CASH FLOW STATEMENT - gargicollege.in€¦ · As per AS-3, under indirect method, net cash flow from operating activities is determined by adjusting net profit or loss for the effect

CASH FLOW STATEMENT

- I S H A C H U G H

A S S I S TA N T P R O F E S S O R

G A R G I C O L L E G E

U N I V E R S I T Y O F D E L H I

ISHA CHUGH, DEPARTMENT OF COMMERCE, GARGI COLLEGE


OBJECTIVES OF CASH FLOW STATEMENT

o Information about the cash flows of an enterprise is useful in providing users of financial

statements with a basis to assess the ability of the enterprise to generate cash and cash

equivalents and the needs of the enterprise to utilise those cash flows.

o The economic decisions that are taken by users require an evaluation of the ability of an

enterprise to generate cash and cash equivalents and the timing and certainty of their

generation.

o The Standard deals with the provision of information about the historical changes in cash and

cash equivalents of an enterprise by means of a cash flow statement which classifies cash flows

during the period from operating, investing and financing activities.


Benefits of Cash Flow Statement

❑ A cash flow statement when used along with other financial statements provides information that

enables users to evaluate changes in net assets of an enterprise, its financial structure (including its

liquidity and solvency) and its ability to affect the amounts and timings of cash flows in order to adapt to

changing circumstances and opportunities.

❑ Cash flow information is useful in assessing the ability of the enterprise to generate cash and cash

equivalents and enables users to develop models to assess and compare the present value of the

future cash flows of different enterprises.

❑ It also enhances the comparability of the reporting of operating performance by different enterprises

because it eliminates the effects of using different accounting treatments for the same transactions and

events.

❑ It also helps in balancing its cash inflow and cash outflow, keeping in response to changing condition. It

is also helpful in checking the accuracy of past assessments of future cash flows and in examining the

relationship between profitability and net cash flow and impact of changing prices.


TYPES OF ACTIVITIES





Examples of cash flows arising from Financing Activities:


ASCERTAINING CASH FLOWS FROM OPERATING ACTIVITIES


Under direct method, major heads of cash inflows and outflows (such as cash received fromtrade receivables, employee benefits expenses paid, etc.) are considered.

NOTE: Items are recorded on accrual basis in statement of profit and loss. Hence, certainadjustments 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.

Direct Method


However, the following items are not to be considered:

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 interestreceived, dividend paid, etc. As per AS-3, under the direct method, informationabout major classes of gross cash receipts and cash payments may be obtainedeither–

▪ from the accounting records of the enterprise, or▪ by adjusting revenue from operation, cost of revenue from operations and other

items in the statement of profit or loss for the following:• changes during the period in inventories and trade receivables and payables;• other non-cash items; and• other items for which cash effects are investing or financing cash flows.





Indirect method of ascertaining cash flow from operating activities begins with theamount of net profit/loss. This is so because statement of profit and loss incorporates theeffects of all operating activities of an enterprise.

However, Statement of Profit and Loss is prepared on accrual basis (and not on cashbasis). 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 ofnet profit/loss as shown by Statement of Profit and Loss for arriving at cash flows fromoperating activities.

Indirect Method


As per AS-3, under indirect method, net cash flow from operating activities is determined byadjusting net profit or loss for the effect of :

▪ Non-cash items such as depreciation, goodwill written-off, provisions, deferred taxes, etc.,which are to be added back.

▪ All other items for which the cash effects are investing or financing cash flows. Thetreatment of such items depends upon their nature. All investing and financing incomes areto be deducted from the amount of net profits while all such expenses are to be addedback. For example, finance cost which is a financing cash outflow is to be added back whileother income such as interest received which is investing cash inflow is to be deductedfrom the amount of net profit.

▪ Changes in current assets and liabilities during the period: Increase in current assets anddecrease in current liabilities are to be deducted while increase in current liabilities anddecrease in current assets are to be added up.





While preparing the cash flow statement, all major items of gross cashreceipts, gross cash payments, and net cash flows from investing andfinancing activities must be shown separately under the headings ‘CashFlow from Investing Activities’ and ‘Cash Flow from Financing Activities’respectively.’

Ascertaining cash flows from Investing and Financing Activities


Accounting Provisions of AS-3 on Treatment of Certain Items

1. Interest and Dividend:

• Cash flows from interest and dividends received and paid should be disclosed separately and classified on the basis of nature of the enterprise as shown below:

• For Financial enterprises:

(i) Interest paid and received, dividend received as operating activities.

(ii) Dividend paid as financing activities.

• For Other enterprises:

(i) Interest and dividend received as investing activities.(ii) Interest and dividend paid as financing activities.



2. Extra Ordinary Items:

The cash flows associated with extraordinary items should be classified as arising from operating, investing or financing activities as appropriate. It should be disclosed separately.

Few examples of such items are:(i) Claim for loss of Stock — operating activity(ii) Claims for loss of assets — investing activity(iii) Recovery of bad debts — operating activity(iv) Damages paid/received for breach of contract — operating activity(v) Winnings from lotteries — Investing activity(vi) Cost of legal action to protect property title — Investing activity.


3. Taxes on Income:

Cash flows arising from taxes on income should be separately disclosed and should be classified as cash-flows from operating activities under they can be specifically identified with financing and investing activists.

For instance:(i) Provision for Taxation for the current year — Non cash charge under operating activity(ii) Tax paid — Operating cash out flow(iii) Income tax refund — Cash inflow from operating activity(iv) Capital gains tax — Cash out flow from investing activity(v) Corporate dividend tax — Cash out flow from financing activity.


4. Foreign Currency Cash Flows:Foreign currency cash flows should be converted at the exchange rate of the dateof cash flow. Exchange gain/loss on cash and cash equivalents held in foreigncurrency will be reported as part of reconciliation of change in cash and cashequivalents for the period and hence, not reported in cash flow statement.

5. Investments in Subsidiaries, Associates and Joint Venture:Acquisition of interest in any subsidiary, associates or in any joint venture istreated as “Investing Activity”. Similarly, sale or disposal of such interest andreceipt of interest or dividends on such investments is treated as “InvestingActivity”.


6. Non-Cash Transactions:Investing and financing transactions that do not require the use of cash or cash equivalents are not shown in the cash flow statement.

Examples of such non-cash transactions are:(i) Issue of shares or debentures for a consideration other than cash i.e. against building, machinery etc.(ii) Conversion of debentures into equity shares.(iii) Purchase of business by issue of shares.

AS-3 (Revised) recommends that such transactions may be disclosed under footnote to cash flow statement.


Ind AS 7, Statement of Cash flows, prescribes principles and guidance on preparation andpresentation of cash flows of an entity from operating activities, investing activities andfinancing activities for a reporting period,

Objective

The objective of this Standard is to provide information about the historical changes in cashand cash equivalents of an entity by means of a statement of cash financing activities flowswhich classifies cash flows during the period from operating, investing and financing activities.

IND AS 7: CASH FLOW STATEMENT


Cash comprises Cash on hand, and Demand deposits.

Cash flows are Inflows and Outflows of cash and cash equivalents.

Cash equivalents are short-term, highly liquid investments that are readily convertible toknown amounts of cash and which are subject to an insignificant risk of changes in value.Cash equivalents are held for the purpose of meeting short-term cash commitments ratherthan for investment or other purposes. Cash and cash equivalents include demand deposits,certain short-term investments and in some cases, bank overdrafts.

1. For an investment to qualify as a cash equivalent it must be readily convertible to aknown amount of cash and be subject to an insignificant risk of changes in value,therefore, an investment normally qualifies as a cash equivalent only when it has a shortmaturity of, say, three months or less from the date of acquisition.


2. Equity investments are excluded from cash equivalents unless they are, in substance, cash equivalents, for example in the case of preference shares acquired within a short period of their maturity and with a specified redemption date.

3. Bank borrowings are generally considered to be financing activities. However, where bank overdrafts which are repayable on demand form an integral part of an entity's cash management, bank overdrafts are included as component of cash and cash equivalents A characteristic of such banking arrangements is that the bank balance often fluctuates from being positive to overdrawn.

Information about the cash flows of an entity is useful in providing users of financial statements with a basis to assess the ability of the entity to generate cash and cash equivalents and the needs of the entity to utilise those cash flows. The economic decisions that are taken by users require an evaluation of the ability of an entity to generate cash and cash equivalents and the timing and certainty of their generation.






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CASH FLOW STATEMENT - gargicollege.in€¦ · As per AS-3, under indirect method, net cash flow from operating activities is determined by adjusting net profit or loss for the effect