Cash plays a very important role in the economic life of a business. A firm needs cash to make payment to its suppliers, to incur day-to-day expenses and to pay salaries, wages, interest and dividends etc. In fact, what blood is to a human body, cash is to a business enterprise. Thus, it is very essential for a business to maintain an adequate balance of cash. Thus, there should be focus on movement of cash and its equivalents.
Cash means, cash in hand and demand deposits with the bank. Cash equivalent consists of bank overdraft, cash credit, short term deposits and marketable securities. Cash Flow Statement deals with flow of cash which includes cash equivalents as well as cash.
This statement is an additional information to the users of Financial Statements. The purpose of cash flow statement analysis is to attain details of cash inflows and outflows. It is one of three required financial statements of public entities. The other two are the balance sheet and the income statement. It requires that an enterprise should prepare a cash flow statement and should present it for each accounting period for which financial statements are presented.
A Cash-Flow statement may be defined as a summary of receipts and disbursements of cash for a particular period of time. The cash flow statement became a requirement for publicly traded companies in 1987. There are various rules governing how information is reported on cash flow statements, as determined by Generally Accepted Accounting Principles (GAAP).
The cash flow statement is one of the most important financial statement an entity prepares. It traces the flow of funds (or working capital) into and out of your business during an accounting period. For a small business, a cash flow statement should probably be prepared as frequently as possible. This means either monthly or quarterly. An annual statement is a must for any business.
When recorded on a cash flow statement, money coming into the business is recorded as “cash inflow”, whilst money going out from the business is referred to as “cash outflow”.
The cash flow statement components provide a detailed view of cash flow from operations, investing, and financing:
The net amount of cash coming in or going from the day to day business operations of an entity is called Cash Flow from Operations. It is related to the production or sale of a company’s products or services. Basically it is the operating income plus non-cash items such as depreciation added. Since accounting profits are reduced by non-cash items (i.e. depreciation and amortization) they must be added back to accounting profits to calculate cash flow.
Cash flow from operations is an important measurement because it tells the analyst about the viability of an entities current business plan and operations. In the long run, cash flow from operations must be cash inflows in order for an entity to be solvent and provide for the normal outflows from investing and finance activities.
Cash flow from investing activities would include the inflow or outflow of cash because of any changes in long term assets or investments such as the purchase or sale of an assets like land, buildings, equipment, securities, etc. or any payments related to mergers or acquisition.
Cash flow from finance activities is the cash inflow or outflow because of any cash adjustments or changes to capital, debts, loan, etc.
Extraordinary items are not the regular phenomenon, e.g., loss due to theft or earthquake or flood. Extraordinary items are non-recurring in nature and hence cash flows associated with extraordinary items should be classified and disclosed separately as arising from operating, investing or financing activities. This is done to enable users to understand their nature and effect on the present and future cash flows of an enterprise.
In case of a financial enterprise (whose main business is lending and borrowing), interest paid, interest received and dividend received are classified as operating activities while dividend paid is a financing activity.
In case of a non-financial enterprise, it is considered more appropriate that payment of interest and dividends are classified as financing activities whereas receipt of interest and dividends are classified as investing activities.
Taxes may be income tax (tax on normal profit), capital gains tax (tax on capital or profits), dividend tax (tax on the amount distributed as dividend to shareholders).
Cash flows arising from taxes on income should be separately disclosed and should be classified as cash flows from operating activities unless they can be specifically identified with financing and investing activities. This clearly implies that:
Investing and financing transactions that do not require the use of cash or cash equivalents should be excluded from a cash flow statement.
Examples of such transactions are – acquisition of machinery by issue of equity shares or redemption of debentures by issue of equity shares. Such transactions should be disclosed elsewhere in the financial statements in a way that provide all the relevant information about these investing and financing activities. Hence, assets acquired by issue of shares are not disclosed in cash flow statement due to non-cash nature of the transaction.
The following terms are used in this Standard with the meanings specified:
1. Cash comprises cash on hand and demand deposits with banks.
2. Cash equivalents 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.
Cash flow statements can be prepared following two different methods: (i)direct, or (ii) indirect.
Under the direct method, the (net) cash flow from operating activities are calculating by taking receipts from collected from customers, receipts from cash paid to suppliers or employers, and interest or income tax paid.
As the name suggests, under direct method, major heads of cash inflows and outflows (such as cash received from trade receivables, employee benefits expenses paid, etc.) are considered.
It is important to note here that items are recorded on accrual basis in statement of profit and loss. Hence, certain adjustments are made to convert them into cash basis such as the following :
1. Cash receipts from customers = Revenue from operations + Trade receivables in the beginning – Trade receivables in the end.
2. Cash payments to suppliers = Purchases + Trade Payables in the beginning – Trade Payables in the end.
3. Purchases = Cost of Revenue from Operations – Opening Inventory + Closing Inventory.
4. Cash expenses = Expenses on accrual basis + Prepaid expenses in the beginning and Outstanding expenses in the end – Prepaid expenses in the end and Outstanding expenses in the beginning.
1. Non-cash items such as depreciation, discount on shares, etc., be written off.
2. Items which are classified as investing or financing activities such as interest received, dividend paid, etc.
|M/s XYZ ltd.|
|Statement of Cash Flows|
|For the Years Ending December 31, 2017 and December 31, 2016 |
|Cash Flows from Operating Activities |
Cash Flows from Investing Activities
Cash Flows from Financing Activities
|NET INCREASE/(DECREASE) IN CASH [A+B+C]||xxx||xxx|
|Add: CASH at the BEGINNING OF YEAR ||xxx||xxx|
|CASH at the END OF YEAR||$xxx||$xxx|
Indirect method of ascertaining cash flow from operating activities begins with the amount of net profit/loss. This is so because statement of profit and loss incorporates the effects of all operating activities of an enterprise. However, Statement of Profit and Loss is prepared on accrual basis (and not on cash basis). Moreover, it also includes certain non-operating items such as interest paid, profit/loss on sale of fixed assets, etc.) and non-cash items (such as depreciation, goodwill to be written-off, etc.. Therefore, it becomes necessary to adjust the amount of net profit/loss as shown by Statement of Profit and Loss for arriving at cash flows from operating activities.