Management Accounting Cash Flow - Accounting Basics

What is a cash flow statement?

In order to meet the day-to-day expenses and to invest as and when required, it is essential for every business to maintain adequate cash in hand and hence playing an important role for business success. Sometimes due to shortage of cash flow, in spite of adequate profits the business will be unable to meet taxes and dividends.

While the information about the operating activities is provided by revenue statements, the financial position of the firm is provided by balance sheets. But both fail to provide information about the generation of cash out of the business activities.

Hence cash flow statement is very essential. Thus a clause, Clause 32 was amended by SEBI according to which the companies along with the balance sheet and profit and loss account, a cash flow statement need to be prepared in a prescribed format providing information about the cash flows from the operating activities, investing activities and financial activities.

The inflows and outflows of the cash are described by the cash statement. The net effect of the various business transactions on cash and cash equivalents are sown by the cash statement. A summary od the changes in the position of the cash between the dates of two balance sheets and revenue statements is a Cash flow statement.

Some of the important terms used in a cash flow statement are:

Cash

Cash implies cash in hand, cash at bank, deposits etc.

Cash and Cash Equivalents

The easily convertible and highly liquid investment, the value of which in cash is known is cash and cash equivalents. The current and short-term commitments are met by the cash equivalents. Cash equivalents are those investments which have short maturity (within three months).

Cash Flows

Cash flows are of two types – cash inflows and cash outflows. If the result of transaction increase the cash it is known as cash inflow and if the result of the transaction decrease the cash it is known as cash outflow.

Note: If decrease in cash is due to cash management rather than its operating, investing, and financing activities, it will be excluded from cash outflows. Cash management means investment of cash in cash equivalents.

How Cash Flows are classified?

The Cash flows are classified into three categories:

  • Cash Flow from operating activities
  • Cash Flow from investing activities
  • Cash Flow from financing activities

Cash flow from operating activities

In order to maintain the operating capability, the cash inflow from the operating activities represents the level of sufficient cash generation without going for external source of financing.

The revenue-producing activities of a firm are known as operating activities. The transactions determining the profit or loss of a firm are represented by these activities.

Some of the examples of cash flows from operating activities are:

  • Cash sale (goods or services)
  • Cash receipts from commission, fees and royalties income etc.
  • Cash payments to workers or employees in form of salary or wages.
  • Cash payments to supplier of goods or services.
  • Cash receipt on account of insurance premium by insurance companies.
  • Cash payments in form of claims, annuity and other benefits.
  • Cash payments or refund of income tax in case not included in investing or financing activities.
  • Cash payments on account of current and future contracts.

Note: Cash receipt on sale of plant and machinery comes under category of investing activities.

Cash flow from investing activities

The assets and long-term investments which do not come under the cash equivalents are investing activities. In order to earn profits in future the amount invested in long-term assets is represented by Investing activity.

Some of the examples of Cash Flows from investing activities:

  • The cash payments done to acquire the tangible and intangible assets along with the construction of assets and research and development cost.
  • Cash receipts from sale of investments and disposal of fixed assets.
  • Cash payments done for investing in shares, warrants and debentures excluding those that are covered in cash equivalents.
  • Cash received from the sale of shares, warrants and other funds which are for trading purpose.
  • Advances or loan made to third party other than by financing companies.
  • Cash payment for future contracts other than trading purpose.
  • Cash received from future contracts other than trading purpose.

Cash flow from financing activities

Financial activities are the activities which are a result of change in size and composition of owner’s capital including preference shares. For financial activities separate disclosure is essential.

Examples of Cash flows from financing activities include cash received on issue of shares, debentures, loans, bonds and other short- or long-term borrowings. Cash payments on redemption of debentures bonds, preference shares etc.

How some of the typical cash flows treated?

Some of the typical cash flows and their treatment is as follows:

Extraordinary Items

According to the nature of activities such as operating, investing or financial the cash flow is classified. Cash flow from extraordinary items is displayed in the statement separately to make the user understand the nature and effect of the cash flow statement.

Interest and Dividends

The interest and Dividends are considered as operating activities for a financial organization. The interest paid is considered as financial activity and the interest / dividends received are considered as investing activity for non-financial organization.

Note: In both the cases, dividend paid is classified as financing activity.

Taxes on Income

A tax on income is classified as operating activities except for the cases where taxes can be easily identifiable by the nature of the income. If the tax is provided in total, it is classified as operating activities.

Taxes on income should be separately disclosed and should be classified under operating activities in most of the cases except where we can easily identify the taxes according to nature of income but if total amount of tax is given, then it should be classified as operating activities.

Note: Dividend distribution tax will be classified as financing activities.

Cash flows from acquisition and disposal of subsidiaries and other business units

Cash flow arises due to acquisition or disposal of subsidiary are shown separately and are classified as investing activities. It facilitates the users to easily understand the effect. The cash flow of disposal is not deducted from the cash flow of acquisitions.

Foreign Currency

All the items that appear in the cash flow statement must be in the local currency by applying the foreign currency rate as on that particular day. A reconciliation of changes is shown separately which is the effect on the value of cash and cash equivalents that is reflected in the cash flow statement which is due to the changes in the foreign currency rate.

Non-Cash Transactions

Some of the investing and financial activities do not directly impact the cash flows. For instance, conversion of debt into equity, by issuing the shares acquisition of enterprise. Such transactions are excluded from cash flow statements as cash or cash equivalents are not used. These investing and financial activities appear separately in other forms of the financial statements.

Format: (Direct Method)

M/s ABC LIMITED

Cash flow Statement for the year ended 31 March 2014

Particulars Amount
Cash Flows from Operating Activities (Schedule- 1) XX
Cash Flows from Investing Activities (Schedule- 2) XX
Cash Flows from Financing Activities (Schedule-3) XX
Extraordinary Items XX
Net Profit before Tax XX
Income Tax Paid XX
Net Increase or Decrease in cash or cash Equivalents XX
Add: Cash & Cash Equivalents at the beginning of the period XX
Cash and Cash Equivalents at the end of the period XXX

Schedule - 1

Cash flow from operating activities

Particulars Amount
Cash received from customers XXX
Cash paid for:
- Suppliers for Purchases XX
- Wages & Salary XX
- Operating and General administrative expenses XX XX
Net Profit before Taxes → XX
Income Tax Paid → XX
Cash flow from Operating Activities → XXX

Schedule-2

Cash flow from investing activities

Particulars Amount
Cash received for:
- Sale of Fixed Assets XX
- Sale of Investment XX
- Interest received XX
- Dividend received XX XXX
Cash paid for:
- Purchase of Fixed Assets XX
- Purchase of Investments XX XX
Net Cash Flow from Investing Activities → XX

Schedule-3

Cash flow from financing activity

Particulars Amount
Cash received for: XX
Issue of Equity Shares XX
Issue of Preference Share XX
Long term borrowings XX XXX
Cash paid for:
- Interest paid XX
- Redemption of preference shares XX
- Repayment of Loans XX
Dividend paid XX
Purchase of Investments XX XX
Net Cash Flow from Financing Activities → XX

Cash Flow Indirect Method

  • Two Balance Sheets are requires.
  • No need of Profit & Loss account in Indirect Method.
  • Non Cash Item require.
  • Current Assets and Current Liabilities account need to be changed.
  • Opening current assets and current liabilities account need to be opened.

Format

(Indirect Method): Given by AS-3

M/s XYZ LIMITED

Cash flow Statement for the year ended 31 March 2014

Particulars Amount
Cash Flows from Operating Activities (Schedule- 1) XX
Cash Flows from Investing Activities (Schedule- 2) XX
Cash Flows from Financing Activities (Schedule-3) XX
Extraordinary Items XX
Net Profit before Tax → XX
Income Tax Paid → XX
Net Increase or Decrease in cash or cash Equivalents → XX
Add: Cash & Cash Equivalents at the beginning of the period → XX
Cash and Cash Equivalents at the end of the period → XXX

Schedule-1

Cash flow from operating activities

Particulars Amount
Changes in Profit & Loss account XX
Changes in Reserve (Any) XX
(+) Interim Dividend XX
Net Profit → XXX
Non Cash Items:
(+) Depreciation XX
(+) Loss on Sale of Fixed Assets XX
(+) Goodwill Amortization XX
(+) Preliminary Expenses written off XX
Non Cash Incomes:
(-) Gain on Sale of Fixed Assets XX
Operating Profit before working Capital changes → XXX
± Changes in Current Assets & Current liabilities XX
Cash operating Expenses before Tax ------
Tax Paid XXX
X
Cash Flow from Operating Activities → ------
XXX

Schedule-2

Cash flow from investing activities

Particulars Amount
Cash received for:
- Sale of Fixed Assets XX
- Sale of Investment XX
- Interest received XX
- Dividend received XX XXX
Cash paid for:
- Purchase of Fixed Assets XX
- Purchase of Investments XX XX
Net Cash Flow from Investing Activities → XX

Schedule-3

Cash flow from financing activity

Particulars Amount
Cash received for:
- Issue of Equity Shares XX
- Issue of Preference Share XX
- Long-term borrowings XX XXX
Cash paid for:
- Interest paid XX
- Redemption of Preference shares XX
- Repayment of Loans XX
- Dividend paid XX
- Purchase of Investments XX XX
Net Cash Flow from Financing Activities → XX

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