(Purchase of Fixed Asset) (loss on sale of Fixed Asset)
By Balance c/d …..

NOTE: Normally, the purchase of fixed asset is a balancing amount on the debit
side of the account and the sale of fixed asset on the credit side of the account.

Dr. ACCUMULATED DEPRECIATION ACCOUNT Cr.

Particulars Rs. Particulars Rs.

To Fixed Asset A/c …… By Balance b/d …..

(Acc. Dep. on Fixed Asset Sold) By Profit & loss A/c
……. ……
To Balance c/d (Dep. Charged for current year)

NOTE: Accumulated depreciation on the fixed asset sold or depreciation charged

for the current accounting year may not be given, which shall be the balancing
amount.

CASH FLOW FROM FINANCING ACTIVITIES

Financing Activities of an enterprise are those activities that result in change in
the size and composition of owner’s capital and borrowing of the enterprise. It
includes proceeds from issue of shares or other similar instruments, issue of
debentures, loans, bonds, other short-term loans or long term borrowings and
repayments of amounts borrowed. Accordingly, receipts and payments on
account of the above are disclosed in the cash flow statement as the cash flow
from financing activities.
Dividends paid (in all enterprises) and interest paid (in case of non-financing
enterprise) is also included in Financing Activities.
It is important to note that an increase in share capital due to bonus issue will not
be shown in the cash flow statement, since it is a capitalization of reserves.
 When shares are issued at a premium, the cash flow statement reflects the total
cash generated by the issue (i.e., Face Value of shares + Premium).
The cash flow from financing activities is ascertained by analyzing the change in
Equity and Preference share capital, Debentures and other borrowings.

Special Items Treatment thereof in Cash Flow Statement

Enterprises

Financial Enterprises Other Enterprises

Cash Flows Arising From Cash Flows Arising From

Interest Dividends Dividends Interest Interest Dividends

Paid and Received Paid Paid Paid and Paid
Received Dividends
Received

Operating Financing Financing Investing Financing

Activities Activities Activities Activities Activities

I. Interest and Dividends: The treatment of interest and dividends received

as well as paid depends on the nature of the business of the enterprise,
i.e., whether the business is of financial or non-financial nature.
II. Proposed dividend:
1. The proposed dividend is proposed by the Board of Directors and
approved by the shareholders in the Annual General Meeting before it
becomes due for payment. Till the time it is approved at the Annual
General Meeting, it is not a liability.
2. The proposed dividend for the current year becomes due and is also
paid in next year. It is an outflow of cash and cash equivalents in the
next year.
3. The proposed dividend of the previous year becomes due and is also paid
in the current year. It is an outflow of cash and cash equivalents in the
current year.
 4. The accounting treatment of the proposed dividend is:
a) Proposed Dividend (current year): Add back to the current year’s
profits to find out cash from operating activities.
b) Proposed Dividend (Previous year): Net dividend paid (proposed
dividend – dividend still payable) is cash used in financing activities.
III. Interim Dividend:
1. The Interim Dividend is a dividend that is declared by the Board of
Directors in between the financial year provided it is allowed by the
company’s Articles of Association.
2. Declaration of the Interim Dividend does not require the approval at
the General Meeting.
3. Therefore, it becomes due and is paid during the year itself.
4. The accounting treatment of the Interim Dividend shall be as:
a) Add Back to the current year’s profits to find out cash from
operating activities.
b) Show as cash used in Financing Activities in the cash flow
statement.
IV. Extraordinary items:
Extraordinary items are incomes or expenses that arise from transactions
that are distinct from ordinary activities of the business which are material
and are not expected to recur frequently or regularly. Extraordinary items
are classified under appropriate activity, i.e., operating, investing and
financing activities and disclosed separately in the cash flow statement.
Examples of extraordinary items are any claim against loss of stocks from
an insurance company (for operating activities), a claim for the destruction
of building from an insurance company (for investing activities), buy-back
of shares (for financing activities).
V. Discount on Issue of Shares and Debentures:
Discount on the issue of shares and debentures may be written off
through the profit & loss account. It is also possible that discount allowed
is increased due to the new issue during the year. Discount on issue of
shares/debentures account shall appear as:

DISCOUNT ON ISSUE OF SHARES/DEBENTURES ACCOUNT

Particulars Dr. Rs. Particulars Cr. Rs.

To Balance b/d ….. By Profit & loss A/c …….

(Written off)
…….
To Share capital/debentures By Balance c/d …….
 Accounting Treatment
a) Amount of Discount Written Off: Add Back to the current year’s
profits for ascertaining cash from operating activities.
b) Amount of Discount Allowed During the year: Show the net proceeds
of shares/debentures as cash from Financing Activities.

INDIRECT METHOD
FORMAT OF CASH FLOW STATEMENT
For the year ended….
As per Accounting Standard-3 (Revised)

Particulars Rs.

I. Cash Flow from Operating Activities

Net profit as per profit & loss A/c or Difference between Closing balance and
Opening Balance of profit & loss A/c
Add: Transfer to reserve
Proposed dividend for current year
Interim dividend paid during the year
Provision for tax made during the current year
Extraordinary item, if any, debited to the profit & loss A/c
Less: Extraordinary item, if any, credited to the profit & loss A/c
Refund of tax credited to profit & loss A/c
(A) Net profit before Taxation and Extraordinary items
Adjustment for Non-cash and Non-operating items
(B) Add: Items to be added
 Depreciation
 Preliminary expenses/Discount on issue of Shares & Debentures
Written off
 Goodwill/patents/Trade marks Amortized
 Interest on borrowings & debentures
 Loss on sale of Fixed Assets
(C) Less: Items to be deducted
 Interest Income ……
 Dividend Income ……
 Rental Income …….. ........
 Profit on sale of Fixed Assets

(D) Operating Profit before Working Capital changes (A+B-C)

 (E) Add: Decrease in Current Assets and
Increase in Current Liabilities
 Decrease in Stock/Inventories
 Decrease in Debtors/Bills Receivables
 Decrease in Accrued Incomes
 Decrease in prepaid expenses
 Increase in creditors/Bills payables
 Increase in outstanding expenses
 Increase in Advance incomes
 Increase in Provision for Doubtful Debts
(F) Less: Increase in Current Assets and
Decrease in Current Liabilities
 Increase in Stocks/Inventories
 Increase in Debtors/Bills Receivables
 Increase in Accrued Incomes
 Increase in Prepaid expenses
 Decrease in creditors/Bills payables
 Decrease in outstanding expenses
 Decrease in Advance Incomes
 Decrease in Provision for Doubtful Debts
(G) Cash Generated from Operations (D+E-F)
(H) Less: Income Tax paid (Net of Tax Refund received)
(I) Cash Flow before Extraordinary items
Extraordinary items (+/-)
(J) Net cash from Operating Activities

II. Cash Flow from Investing Activities

 Add: Proceeds from Sale of Fixed Assets
 Add: Proceeds from Sale of Investments
 Add: Proceeds from Sale of Intangible Assets
 Add: Interest and Dividend Received
(For non-financial companies only)
 Add: Rent Income
 Less: Purchase of Fixed Asset
 Less: Purchase of Investment
 Less: Purchase of Intangible Assets like Goodwill
Extraordinary items (+/-)
Net Cash from Investing Activities
III. Cash Flow from Financing Activities
 Add: Proceeds from issue of shares and Debentures
 Add: Proceeds from Other Long term Borrowings
 Less: Final Dividend Paid
 Less: Interim Dividend Paid
 Less: Interest on Debentures and Loans paid
 Less: Repayment of Loans
 Less: Redemption of Debentures/Preference shares
Extraordinary items (+/-)
Net Cash from Financing Activities

IV. Net Increase/Decrease in Cash and Cash Equivalents (I+II+III)

V. Add: Cash and Cash Equivalents in the beginning of the year.

 Cash in Hand
 Cash at Bank (Less: Bank Overdraft)
 Short-term Deposits
 Marketable Securities.

VI. Cash and Cash Equivalents at the end of the year

 Cash in Hand
 Cash at Bank ( Less: Bank Overdraft)
 Short-term Deposits
 Marketable Securities

Notes:
1. Amounts in brackets indicate negative amounts, i.e., amounts that are to be
deducted.
2. Increase/Decrease in unpaid Interest on Debentures/Loans affects the Cash
Flow from Financing Activities and not Operating Activities.
3. Increase/Decrease in Unclaimed Dividend affects the Cash Flow from
Financing Activities and not Operating Activities.
4. Increase/Decrease in Accrued Interest on Investment affects the Cash Flow
from Investing Activities and not Operating Activities.