Analysis of cash flow statements

By- BarkhaHarit Rahul

Meaning of financial statement analysis

• The analysis of financial statements is a systematic process of the critical examination of the financial information contained in the financial statements in order to understand and make decisions regarding the operations of the firm.

• The analysis of financial statements is the study of relationship among various financial facts and figures as set out in the financial statements i.e. balance sheet and profit and loss account.

• According to Myer, ‘’financial statement analysis is largely a study of relationships among various financial factors in a business as disclosed by a single set of statements, and a study of trends of these factors , as shown in a series of statements.”

Tools of financial statement analysis

• Comparative financial statements• Common size statements• Trend percentages ratio analysis• Fund flow statement • Cash flow statement

Changes in the financial positionBalance sheet gives a summary of the firms resources and obligations at a point of time, the profit and loss account reflects the results of the business operations during a period of time.These statements fail to explain the changes in assets , liabilities and owners equity.So additional statement is needed to show the changes and it as referred to as the statement of changes in financial position. 1) Change in assets and liabilities resulting from financial and

investment transactions during the period.2) The way in which the firm used its financial resources

during the period.

Meaning of cash flow statement

• Cash flows are inflows and outflows i.e. movement of cash and cash equivalents.

• All transactions that lead to an increase in cash and cash equivalents are classified as inflows of cash.

• All those transactions that lead to decrease in cash and cash equivalents are classified as outflows of cash.

• Cash flow statement is prepared classifying the transactions into:

1)Operating activities 2)investing activities 3) financing activities

As per accounting standard-31) Cash –comprises cash on hand and demand

deposits with banks.2) Cash equivalents- are short term , high liquid

investments that are convertible into known amount of cash.

3) Cash flows- are inflows and outflows of cash and cash equivalents.

Uses of cash flow statement

1. Short term planning 2. Understanding liquidity and solvency3. Efficient cash management4. Comparative study5. Reasons for cash position 6. Test for the management decisions

Classification of cash flows

1) Operating Activities :Operating activities are the principal revenue producing activities of the enterprise and the other activities that are not related to investing or financing activities.Examples:• Cash receipts from the sale of goods and services • Cash received from royalties , fees and commission etc• Cash payments to supplier of goods• Cash payments to and behalf of employees for wages.The net effect of the operating activities on the flow of cash is reported as cash flow or cash used in operating activities in the cash flow statement.

2) Investing activities – investing activities are the acquisition and disposal of the long term assets and other investments, not included in cash equivalents. These activities include transactions involving purchase and sale of the long term productive assets.Examples:• Cash payments to acquire fixed assets.• Cash receipts from disposal of the fixed assets.• Cash payments to purchase shares, warrants and debt

instruments.• Cash receipts from sale of shares , warrants or debt

instruments.• cash receipts from future ,forward, option and swap

contracts.

3) Financing activities :Financing activities are the activities which result in changes in the size and composition of the owners capital and borrowings of the enterprise from other sources.Examples :• Cash proceeds from the issue of the shares or other

instruments.• Buy back of shares • Cash proceeds from the issue of debentures and other

short term borrowings.• Payment for interest on debentures and loans.• Payments of dividends both equity shares and

preference dividends.

CASH FLOW STATEMENT for the year ending….. ( direct method )

A. Cash flow from operating activities : Cash receipts from customers cash paid to suppliers and employees Cash generated from operating activities Income tax paid

Cash flow before extraordinary items (+) or (-) Extraordinary items

Net cash from operating activities

B. Cash flows from investing activities : Purchase of fixed assets sale of fixed assets purchase of investments (long-term) sale of investments (long –term) interest received dividend received Net cash flow from investing activities

…………….. (……………)

…………….. (……………. )

…………….. …………….

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(……………) …………… (………….) …………… ………….. …………..

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C. Cash flow from financing activities : proceeds from issue of share capital proceeds from long term borrowings repayments of long term borrowings Interest paid Dividend paid

Net cash from financing activities

Net increase (or decrease) in cash and cash equivalents (A + B + C) Cash and cash equivalents at the beginning of the period Cash and cash equivalents at the end of the period

……………… …………….. (…………..) ……........ …………….

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Cash flow statement for the year ending….(indirect method)

PARTICULARS AMOUNT AMOUNT

A. Cash flow from operating activities : Net profit before tax and extraordinary items Adjustments for : Depreciation Foreign exchange Loss on sale of fixed assets Gain on sale of fixed assets Interest paid Interest received Dividend received

Operating profit before working capital changes Add : Decrease in current assets Increase In current liability

Less : Increase in current assets …………… decrease in current liability …………..

……………

……………. …………….. …………….. (……………) ……………. (…………..) (…………..) ----------------- …………… …………… …………… ------------------- (…………….)

Cash generated from operating activities Income tax paid

Cash flow before extraordinary items (+) or (-) Extraordinary items

Net cash from operating activities

B. Cash flows from investing activities : Purchase of fixed assets sale of fixed assets purchase of investments (long-term) sale of investments (long –term) interest received dividend received Net cash flow from investing activities

B. Cash flow from financing activities : proceeds from issue of share capital proceeds from long term borrowing repayments of long term borrowings

…………….. (……………)

…………….. …………….

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(……………) …………… (………….) …………… ………….. …………..

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……………. …………… (………….)

……………..

……………

Interest paid Dividend paid

Net cash from financing activities

Net increase (or decrease) in cash and cash equivalents (A + B + C) Cash and cash equivalents at the beginning of the period Cash and cash equivalents at the end of the period

(……………) (……………)

…………….. -------------------

……………. ----------------

…………….

……………. …………….

The cash flow from the operating activities is ascertained by the adjustment for non cash and non operating items & adjustment of current assets and liabilities related to operating activities

The cash flow from the investing activities is ascertained by analysing the changes in fixed assets and long term investments in the beginning and end of the year.

The cash flow from the investing activities is ascertained by analysing the change in equity and preference share capital , debentures and other borrowings.

Points To Be Taken Into Consideration- The net cash flow from the activities can e positive or

negative. The sum of the cash flow from all the activities taken

together , together with the opening cash and cash equivalents , shall be equal to closing cash and cash equivalents.

A single transaction may include cash flows belonging to the two different activities.

Issue of shares and debentures for consideration other than cash are not taken into account while preparing cash flow statement.

Any inflow and outflow of cash and cash equivalents are also not taken into account.

Limitations of cash flow statement

1. Non cash transactions are ignored 2. Not a substitute for an income statement3. Historical in nature

Relation between the three activities

OPERATING ACTIVITIES INVESTING ACTIVITIES FINANCING ACTIVITIES

The amount of the cash flow arising from the operating activities is the key indicator of the extent to which the operations of the enterprise have generated cash i.e. whether the cash generation is adequate to maintain operating capability of the enterprise , pay dividends , repay loans , and make new investments. It is also helpful in future cash flows from operations.

The amount of the cash flow arising from the investing activities represents the extent to which expenditure has been incurred to generate future income and cash flows.

The amount of the cash flows arising from financing activities is useful in assessing the claims of the future cash flows by providers of funds to the enterprise.