CkBooks Online – Free Online Books

Cash Flow Statement IAS-7
Cash Flow Statement

Cash Flow Statement:

1. Cash flow statement shows the movement in cash resources of the business.
2. This statement shows the sources from which business generated cash and its application.
• For any business it is important to ensure that:
1. Sufficient profits are made to compensate owners for the investment made, efforts put in and the risk taken for the business,
2. Sufficient funds are available to meet the obligations of the business as and when required.

• The information as to profitability is provided by the Profit and Loss Account.
• The information as to availability of funds or financial health is provided by the balance sheet.
• But we know that the balance sheet is prepared on a specific date and can provide information of financial position as on that date only. • Cash flow on the other hand provides more detailed information about the movement of funds during the period.
• With the help of cash flow we can determine the amount of cash generated form different sources and the areas on which it is utilized

Difference between Profitability and Liquidity:
• Liquidity.
It is the ability of a business to pay its debts in time. By having good liquidity we mean that a business has sufficient liquid funds (cash and cash equivalents) so that it can repay liabilities.
• Cash
Cash includes cash in hand and demand deposits.
• Cash Equivalents
Cash equivalents are those short term investments that can be converted into a known amount of cash at any time. Usually investments up to three months maturity are included in cash equivalents.

• Profitability is generally mixed-up with liquidity.
One might think that if a business has earned say One Million Rupees of profit than it should have approximately the same amount of cash in it. But mostly this is not the case.
• Consider the following example:

• A small business is started with a capital of 20,000.
• During the first accounting period goods worth Rs. 15,000 are purchased. Out of the total 15,000, Rs.10, 000 are paid in cash while the remaining amount will be paid in 15 days.
• All the goods are sold on credit for Rs. 35,000, receivable in 30 days
• Expenses incurred during the period amount to Rs. 10,000 – 5,000 paid in cash and balance payable in 15 days time.
• What is the profitability and liquidity position of the business

• Profitability:

• The business earned a total profit of Rs. 10,000 (35,000 sale – 15,000 purchases – 10,000 expenses).

• Liquidity:

• The business has 5,000 cash on reporting date (20,000 capital – 10,000 purchases – 5,000 expenses). This cash will be utilized either for payment of expenses or payments, both becoming due in 15 days.

• Although the business earned a profit but it is going to face problems in paying its liabilities.
• By taking this simple example we have tried to explain that liquidity is different from profitability
• But it is as important as profitability. Some people even say that it is more important than profitability.

Components of Cash Flow Statement:
• Cash flow statement is divided into three components

• Cash Flow from Operating Activities
• Cash Flow from Investing Activities
• Cash Flow from Financing Activities

Cash Flow from Operating Activities:

• Cash flow from operating activities is generally derived from the principal revenue producing activities of the business.
• Examples of cash flows from operating activities are:
• Cash receipt from sale of goods and rendering of services.
• Cash receipts from fees, commission and other revenues.
• Cash payments to suppliers for goods and services.
• Cash payments to and on behalf of the employees.
• Cash payments or refunds of income taxes.

Cash Flow from Investing Activities:

• Cash flow from investing activities includes cash receipts and payments that arise from Fixed and Long Term assets of the organization.
• Examples of cash flows from investing activities are:
• Cash payments to acquire property plant and equipment. These also include payments made for self- constructed assets.
• Cash receipts from sale of property plant and equipment.
• Cash payments and receipts from acquisition and disposal other long term assets e.g. Shares, debentures, TFC, long term loans given etc.
• If assets are held for trading purposes or in normal course of business e.g. car / property dealers and loans given by banks, then cash flows from them are included in Operating Cash Flow.

Cash Flow from Financing Activities

• Cash flow from financing activities includes cash receipts and payments that arise from Owners of the business and other long term liabilities of the organization.
• Examples of cash flows from financing activities are:
• Cash received from owners i.e. share issue in case of company and capital invested by sole proprietor or partners.
• Cash payments to owners i.e. dividend, drawings etc.
• Cash receipts and payments for other long term loans and borrowings.

Procedure of Preparing Cash Flow

• It is constructed as follows:
• We start from the Profit / Loss for the period before taxation.
• Adjustments are made for non-cash items that are included in the profit and loss account such as Depreciation, Provisions and other items that relate to investing and financing activities.
• This gives us Operating Profit before Working Capital Changes.
• Then Working Capital Changes, i.e. increase or decrease in items of current assets and liabilities, are added / subtracted (Remember, Cash and Cash Equivalents are not included here)
• This gives the Cash Flow from Operations.
• To this figure we add / subtract cash flows from investing and financing activities.
• This gives us Net Increase / Decrease in Cash and Cash Equivalents.
• To this figure we add Opening Balance of Cash and Cash Equivalents (that we excluded from current assets)
• This gives us the Closing Balance of Cash and Cash Equivalents.
• Increase or Decrease is generally taken as difference in opening and closing balances of accounts reported in balance sheets.