Module 6 : Cash Flow

Lecture 1 : Cash Flow Statement

Objectives In this lecture you will learn the following Introduction Cash Flow Statement. Meaning. Applicability. Cash and Cash equivalents. Meaning and Types Cash Flow. Operating Activities. Investing Activities. Financing Activities. Interest. Dividend. Foreign Currency transactions. Extraordinary items. Treatment of Tax. Investments in subsidiaries, associates and joint ventures. Acquisitions and disposals of subsidiaries and other business units. Non-cash transactions. Disclosures of cash and cash equivalents.

Introduction

Traditional financial statement fails to inform the way enterprise has generated cash and were utilised in the accounting period.

The need for inclusion of cash summary was therefore recognised.

Meaning

The summary of cash transactions (receipts and payments) during an accounting period is called Cash Flow Statement. The transactions are catagorised as Operating, Investing and Financing.

Accounting Standard

The ‘Accounting Standards’ are issued to establish principals and policies which have to be complied by the business entities in preparing the financial statement.

AS-3

AS-3/IAS-7/IndAS-7 deals with preparation of Cash flow Statement.

AS-3 applies to the enterprises:

Having turnover more than Rs. 50 Crores in a financial year. Listed companies.

Cash and Cash Equivalents Cash:-

Cash in hand and deposits repayable on demand with any bank or other financial institution.

Cash Equivalents:- Short term, highly liquid investments, that are readily convertible into known amounts of cash and are subject to insignificant risk/change to value.

Meaning of Cash Flow

Cash flows are inflows (i.e. receipts) and outflows (i.e. payments) of cash and cash equivalents. Movement in cash and cash equivalents are not cash flows.

Types of Cash Flow The cash flows generated through various activities are classified as

Operating cash flow. Investing cash flow. Financing cash flow.

Operating Activities

These are principal revenue producing activities of the enterprise. Examples: Cash receipts from sale of goods or rendering services. Cash receipts from royalties, fees, commissions and other revenue. Cash payments to suppliers of goods and service. Cash payments to and on behalf of employees.

Reporting of Cashflow from operating activities

It can be derived either from direct method or indirect method. Direct method: In this method, gross receipts and gross payments of cash are disclosed.

Direct Method Cash receipts from customers XX Cash paid to suppliers XX Cash paid to employees XX Cash paid for other operating expenses XX Cash generated from operation XX Income tax paid XX Net cash from operating activities XX Indirect method: In this method, profit and loss account is adjusted for the effects of transaction of non- cash and non-operating nature. Cash flow statement of listed companies shall be presented only under the indirect method as prescribed in AS 3.

Retained Earning XX Add: Dividend paid XX Income Tax XX Net Profit Before Tax XX Add: Depreciation XX Loss on sale of Asset/Investment XX Interest Paid XX Provision for Bad debts XX Less: Interest/ Dividend Received XX Profit on sale of Asset/ Investment XX Funds from operations XX Add: Decrease in Current Asset XX Add: Increase in Current Liabilities XX Less: Increase in Current Asset XX Less: Decrease in Current Liabilities XX Cash generated from operation XX Income Tax Paid XX Net Cash flow from operating activities XX

Investing Activities

The activities of acquisition and disposal of long term assets and other investments not included in cash equivalent are investing activities. It includes acquiring and disposal of debt and equity instruments, property and fixed assets etc. Examples: Cash payments for purchase of fixed assets. Cash receipts from disposal of FAs. Cash payments to purchase shares, or debt instruments of other companies. Cash receipt from disposal of above investments.

Financing Activities

Those activities that result in changes in size and composition of owners capital and borrowing of the organization. It includes receipts from issuing shares, debentures, bonds, borrowing and payment of borrowed amount, loan etc.

Financing Activities Example: Issue of equity shares. Buy back of equity shares. Issue/ Redemption of preference shares. Issue / redemption of debentures. Long term loan / payment thereof. Dividend / interest paid.

Interest

Interest Received

Received on investment – it is investment inflow. Received from short term investment classified, as cash equivalents should be considered as cash inflows from operating activities. Received on trade advances and operating receivables should be in operating inflows. For financial enterprises – in operating inflow.

Interest Paid

On loans/debts is financing activities. On working capital loan or loan taken to finance operating activities are included in operating inflows. For financial enterprises – in operating outflow.

Dividend

• Dividend Received

For non-financial enterprises – investing inflow. For financial enterprises – operating inflow.

• Dividend Paid

Always classified as financing inflow.

Foreign currency transactions

The effect of change in exchange rate in cash and cash equivalents held in foreign currency should be reported as separate part of the reconciliation of cash and cash equivalents. Unrealized gain and losses arising from changes in foreign exchanges rates are not cash flows.

Extraordinary items

Ex. loss by Fire

The cash flows associated with extraordinary items should be classified as arising from Operating, Investing or Financing activities as appropriate and separately disclosed.

Example:

Insurance claim received against loss of stock or profits is extraordinary operating cash inflow. Insurance claim received against loss of fixed assets is extraordinary investing cash inflow.

Treatment of tax

Cash flow for tax payments / refund should be classified as cash flow from operating activities. Tax deducted at source against income are operating cash outflows if concerned income are operating. Cash flow for tax payments identified with a specific investing or financing flow should be classified as investing or financing flow respectively. E.g. Dividend Tax is recognised as financing flow. Investments in subsidiaries/ associates

Only the cash flow between enterprise itself and the investee is required to be reported. Example: Cash flow relating to dividends and advances.

Acquisitions and disposals of subsidiaries/other businesses

Cash flow on acquisition and disposal of subsidiaries and other business units should be :

Presented separately, Classified as investing activities. Total purchase and disposal should be disclosed separately. The position of the purchase / disposal consideration discharged by means of cash and cash equivalents should be disclosed separately.

Non-cash transactions

These should be excluded from the cash flow statement. These transactions should be disclosed in the financial statements. Examples Acquisition of assets by assuming directly related liabilities. Acquisition of an enterprise by means of issue of equity shares. Conversion of debt to equity.

Disclosures of cash and cash equivalents

The components of cash and cash equivalents should be disclosed. Reconciliation of the amount in the cash flow statement with the equivalent items reported in the balance sheet. The amount of cash and cash equivalent balance held by the enterprises that are not available for use (with explanation by management). The amount of undrawn borrowing facilities that may be available for future operating activities (indicating any restriction on use of these facilities).