Cash Flow Notes1

Study Material & Notes for the Chapter 12

CASH FLOW STATEMENT

I.  INTRODUCTION AND BASIC CONCEPTS

i. Meaning

• Cash Flow Statement is a statement that shows the cash flows, i.e., inflow and outflow of Cash and Cash Equivalents during a particular period
• 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.

ii. Cash

• Cash comprises of Cash on Hand, cash at bank and demand deposits (fixed deposits) with banks

iii. Cash Equivalents

• Cash Equivalents are short-term, highly liquid investments that are readily convertible into cash and which are subject to an insignificant risk of change in value. 
• An investment normally qualifies as cash equivalent only when it has short maturity period of, say, three months or less from the date of acquisition, i.e., purchase. 
• Examples: Current/Short-term Investments, Short-term deposits with Banks, Marketable Securities, Commercial Papers, Preference shares 

iv. Statutory Requirements

• Cash Flow Statement is prepared according to the Accounting Standard-3 (Revised). 
• The AS-3 (Revised) prescribes that Cash Flow Statement be prepared either by (i) Direct Method or (ii) Indirect Method 
• Showing cash flow under three heads, namely:
  1. Cash Flow from Operating Activities;
  2. Cash Flow from Investing Activities; and
  3. Cash Flow from Financing Activities.
• Cash Flow Statement shows the net increase or net decrease of Cash and Cash equivalents under each activity, i.e., Operating, Investing, Financing separately and collectively.

v. Cash flow arising out of increase/decrease in Balance Sheet items

vi. Cash flows are inflow & Outflow of Cash & Cash Equivalents

vii. Objectives

a. Knowledge of movement of cash

• A cash flow statement discloses the speed at which the cash is being generated from current assets such as debtors, bills receivable, inventory etc., and the speed at which the current liabilities such as creditors, bills payable etc. are being paid. 
• This information is very useful in testing the capacity of a business to meet its short-term liabilities maturing, say within one month or in the Immediate future. 
• Thus, it enables the management to assess the true position of cash in future.

b. Helpful in decision-making

• Cash flow statement gives information about cash inflow from operations of business. Such information is used by management for certain decision-making, e.g., repayment of long-term loans, purchase of fixed assets etc.

c. Knowledge of cash flow for different activities separately

• An enterprise presents its cash flows from Operating, Investing and Financing activities. Classification by activity provides information that allows users to assess the impact of these activities on the financial position of the enterprise and the amount of its cash and Cash equivalents. This information may also be used to evaluate the relationship among these activities.

d. Knowledge of change in Cash

• A business may have made profit and yet is running short of cash. Similarly, a business may have suffered a loss and still has sufficient cash balance. A cash flow statement reveals reasons for such increase or decrease of cash balance.

viii. Advantages

1. Cash Flow Statement is very useful in the evaluation of cash position of a firm. It helps in efficient and effective management of cash.
2. Cash flow statement aims at highlighting the cash generated from operating activities.
3. Cash flow statement helps in planning the schedule for repayment of loan schedule and replacement of fixed assets, etc.
4. Cash is the centre of all financial decisions. It is used as the basis for the projection of future investing and financing plans of the enterprise
5. Cash flow statement helps to ascertain the liquid position of the firm in a better manner. Banks and financial institutions mostly prefer cash flow statement to analyse liquidity of the borrowing firm.
6. The Management reviews cash flow statements to understand the internally generated cash which is best utilised for payment of dividends.

ix. Preparation of Cash Flow Statement

1. Compute Cash Flow from Operating Activities 
2. Compute Cash Flow from Investing Activities 
3. Compute Cash Flow from Financing Activities. 
4. Cash flows under each activity, i.e., Operating Activity, Investing Activity and Financing Activity as computed under Steps 1, 2 and 3 are added in Cash Flow Statement and the resultant amount is Net Increase or Decrease in Cash and Cash Equivalents
5. Cash and Cash Equivalents balance in the beginning of the period is added to the cash flows as arrived under Step 4. The amount so determined should be equal to Cash and Cash Equivalents balance at the end of the year.