AMITY UNIVERSITY HARYANA

AMITY BUSINESS SCHOOL

MBA 1 SEMESTER-ACCOUNTING FOR MANAGEMENT
MODULE-3 CASH FLOW STATEMENT
DISTINCTION BETWEEN FINANCIAL ACCOUNTING AND
MANAGEMENT ACCOUNTING
Financial and Management Accounting are inter-related. Financial
accounting records day-to-day financial transactions. Management
Accounting depends on financial accounting which is its main source
of information. Main objective of financial accounting is to ascertain
profit and depict the financial position of a business. The main
objective of management accounting is to provide information to the
management for decision-making. Inspite of the close relationship
between the two, there are differences between them.
1.Purpose:
The purpose of financial accounting is to ascertain profit or loss b y
preparing profit and loss account, reveal the financial position
through the balance sheet and present them to owners, creditors,
government etc. The purpose of management accounting is to
provide information to the management for decision making on
internal operations.
Therefore, while financial accounting is concerned with external
operations, while management accounting is concerned internal
operations.
2.Nature of information used:
Financial accounting records transactions as and when they occur.,
recording the past while management accounting is concerned with
future plans and operations. Thus, financial accounting is historical
and objective, while management accounting is subjective and
relates to the future.
3.Analysis and Interpretation of Data:
Financial accounting analyses data of the business as a whole i.e the
financial accounting provides consolidated information of whole
business enterprise.
Management accounting evaluates the performance of different
divisions, and as per requirements of the management.
4.Flexibility:
Financial accounts are prepared as per the guidelines laid down by
Companies Act and Income Tax Act, whereas management
accounting follows requirements of the management in the
preparation of various statements. The management accountant has
the flexibility in following different standards set the management,
whereas, financial accountant has not such freedom.
5.Legal requirement:
Financial accounting has become compulsory as per the statutory
requirements.
Management accounting is of voluntary adoption by the
management to function effectively.
6.Frequency of reporting:
Periodical reporting is the feature of financial accounting, financial
accounts are prepared at the end of the year to the external users
whereas frequent reporting of performance of various activities is
the feature of management accounting. Prompt and quick reporting
is the main feature of management accounting.
7.Emphasis of principles:
Financial accounting records the transactions as per established
conventions and principles. Management does not have any set of
rigid principles. The manner of presentation depends on the
requirement of the firm.
8.Audit:
Financial statements prepared under financial accounting system are
published for the information of general public in case of public
limited companies.
The financial statements are audited by a chartered accountant. The
management accounting statements and reports are means for
internal purpose and they are not subject to audits.
9.Format of statements:
In financial accounting system the financial statements are prepared
under different forms as revenue, capital, personal accounts and
property accounts etc. In management accounting expenses and
incomes are reported by various responsibility centres. Therefore,
management accounting and management accounting differ on
methodology also.
10.Unit of Account:
Financial accounting considers the whole enterprise as a single unit
of account. Financial statement prepared under financial accounting
system reveal the operating results of an entire firm.
Management accounting presents reports relating to the whole
concern and also division-wise performance is revealed.
CASH FLOW STATEMENT
Cash Flow includes cash inflows and out flows-cash receipts and cash
payments-during a period . Movements of cash of are of vital
importance to the management. The short term liquidity and short
term solvency position of a firm are dependent on its cash flows.
The term cash in the context of cash flow analysis includes the cash
balance and the bank balance of a business unit.
CASH FLOW VS PROFIT:
The key difference between cash flow and profit is that while profit
indicates the amount of money left over after all expenses have been
paid.
Cash flow indicates the net flow of cash into and out of a business.
WHICH IS MORE IMPORTANT: CASH FLOW OR PROFIT
Investors and business owners are often in search of a single metric
by which they can understand the health of a company. They want
to know the one number they should look at to determine whether
they should make an investment, or pivot their business strategy.
Cash flow and profit, as wo critical are related financial metrics, often
get fitted against each other: which is more important?
There is not a simple answer to that question; both profit and cash
flow are important in their own ways. As an investor, business,
owner, key employee, or entrepreneur, you need to understand both
metrics and how they interact with each other if you want to
evaluate the financial health of a business.
For example, its possible for a company to be both profitable and
have negative cash flow hindering its ability to pay its expenses,
expand, and grow. Similarly, its possible for a company with positive
cash flow and increasing sales to fail to make a profit, as is the case
with many startups and scaling business.
Profit and cash flow are just two of the dozens of financial terms,
metrics, and ratios that you should familiarize yourself with to make
informed decisions about a business. By gaining a thorough
understanding of key financial principles, it’s possible to advance
professionally and become a smarter investor or business owner.
Profit is the revenue remaining after deducting business costs, while
cash flow is the amount of money flowing in and out of a business at
any given time.
Profit is more indicative of your business success but cash flow is
more important to keep the business operating on a day-to-day
basis.
Cash Flow Statement:
Cash flow statement reports the inflows(receipts) and
outflows(payments) of cash and its equivalents of an organization
during a particular period. It reports the cash receipts and payments
classified according to the firm’s major activities-operating, investing
and financing.
It shows the net cash inflow or net cash outflow for each activity and
for the overall business of the firm. It reports from where cash has
come and how it has been utilized. It explains the causes for the
change in the cash balance by reconciling the opening balance of
period with the closing balance.
Objectives of CFS(as per Accounting Standard-3 Revised)
a) To provide information about the cash flows of an enterprise to
users of financial statements which can be used as a basis to
assess the ability of the enterprise to generate cash and cash
equivalents and the needs of the enterprise to utilize those
cash flows.
b) To enable the users of financial statements to evaluate the
timing and certainty of the generation of cash flows.
c) To classify the cashflows on the basis of operating, investing
and financing activities.
Advantages of CFS:
a) Assessment of firm’s ability to generate cash flows: cash flow
statement is helpful in assessing the ability of the firm to
 generate cash and cash equivalents and also the timings and
certainty of such cash flows.
b) Classification of cash flows: cash flows are classified on the
basis of major activities i.e operating, investing, and financing.
It helps to assess the effectiveness of the management’s
policies relating to each of these major activities.
c) Historical analysis as a guide in forecasting: cash flow
statement presents in detail the movements of cash in the
recent past. This can provide clear indications for the cash
flows in the future period, thus helping in forecasting the
future commitments and needs.
d) Effective cash management: cash flow statement acts as a
guide for coordinating the inflows and outflows of cash. The
matching of the future cash receipts with payments results in
effective cash management.
e) Formulation of financial policies: a clear insight into the cash
flows of the firm is the basis for financial policies like dividend
polity, cash discount, credit terms etc.
f) Preparation of cash budget: cash flow statement is almost like
the foundation for cash budget. The cash flows in the recent
past indicate the quantum and direction of such flows and form
the basis for preparing monthly or quarterly budgets for cash or
even the annual cash budget for the ensuing year.
g) Short-term financial analysis: short-range financial decisions,
like repayment of overdraft or loans, payment of bonus,
adverting campaigns, investment outside the firm etc., may be
taken on the basis of the analysis provided by the cash flow
statement.
h) Liquidity position: it reveals the liquidity position of the firm by
highlighting the various sources of cash and its uses.
i) Revealing mismatch: it can reveal the causes for profitable
firms experiencing acute cash shortages. The reasons for any
 mismanagement of cash resulting in such a situation can be
analysed and its recurrence can be avoided.
Legal status of CFS:
1.Accounting Standard 3(AS-3): Cash Flow Statements issued by
the Institute of Chartered Accountants of India in March 1997 and
revised again in March 1999 was recommendatory in character in
the initial years. However, it was made mandatory with effect
from 1st April, 2001 in respect of the following:
i. Companies whose shares or debentures are listed in a
recognized stock exchange in India and companies which are
in the process of issuing shares or debentures that will be
listed in a recognized stock exchange in India;
ii. All other commercial, industrial and business enterprises
whose turnover for the accounting period exceeds Rs 50
crore
2.SEBI(Securities and Exchange Board of India) has made it
mandatory, from 1995, on all listed companies to prepare and issue a
cash flow statement along with other financial statements
periodically.
We can sum up the position as under:
i. For all listed companies and other businesses with turnover
of Rs 50 crore, preparation of cash flow statement is
compulsory
ii. For all other firms and unlisted companies, preparation of
cash flow statement is not mandatory; but they may also
prepare the statement because of undeniable usefulness.
Meaning of cash and cash equivalents:
Cash: cash consists of cash on hand and demand deposits with
banks. Demand deposits are those deposits which are repayable by
bank on demand by the depositor.
Cash equivalents: these are 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’. An
investment normally qualifies are cash equivalent only when it has a
short maturity of say, three months or less from the date of
acquisition. Examples of cash equivalents are treasury bills and
commercial paper etc.
Cash flows: cash flows are inflows and outflows of cash and cash
equivalents. An inflow increases the total cash and cash equivalents
at the disposal of the enterprise where as cash outflow decreases
them.
Net cash flow is the difference between the cash inflows and cash
outflows. The net cashflow may be either net cash inflow or net cash
outflow.
Preparation of CFS: Indirect Method
In this method, net profit as disclosed by P&L Account is taken as
base. Necessary adjustments are made to the value of the net profit
to arrive at the value of ‘net cash flow’ from operating activities.
Here, net profit is adjusted for items which affect net profit but do
not affect cash. Non-cash and non-operating charges in the P&L
Account are added back to the net profit while non-cash and non-
operating incomes are deducted from net profit to arrive at
operating profit before working capital changes.
Then necessary adjustments are made for increase/decrease in
current assets and current liabilities to ascertain net cash flow from
operating activities.
The following is the procedure:
Net profit before tax and extraordinary items
a)adjustments for non-cash and non-operating items:
Add: Depreciation on fixed assets
Intangible assets like goodwill written off
Fictitious assets and capital losses written off, like discount on
Issue of debentures, preliminary expenses
b)adjustments for gains and losses on sale of fixed assets and
investments
Add: loss on sale of fixed assets
Loss on sale of investments
Less: gain on sale of fixed assets
Gains on sale of investments
c)Adjustments for current assets(except cash and cash
equivalents) and current liabilities:
Add: decrease in current assets
Add: increase in current liabilities
Less: increase in current assets
Decrease in current liabilities
d)adjustment for income tax paid
Less: income tax paid
e)adjustment for extraordinary items, if any
Add/Less: extraordinary losses/gains
The balance at this stage will be the amount of net cash provided
by(or used in) operating activities. It must be noted that either direct
or indirect method will result in the same amount of net cash flow
from operations.
Explanation:
1.adjustments for depreciation and other non-cash and non-
operating items:
Depreciation and intangible assets like goodwill and patent rights
written off do not affect cash at all. Since they are shown as
charges/losses in P&L Account, net profit reduces to that extent.
Bust cash does not go out. So, such charges should be added back
to the net profit. Similarly, fictitious assets or capital losses written
off like underwriting commission, discount on debentures,
preliminary expenses written etc. also do not affect cash. They are
also added back to net profit. If any revenues are shown in P&L
Account which do not provide cash, they are subtracted from the net
profit.
2. adjustments for gains and losses on sale of fixed assets and
investments:
When assets or investments are sold at profit, the total cash received
is shown as a part of cash flow from investment activities. If profit
on sale is separately shown in P& L account, it duplicates the effect
because net profit also increases to that extent.
So, the profit should be reduced from net profit if it was already
credited to P& L A/c.
Similarly, any loss on sale of fixed assets or investments results in
reduced cash flow shown in cash flow from investing activities. So, it
should not be duplicated in ascertaining cash from operating
activities. Any such losses shown in P%L A/c should be added back to
net profit.
3.Adustments for changes in current assets and current liabilities:
Increase in current assets increases profit because credit sales and
higher stocks push up the values of debtors and bills receivable.
Similarly, increase in inventories increases the trading account credit
side. Total thereby increasing gross profit and net profit. But, the
increase in net profit is reflected in cash till the debtors are collected
or the increased inventories are sold.
Increase in current liabilities results in lower net profit because
purchases etc increase without actually depleting cash. Thus, cash is
conserved, though profit decreases.
It is necessary to adjust the increase or decrease in current assets
and current liabilities in the net profit to arrive at the value of cash
profit.
B)Reporting cash flows from investing and financing activities:
An enterprise should report separately major classes of gross cash
receipts and gross cash payments from investing activities and
financing activities. Some of the cash flows, from investing and
financing can be reported on ‘net basis’ as described below.
Reporting cash flows on a net basis
Cash flows arising from the following operating, investing or
financing activities may be reported on a net basis:
a) Cash receipts and payments on behalf of customers when the
cashflows reflect the activities of the customer rather than
those of the enterprise; and
b) Cash receipts and payments for items in which turnover is
quick, the amounts are large, and the maturities are short.
Foreign currency cash flows
Cash flows arising from transactions in a foreign currency should
be recorded in an enterprise’s reporting currency by applying to
the foreign currency amount the exchange rate between the
reporting currency and the foreign currency at the date of the
cash flow.
Extraordinary items
The cashflows associated with extraordinary items should be
classified as arising from operating investing or financing activities
as appropriate and separately disclosed to enable the users to
understand their nature and effect on the present and future cash
flows of the enterprise.
Interest and dividends
Cash flows from interest and dividend received and paid should
each be disclosed separately.
(i) Cash flows arising from interest paid and dividend and
interest received in the case of a financial enterprise should
be classified as cash from operating activities
(ii) In the case of other enterprises a) cash flows arising from
interest paid should be classified as cash flows from
financing activities b)interest and dividend received should
be classified as cashflows from investing activities c)dividend
paid should be classified as cash flows from financing
activities.
(iii) Taxes on income
Cash flows arising from taxes on incomes should be
separately disclosed and should be classified as ‘cash flows
from operating activities’ unless they are specially identified
with financing and investing activities. For example, tax on
capital gains should be classified as cash outflow from
investing activities because it is levied on profit made on sale
of investments.
Non-cash transactions:
Investing and financing transactions that do not require the
use of cash or cash equivalents should be excluded from a
cash flow statement. Such transactions should be disclosed
elsewhere in the financial statements in a way that provides
all the relevant information about those investing and
financing activities.
 Examples of non-cash transactions are:
a) The acquisition of assets by assuming directly related
liabilities
b) The acquisition of an enterprise by means of issue of
shares; and
c) The conversion of debt to equity
Format of cash flow statement:
AS-3 has not provided any specific format for the preparation of cash
flow statement. However, SEBI, which amended clause 32 of the
Listing Agreement in 1995 requiring all listed companies to prepare a
cash flow statement, has provided a format for cash flow statement.
Cash flow statement for ………….(Indirect method)
Rs Rs
Cash flows from operating activities:
Net profit before tax and extraordinary items Xxx
Adjustments for: Xxx
Depreciation Xxx
Loss on foreign exchange Xxx
Interest expense Xxx
Loss on sale of fixed assets (xxx)
Dividend income (xxx)
Interest income
Xxx
Operating profit before working capital
changes
Adjustments for: Xxx
Add: Increase in current liabilities Xxx
Add: Decrease in current assets (xxx)
Less: Increase in current assets (xxx)
Less: Decrease in current liabilities Xxx
Cash generated from operations Xxx
Less: Income tax paid Xxx
Cash flows before extraordinary items Xxx
Add: Extraordinary income or Less:
extraordinary loss

Net cash flow from operating activities Xxx

Cash flows from investing activities: (xxx)
Purchase of fixed assets and investments Xxx
Proceeds from sale of fixed assets and
investments Xxx
Interest received Xxx Xxx
Dividend received
Net cash from investing activities
Xxx
Cash flows from financing activities:
Xxx
Proceeds from issue of share capital
(xxx)
Proceeds from long term borrowings
(xxx) Xxx
Repayment of long term borrowings
(xxx) Xxx
Interest paid
Dividend paid Xxx
Net cash from financing activities
Net increase/decrease in cash and cash Xxx
equivalents
Add: cash and cash equivalents at the
beginning of the period
Cash and cash equivalents at the end of the
period