Cash flow Statement (CFS) is an additional information provided to the users of accounts in the form of an statement, which reflects the various sources from where cash was generated (inflow of cash) by an enterprise during the relevant accounting year and how these inflows were utilised (outflow of cash) by the enterprise. This helps the users of accounts:
- To identify the historical changes in the flow of cash & cash equivalents.
- To determine the future requirement of cash & cash equivalents.
- To assess the ability to generate cash & cash equivalents.
- To estimate the further requirement of generating cash & cash equivalents.
- To compare the operational efficiency of different enterprises.
- To study the insolvency and liquidity position of an enterprises.
- As an indicator of amount, timing and certainty of future cash flows.
- To check the accuracy of past assessments of future cash flows.
- In examining the relationship between profitability and net cash flow and the impact of changing prices.
Meaning of the term cash and cash equivalents for cash flow statements
Cash and cash equivalents for the purpose of cash flow statement consists of the following:
- Cash in hand and deposits repayable on demand with any bank or other financial institutions and
- Cash equivalents, which are short term, highly liquid investments that are readily convertible into known amounts of cash and are subject to insignificant risk or change in A short-term investment is one, which is due for maturity within three months from the date of acquisition. Investments in shares are not normally taken as cash equivalent, because of uncertainties associated with them as to realisable value.
Note : For the purpose of cash flow statement, ‘cash and cash equivalent’ consists of at least three balance sheet items, viz. cash in hand; demand deposits with banks etc. and investments regarded as cash equivalents. For this reason, the AS 3 requires enterprises to give a break-up of opening and closing cash shown in their cash flow statements. This is presented as a note to cash flow statement.
Meaning of the term cash flow
Cash flows are inflows (i.e. receipts) and outflows (i.e. payments) of cash and cash equivalents. Any transaction, which does not result in cash flow, should not be reported in the cash flow statement. Movements within cash or cash equivalents are not cash flows because they do not change cash as defined by AS 3, which is sum of cash, bank and cash equivalents. For example, acquisitions of cash equivalent investments or cash deposited into bank are not cash flows.
It is important to note that a change in cash does not necessarily imply cash flow. For example suppose an enterprise has a bank balance of USD 10,000, stated in books at ₹ 4,90,000 using the rate of exchange ₹ 49/USD prevailing on date of receipt of dollars. If the closing rate of exchange is ₹ 50/USD, the bank balance will be restated at ₹ 5,00,000 on the balance sheet date. The increase is however not a cash flow because neither there is any cash inflow nor there is any cash outflow.
Types of cash flow
Cash flows for an enterprise occur in various ways, e.g. through operating income or expenses, by borrowing or repayment of borrowing or by acquisition or disposal of fixed assets. The implication of each type of cash flow is clearly different. Cash received on disposal of a useful fixed asset is likely to have adverse effect on future performance of the enterprise and it is completely different from cash received through operating income or cash received through borrowing. It may also be noted that implications of each cash flow types are interrelated. For example, borrowed cash used for meeting operating expenses is not same as borrowed cash used for acquisition of useful fixed assets.
For the aforesaid reasons, the standard identifies three types of cash flows, i.e. operating cash flows, investing cash flows and financing cash flows. Separate presentation of each type of cash flow in the cash flow statement improves usefulness of cash flow information.
The operating cash flows are cash flows generated by operating activities or by other activities that are not investing or financing activities. Operating activities are the principal revenue-producing activities of the enterprise. Examples include, cash purchase and sale of goods, collections from customers for goods, payment to suppliers of goods, payment of salaries, wages etc.
The investing cash flows are cash flows generated by investing activities. The investing activities are the acquisition and disposal of long-term assets and other investments not included in cash equivalents. The examples of investing cash flows include cash flow arising from investing activities include: (a) receipts from disposals of fixed assets; (b) loan given to / recovered from other entities (other than loans by financial enterprises) (c) payments to acquire fixed assets (d) Interests and dividends earned (other than interests and dividends earned by financial institutions).
The financing cash flows are cash flows generated by financing activities. Financing activities are activities that result in changes in the size and composition of the owners’ capital (including preferences share capital in the case of company) and borrowings of the enterprise. Examples include issue of shares / debentures, redemption of debentures / preference shares, payment of dividends and payment of interests (other than interests paid by financial institutions).
Identifying type of cash flows
Classification of Cash Flows
Cash flow type depends on the business of the enterprise and other factors. For example, since principal business of financial enterprises consists of borrowing, lending and investing, loans given and interests earned are operating cash flows for financial enterprises and investing cash flows for other enterprises. A few typical cases are discussed below.
Loans/Advances given and Interests earned
- Loans and advances given and interests earned on them in the ordinary course of business are operating cash flows for financial enterprises.
- Loans and advances given and interests earned on them are investing cash flows for non-financial enterprises.
- Loans and advances given to subsidiaries and interests earned on them are investing cash flows for all enterprises.
- Loans and advances given to employees and interests earned on them are operating cash flows for all enterprises.
- Advance payments to suppliers and interests earned on them are operating cash flows for all enterprises.
- Interests earned from customers for late payments are operating cash flows for non-financial enterprises.
Loans/Advances taken and interests paid
- Loans and advances taken and interests paid on them in the ordinary course of business are operating cash flows for financial enterprises.
- Loans and advances taken and interests paid on them are financing cash flows for non-financial enterprises.
- Loans and advances taken from subsidiaries and interests paid on them are financing cash flows for all enterprises.
- Advance taken from customers and interests paid on them are operating cash flows for non-financial enterprises.
- Interests paid to suppliers for late payments are operating cash flows for all enterprises.
- Interests taken as part of inventory costs in accordance with AS 16 are operating cash flows.
Investments made and dividends earned
- Investments made and dividends earned on them in the ordinary course of business are operating cash flows for financial enterprises.
- Investments made and dividends earned on them are investing cash flows for non-financial enterprises.
- Investments in subsidiaries and dividends earned on them are investing cash flows for all enterprises.
Dividends paid are financing cash outflows for all enterprises.
- Tax paid on operating income is operating cash outflows for all enterprises
- Tax deducted at source against income are operating cash outflows if concerned incomes are operating incomes and investing cash outflows if the concerned incomes are investment incomes, e.g. interest earned.
- Tax deducted at source against expenses are operating cash inflows if concerned expenses are operating expenses and financing cash inflows if the concerned expenses are financing expenses, e.g. interests paid.
Insurance claims received
- Insurance claims received against loss of stock or loss of profits are extraordinary operating cash inflows for all enterprises.
- Insurance claims received against loss of fixed assets are extraordinary investing cash inflows for all enterprises.
AS 3 requires separate disclosure of extraordinary cash flows, classifying them as cash flows from operating, investing or financing activities, as may be appropriate.
Reporting Cash Flows from Operating Activities
Net cash flow from operating activities can be reported either as direct method or as indirect method.
In ‘Direct method’ we take the gross receipts from sales, trade receivables and other operating inflows subtracted by gross payments for purchases, creditors and other expenses ignoring all non-cash items like depreciation, provisions. In ‘Indirect method’ we start from the net profit or loss figure, eliminate the effect of any non-cash items, investing items and financing items from such profit figure i.e. all such expenses like depreciation, provisions, interest paid, loss on sale of assets etc. are added and interest received etc. are deducted. Adjustment for changes in working capital items are also made ignoring cash and cash equivalent to reach to the figure of net cash flow.
Direct method is preferred over indirect because, direct method gives us the clear picture of various sources of cash inflows and outflows which helps in estimating the future cash inflows and outflows.
Below is the format for Cash Flow Statement (Illustrative):
Cash Flow Statement of X Ltd. for the year ended March 31, 20XX (Direct Method)
|Cash received from sale of goods||xxx||
|Cash received from Trade receivables||xxx|
|Cash received from sale of services||xxx|
|Less: Payment for Cash Purchases||xxx||
Payment to Trade payables
Payment for Operating Expenses
e.g. power, rent, electricity
Payment for wages & salaries
Payment for Income Tax
|Adjustment for Extraordinary Items||xxx|
|Net Cash Flow from Operating Activities||xxx|
Cash Flow Statement of X Ltd. for the year ended March 31, 20xx (Indirect Method)
|Closing balance of Profit & Loss Account||xxx|
|Less: Opening balance of Profit & Loss Account||xxx|
Reversal of the effects of Profit & Loss Appropriation Account
|Add: Provision for Income Tax||xxx|
|Effects of Extraordinary Items||xxx|
|Net Profit Before Tax and Extraordinary Items||xxx|
|Reversal of the effects of non-cash and non-operating items||xxx|
|Effects for changes in Working Capital except cash & cash equivalent||xxx|
|Less : Payment of Income Tax||xxx|
|Adjustment for Extraordinary Items||xxx|
|Net Cash Flow from Operating Activities||xxx|