CHAPTER5

Cash Flow Statement

LEARNING OBJECTIVES
ThestudyofthisChapter would enable students to understand:
Meaning of Cash Flow and Cash Flow Statement
Flow Statement
5.1
Objectives of Cash 5.2
of Cash Flow Statement
Importance or Uses 5.2
Limitations of Cash Flow Statement
5.3
Computation of Cash Flow from Different Activities:
5.15
-Cash Flow from Operating Activities 5.15
-Cash Flow from Investing Activities
5.42
-Cash Flow from Financing Activities 5.51
Preparation ofCash Flow Statement 5.56

MEANING OF CASH FLOW AND CASH FLOW STATEMENT

Cash Flow Statement is a statement that shows the cash flows, ie., inflow and outflow
of Cash and Cash Equivalents during the accounting period from operating, investing
and financing activities.
Transactions that increase Cash and Cash Equivalents are inflows of Cash and Cash
Equivalents and transactions that decrease it are outflows of Cash and Cash Equivalents.
Cash and Cash Equivalents includes Cash on hand, Bank Balance, Marketable Securities,
etc. Unless specified otherwise, Current Investments are taken as Marketable Securities.

Hence, are included in Cash and Cash Equivalents

Cash Flow Statement is prepared according to the Accounting Standard-3 (Revised)
AS-3 (Revised)], Cash Flow Statement. The accounting standard prescribes that Cash Flow
Statement be prepared either by:
) Direct Method (Not in Syllabus); or
i) Indirect Method;
Snowing cash flow under three heads, namely:
Cash Flow from
Operating Activities;
Cash Flow from Investing Activities; and
Cash Flow from Financing Activities.
Cash Flow State
atement by Indirect Method is prepared from the financial statemen i.e.,
Balan Sheet and Statement of Profit and Loss.
 Analysis of Financial Statements
5.2
nts-CeSE
OBJECTIVES OF CASH FLOW STATEMENT
The objectives of Cash Flow Statement are:

) To determine the sources (receipts) of Cash and

Cash Equivalents
under
under Operating
Investing and Financing Activities of the enterprise.

alents under
(i7) To determine applications (payments) of Cash and Cash Equivalents Operating
under Oper.
and Financing Activities of the enterprise.
Investing
10) To determine net change in Cash and Cash Equivalents. It is the difference
Sources (receipts) and applications (payments) under Operating, Investin betwen
Sheets. and
Financing Activities between the dates of two Balance

IMPORTANCE OR USES OF CASH FLOW STATEMENT

G) Facilitates in Ascertaining Cash Flow from Operating, Investing and Financing Actinis.
Cash Flow Statement shows inflows and outflows of Cash and Cash Equivalents unde
Cash Flow from Operating, Investing and Financing Activities. The net result is net change
in Cash and Cash Equivalents.
(i) Facilitates Planning
Cash Flow Statement gives information about sources and applications of Cash and Csh
Equivalents for a specific period. It helps in planning investments and assessing the finandal
requirements of the enterprise.

(ii) Helps in Assessing Liquidity and Solvency

Solvency is the ability of the enterprise to meet its liabilities on time. Cash Flow Statement
helps to assess liquidity.

(iv) Efficient Cash Management

Cash Flow Statement gives information relating to surplus or deficit of cash. An
enterprise,
therefore, can decide about the Short-term Investments of the surplus and can arrange
the Short-term Credit in case of deficit.

(v) Comparative Study

A comparison of the actual cash flows with the budgeted cash flows of the year shows
the extent to which Cash and Cash
Equivalents were generated (sourced) and appied
(used) as per the plan.

(vi) Reasons for Cash Position

Cash Flow Statement shows the for lower and higher cash balances
reasons the
w
enterprise. Sometimes, an enterprise has lower cash balance in spite of higher orofits

or has higher cash balance in

P
spite of lower profits. Reasons for such situations b e
analysed with the help of Cash Flow Statement.
CashF l o w
w Statement
5.3
Management Decisions
i Evaluate
(vri)
low
Cash Statement, by providing information relating to company's Investing and
Flow Sta
Financing A c t i Activities, gives the shareholders, potential investors, lenders and creditors

i n f o r m a t i o n
bout cash flows which helps them evaluate management decisions. It also
in dividend decision.
helps
(aii) Dividend Decision

hdend payable is deposited in a separate Bank Account upon it being declared (i.e.,

dividend) or approved (1.e, final dividend). Cash Flow Statement helps in deciding
interim vidend should be paid.
much
how

Capital Budgeting Decisions

(iat) Facilitates
u cilitates
fac Capital Budgeting decisions by providing information of Net Cash Flows
from Investing Activities.

FLOW STATEMENT
LIMITATIONS OF CASH
of Cash Flow Statement are:
The limitations
Transactions are not Shown
) Non-cash
cash. does not show non-cash
Cash Flow Statement shows only inflows and outflows of
the vendors,
transactions like the purchase of building by issue of shares or debentures to

issue of bonus shares, etc.

(i) Not a Substitute for Statement of Profit and Loss

Statement of Profit and Loss since it does
Cash Flow Statement is not a substitute for
incurred by the enterprise during the accounting period.
not show profit earned or loss

(Gii) Not a Substitute for Balance Sheet

because it does not show the
It is not a substitute for Balance Sheet (Position Statement)
financial position Equity, Liabilities and Assets).
(i.e.,
(iv) Historical in Nature
Statement of Profit and
Loss (Income Statement) and the Balance
t is
prepared from the
Sheet. Thus, it is historical in nature.

lo) Assessment of Liquidity Statement alone because

determined from Cash Flow
Lquidity of the enterprise cannot be
current liabilities. Cash and Cash
also like current assets and
on other factors
epends assets.
of current
valents is one of the components

AcCuracy of Cash Flow Statemnent

f financial statements are prepared incorrectly,
statements.
prepared from the financial
Cash Flow Statemen will also be incorrect.
used in Cash Flow 9
Statement.
Before we proceed
pr discuss the meaning of terms
further let us
 5.4 Analysis of Financial Statementso

DEFINITION OF KEY TERMS USED IN CASH FLOW STATEMENT AS PER

PER AS.
AS-3
CBSEX
Term Definition
with banks.
Cash Cash comprises of Cash on Hand and demand deposits
Cash Cash Equivalents are short-term, highly liquid investments that are readily
Equivalents into the known amount of cash and which are subject to an insignificant risk ofconvert
chble
value. An investment normally qualifies as cash equivalent only when it has a shoe in
of, say, three months or less from the date of acquisition. maturity
Current Investments, unless specified otherwise, are taken as Marketable Securt
Securities and
included in Cash and Cash Equivalents.
Examples Cash Equivalents are Current Investments, Treasury Bills, Commercial Pap
PreferenceofShares if these are redeemable within three months from the date
date of
of ner
and these have insignificant risk of change in its value, etc. purchase
Cash and Cash Equivalents is calculated as:
Cash on Hand
Add: Cash at Bank
Cheques and Drafts on Hand
Short-term Investments (Marketable Securities) **

Short-term Deposits in Banks

Cash and Cash Equivalents **

Cash Flows Cash Flows are inflows and outflows of Cash and Cash Equivalents.
Cash flows exclude movement between items that constitute cash or cash equivalents because they
are part of the cash management of an enterprise rather than part of its Operating, Investing and
Financing Activities. Cash management includes the investment of excess Cash in Cash Equivalents
Examples of transactions, that are movements between items of Cash and Cash Equivalents, ae
() Cash withdrawn from bank for business.
(i) Cash deposited into bank out of Cash in Hand.
Gin) Sale/Purchase of Short-term Marketable Securities being cash equivalents.
Operating Operating Activities are the principal revenue producing activities of the enterprise
Activities and other activities that are not Investing or Financing Activities.
Investing Investing Activities are the acquisition and disposal of Long-term Assets and other investments
Activities not included in cash equivalents.
Financing9 Financing Activities are the activities that result in change in the size and composition of the
Activities owners' capital (including Preference Share Capital in the case of a company) and borrowings
of the enterprise.

Classification of Cash Flows

Accounting Standard-3 (Revised) prescribes that the changes resulting in inflows and
outflows of Cash and Cash Equivalents be classified (shown) under three activities, ie,
Operating Investing and Financing. These are discussed below:

1. Operating Activities
nd
Operating Activities are the principal revenue producing activities of the enterprise and
other activities that are not Investing or Financing Activities.
of
Cash Flow from Activities
Operating being the principal revenue producing activity o
enterprise, generally results from the business transactions and events that determine e
profit or loss.
C a s h F l o wS t a t e m e n t
5.5

Examples of Cash Flow from Operating Activities are:

For Not-financial Companies

from.sale of goods and/or rendering services;

Cash receipts
(o)
royalties, fees and commission, etc.;
Cash receipts from
(i) Cashreceipts from TradeiReceivables (i.e., Debtors and Bills Receivable);

Cash ayment for purchase of goods and/or

availing services;
(d)
Cash payment
to Trade Payables (i.e., Creditors and Bills Payable);
(e)
of wages, salaries and other payments to employees;
Cash payment
(n
Cash receipts of premium and payment of claims (foran Insurance Company);

Cash payment of
and refund of income tax unless these are identified with Investing or
Financing Activities.

For Financial Companies

of securities;
lal Payment for purchase
of interest on loans;
(0) Payment
(c)Receipts from sale ofsecurities;

(d) Dividend received

on securities;
(e) Interest received on loans given;
( Payment of salaries, bonus, etc. to employees;

of and refund of income tax unless these are identified with Investing or
(g) Payment
Financing Activities.
The net effect of Cash Flow from Operating Activities is shown in Cash Flow Statement
as Cash Flow from (or Used in) Operating A ctivities.

Principal Revenue Producing Activities

Principal revenue producing activities mean business activities being carried by the enterprise to earn profit.
For example:
0) Fora computer manufacturing company, manufacturing and selling of conputers is its principal revenue

producing activity.
) For a trading company, purchase and sale of goods is its principal revenue producing activity.

For a finance company, giving and taking loans, purchase and sale of securities (on own behalf) is its

principal revenue producing activity.

llustration1.
l y which of the following transactions are classified or shown as
Operating Activity
by non-financial companies:
0) Cash received from sale of
goods.
Cash paid for purchase of go0ds.
rayment of salaries and wages.
0)
Payment of interest on loan.
5.6 Analysis of Financial
Statements-CRe
CBSE A
() Repayment of loan.
(i) Purchase of machinery against payment.
(vii) Dividend paid.

(vii) Sale of car in cash.

ix) Commission received.

(x) Cash received from trade receivables.

Solution:
Transactions that are classified as Operating Activity are:

i) Cash received from sale of goods

(i) Cash paid for purchase of goods.
(ii) Payment of salaries and wages.
(ix) Commission received.
x) Cash received from trade receivables.

Illustration 2.
ldentify which of the following transactions are classified or shown as Operating Activity
ivity
by a financial company:
) Payment of salaries and wages;
(i) Payment of interest on loans taken;
(ii) Receipt of interest on loans given;
(iv) Purchase of shares for trading;
() Purchase of shares as investment;
(oi) Purchase of shares on behalf of customers;
(vi) Sale of shares on behalf of customers;
(vii) Issue of Debentures.

Solution:
Transactions that are classified as Operating Activity are:
() Payment of salaries and wages;
(ii) Payment of interest on loans taken;
(ii) Receipt of interest on loans given;
(iv) Purchase of shares for trading.
Notes:
1. Purchase of shares as investments is long-term assets not held for resale and thus, is an Investing Activity;
2. Purchase of shares on behalf of customers and sale of shares on behalf of customers is not an Operating
Activity, they being purchased for its customers. However, brokerage received is an Operating Activity.
3. Issue of Debentures being a borrowing is a financing activity.

Illustration 3.
State a transaction that is classified or shown as an Operating Activity by both non-financiung
companies and financing companies.

Solution:
Payments of Salaries, bonus, gratuity, etc, are always shown as Operating Activity.
Cash Flow S t a t e m e n t

5.7
2,Investing Activities

Inoesting Activities
iaa Activities are the
acquisition and
estments, not included in cash equivalents. disposal of the Long-term Assets and Other
activities
These activitie include transactions
involving purchase and sale of the Long-term Assets,
held
10t held
not for resale such as plant and
ohich
are
machinery, land and building, investments, etc.
include investments that are not included in Cash and Cash
ents
stments other than marketable securities.
current investm Equivalents such
Investments include investment
i n long-term investments and other investments by the
made

income and thus, cash flow.

enterprise with a purpose
to generate

IMPORTANT NOTE
ha iestion, if the term used is Investment' under Current Assets, it is to be taken Cash
as Equivalent.
Exampl of Cash Flow from Investing Activities are:
Payments for purchase of fixed assets (including intangible assets).
() Receipts from sale (disposal) of fixed assets (including intangible assets).
il Payments for purchase (acquisition) of securities, i.e., shares, warrants, debentures, bonds
or debt instruments ot other enterprises as investment.
)Receipts from sale (disposal) of securities, ie, shares, warrants, debentures, bonds or
debt instruments of other enterprises held as investments.
e) Advances and loans made to third parties (other than advances and loans made by a
financial enterprise).
(Receipts from repayments of advances and loans made to third parties (other than
advances and loans made by financial enterprise).
Illustration 4
ldentify out of the following transactions that are classified or shown as Investing Activity
by (a) Non-finance companies; and (6) Finance companies:
() Cash proceeds from sale of fixed asset.
(i) Cash paid for purchase of Stock-in-Trade.
(Gii) Repayment of loan taken.
(iv) Debentures purchased.
(o) Loan advanced.
(oi) Purchase of Patents.
Solution:
Iransactions that are classified as Investing Activity by Non-finance companies are:

) Cash proceeds from sale of fixed asset.

(0p) Debentures purchased.
() Loan advanced.
(oi) Purchase of Patents.
finance companies
ransactions that are classified as Investing Activity by are:

asset.
Cash proceeds from sale of fixed
iv) Debentures purchased.
(oi) Purchase of Patents.
5.8 Analysis of Financial Statement.

1llustration 5. CBSE A
State, giving reason, a transaction that is always classified as an Inves
yesting Activi
Solution:
Payment towards purchase of fixed asset, as it is not purchased for resale. amples
Purchase of building, furniture for office use, goodwill, Ate

3. Financing Activities
Financing Activities are the activities which result in change in size and comm
of owner's capital (including Preference Share Capital in the case of a. osition
borrowings of the enterprise from other sources. npany) and
Thus, increase in share capital (both equity and preference), redemption of prefe
shares, issue of debentures, increase in borrowings (short-term and lonae
repayment of borrowings (short-term and long-term) and redemption of debentures,
are Financing Activity. etc.,
Examples of Cash Flow from Financing Activities are:
(a) Proceeds from the issue of shares or other similar instruments.
6) Proceeds from the Isue of Debentures, Loans, Bonds and other Short-term Borrowines
()Payment for Buy-back of Equity Shares.
(a) Repayments of the amounts borrowed including redemption of debentures.
(e) Payments of dividends both on Equity and Preference Shares.
Payments ofInterest on Debentures and Loans (Short-term and Long-term).
g) Increase or decrease in Bank Overdraft and Cash Credit.
Illustration 6.
Identify out of the following transactions that are shown as Financing Activity:
() Repayment of Loan taken.
(i) Proceeds from Issue of Shares.
(ii) Debentures subscribed by the company.
(io) Redemption of Preference Shares
() Interest paid on Borrowings.
(oi) Dividend paid.
(vii) Increase in Bank Overdraft or Cash Credit.
(vii) Issue of bonus shares.

Solution:
Transactions that are shown as Financing Activity are:
(i) Repayment of Loan taken.

(i1) Proceeds from Issue of Shares.

(io) Redemption of Preference Shares.
(o) Interest paid on Borrowings.
(vi) Dividend paid.
(vi) Increase in Bank Overdraft or Cash Credit
 a s F
h l o w S t a t e m e n t

5.9

lustration,

reason,
S t a t e ,g a v i n g r e a s o n , a transaction that is always classified as a Financing Activity.
S o l u t i o n :

vidend paid
aaid is always classified as a Financing Activity because it is a payment relating
re capital, which is a Financing Activity.
llustration8.

1saction, a part of which is shown as an

Investing Activity and part as

Financing Activity.

Solution:
urchase of an asset in instalments under Hire-purchase System. The instalment
Payment forpu
Las fwO Components, 1.., principal and interest. Principal is shown as an Investing Activity
has

and interest
is shown as a Financing Activity.

Transactions not Regarded as Cash Flow

Transactions that are movement in between the items of Cash and Cash Equivalents are not
and
Cash Flow because
it reduces balance of one component of Cash and Cash Equivalent
For example, cash deposited into bank is not Cash Flow because
increases another component.
Both Cash and Bank are items of
Cash-in-Hand reduces but bank balance increases.
Cash and Cash Equivalents.
Non-cash Transactions

those transactions which do not involve cash and,

therefore,
Non-cash Transactions are

Cash and Cash does not take place. For example,

Equivalent
fow (inflow or outflow) of
Shares Debentures for consideration other than cash, etc.
Depreciation, Issue of Equity or

Statement.
Non-cash transactions are not shown in Cash Flow

REMEMBER
be positive or negative
. Net Cash Flow within an activity-operating,
investing or financing-may
of Cash and Cash
along with opening balance
2. Sum of Cash Flow from all the activities taken together,
of Cash and Cash Equivalents.
Equivalents, equals the closing balance
or Financing Activity.
or Investing Activity
S. A transactionis classified as an Operating Activity
under two diferent activities,
for instance, if machinerya
A Single transaction may include cash flow
include interest and a part of principal.
s purchased under Hire-purchase System,
each instalment will
the amount paid for principal
is an Investing
Amount paid for interest is a Financing
Activity whereas

Activity other than cash and

also the conversion of debentures
5. S u e of debentures for consideration shares
b shares and
Statement. For example, purchase of building by issuing
OShares are not shown in Cash
Flow
involve receipt and payment of cash.
to the vendor does not considered while preparing the
DEnTures Equivalents is not
5.
inlow or outflow between components
of Cash and Cash withdrawn from bank are not cash flow.
deposited into bank or cash
cash
iOw Statement. For example, of cash.
is a part Cash Flow Statement but is management
It of
 Financial Statemen:
Analysis of
5.10 CBSE K
(Revised), show owing the Infloy
Classification of Business Activities as per AS-3
and
Outflow of Cash
Operating Activities

Cash Outflow
Cash Inflow
In case of Non-financial Companies
In case of Non-financial Companies
(i) Cash Purchases
) Cash Sales
to Trade Payables
Received fronm Trade Receivables (it) Payment
(i) Cash
(it) Payment
of Operating Expenses
(ti) Royalty, Fee, Commission Received
(iv) Payment Wages
of
(io) Income Tax Refund*
Income Tax Paid" (Unless identified with Inuo
In case of Financial Companies
(v)
or Financing Activities)
vesing
() Receipts of Interest and Dividends
In case of Financial Companies
(oi) Proceeds from Sale of Securities (held
Interest
for sale) (oi') Payment for
(vi) Payment for Purchase of Securities (for sale
(vii) Brokerage received by a stock broker
"Income Tax paid is normally shown as net of Income Tax Refurnd, i.e., Income Tax Paid less Income Tax Rehund

Investing Activities

Cash Inflow Cash Outflow

) Proceeds from Sale of Fixed Assets
i) Proceeds from Sale of Investments
(Other than Marketable Securities)
(ii) Interest Received
(io) Dividend Received
(o) Rent Received from Property
held as Investment
() Purchase of Fixed Assets
(ii) Purchase of Securities as Investments
(Other than Marketable Securities)
(ii) Income Tax Paid (If related to Investing
Activities)

Financing Activities

Cash lnflow Cash Outflow

() Proceeds from Issue of Shares () Payment of Loans (Short-term
Long-term) and
(i) Proceeds from Issue of Debentures (i) Payment Redemption of Preference Shares
for
(ii) Proceeds from Long-term Borrowings ii)
Payment for Buy-back of Equity Shares
(iv) Increase in balance of Bank verdraft (iv) Payment of Dividend
or Cash Credit Account
() Payment of Interest
(vi) Decrease in balance of Bank Overdraft or Cash
Credit Account
(vii) Income Tax Paid (If related to Financing Activities