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Cash Flow Statement
Session Four
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Rationale
Profit alone is not sufficient. ± accrual & matching concept
± accounting assumptions
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Cash Flow Statement
A statement that presents the inflows andoutflows of cash to and from an organization dueto various transactions in a given accountingperiod.
Helps assess the ability of an enterprise togenerate cash & cash equivalents and to utilizethe same.
Also helps to assess the liquidity and solvency of the entity.
AS 3 issued by the ICAI guides the preparation of cash flow statement in India.
SEBI ± Clause 32 of the listing agreement of stock exchanges
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Basic Elements
Cash flow from operating activities:
Principal revenue producing activities of theenterprise
Cash flow from investing activities:
Acquisition and disposal of long term assetsand investments (other than thoseconsidered in cash equivalents)
Cash flow from financing activities:
Activities that result in change in size andcomposition of owners¶ capital (equity) andborrowings of the enterprise
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Cash Flow Statement Format
Cash Flows from Operating Activities [A] Cash flows from Investing Activities [B]
Cash Flows from Financing Activities [C]
Net increase/(decrease) in cash and cashequivalents [A+B+C] [D]
Opening balance of cash and cashequivalents [E]
Closing balance of cash and cash equivalentsF =[D+E]
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Operating Activities
It is the principle revenue generating activities of an entity
Two ways of calculating it
Direct method
major classes of gross cash receipts andgross cash payments are disclosed -changesthat cash transactions cause in revenue &expense accounts are analyzed.
Indirect method The Profit and Loss Account is adjusted for
the effects of transactions of non-cash andnon-operating nature
Also known as ³Reconciliation to Net Income´
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Cash flow from Operating Activities: Indirect
Method
A. Start with Profit before tax from P&L a/c B. Adjust for Non cash items:
» Add Non cash expenses -Depreciation & other non cashamortizations, provisions for liabilities
C. Adjust for Non operating items
» Add Non operating expenses - Interest costs and other non operating expenses
» Deduct Non operating income
» Deduct Non recurring income
» Deduct Actual cash tax paid
D. Operating Profit before working capital adjustment(Adjusting A B & C)
E. Working capital adjustments Changes in current assets and current liabilities (other than cash
and cash equivalents)
Cash flow from operating activities (D +/- E)
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Illustration ± KK Ent.
Particulars Rs. Particulars Rs.
Purchases for the Year
Direct Expenses
Gross Profit
Total
80,000
20,000
65,000
1,65,000
Sales
Total
1,65,000
1,65,000
Rent
Salary
Provision for taxNet Profit
8,000
20,000
2,00035,000
Gross Profit B/d65,000
Profit & Loss AccountFor the Year ending 31st March 20X9
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Solution ± Direct Method
Cash Flow From Operating Activities:
Cash received on account of sale of goods 1,65,000
Less: Payment made on account of
Purchases of goods 80,000
Freight and Cartage 20,000
Salary Paid 20,000Rent Paid 8,000
Tax paid during the year 2,000 1,30,000
Cash Inflow 35,000
Kk EnterprisesCash Flow Statement
For the Year ending 31st March 20X9(all figures in Rs)
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Illustration ± KK Ent.
Particulars Rs. Particulars Rs.
Purchases for the Year
Direct Expenses
Gross Profit
Total
80,000
20,000
65,000
1,65,000
Sales
Total
1,65,000
1,65,000
Rent
Salary
Depreciation
Provision for Bad Debts
Proposed Dividends
Interest on debt
Preliminary Exp. written off
Profit before taxes
Provision for taxes
Profit after taxes
8,000
20,000
15,000
5,000
10,000
2,500
1,500
16,000
2,000
14,000
Gross Profit B/d
Profit on sale of oldmachinery
65,000
13,000
Profit & Loss AccountFor the Year ending 31st March 20X9
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Solution ± Direct Method
Cash Flow From Operating Activities:
Cash received on account of sale of goods 1,65,000
Less: Payment made on account of
Purchases of goods 80,000
Freight and Cartage 20,000
Salary Paid 20,000
Rent Paid 8,000Tax paid 2,000
Cash Inflow 35,000
Kk EnterprisesCash Flow Statement
For the Year ending 31st March 20X9 (all figures in Rs)
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Solution ± Indirect Method
Cash Flow From Operating Activities:
PBT as per Profit & loss Account 16,000Add: Non-cash transaction
Provision for Bad Debts 5,000Depreciation 15,000Proposed Dividends 10,000Interest on debt 2,500Preliminary Expenses written off 1,500 34,000
Less: Non-operation incomesProfit on sale of machinery 13, 000Tax paid during the year 2,000
Cash Inflow before working capital changes 35,000Working capital changes NILOperating Cash Flow 35,000
Kk Enterprises
Cash Flow Statement
For the Year ending 31st March 20X9 (all figures in Rs)
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Illustration ± KK Ent.
Particulars Rs. Particulars Rs.
Purchases for the Year
(cash ± 60000, credit ± 20000)
Direct Expenses
(Cash 12000, due ± 8000)
Gross Profit
Total
80,000
20,000
65,000
1,65,000
Sales
(Cash ± 100000
Credit ± 65000)
Total
1,65,000
1,65,000
Rent
Salary
(Paid ± 15000,Due - 5000)
DepreciationProvision for Bad Debts
Proposed Dividends
Interest on debt
Preliminary Exp. written off
PBT
Provision for taxesProfit after taxes
8,000
20,000
15,0005,000
10,000
2,500
1,500
16,000
2,00014,000
Gross Profit B/d
Profit on sale of old
machinery
65,000
13,000
Profit & Loss Account
For the Year ending 31st March 20X9
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Solution ± Direct Method
Cash Flow From Operating Activities:
Cash received on account of sale of goods 1,00,000
Less: Payment made on account of
Purchases of goods 60,000
Freight and Cartage 12,000
Salary Paid 15,000
Rent Paid 8,000
Tax paid 2,000
Cash Inflow 3,000
Kk EnterprisesCash Flow Statement
For the Year ending 31st March 20X9 (all figures in Rs)
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Solution ± Indirect Method
Cash Flow From Operating Activities:
PBT as per Profit & loss Account 16,000Add: Non-cash transaction
Provision for Bad Debts 5,000
Depreciation 15,000
Proposed Dividends 10,000
Interest on debt 2,500
Preliminary Expenses written off 1,500 34,000
Less: Non-operation incomes
Profit on sale of machinery 13,000
Tax paid 2,000
Cash Inflow before working capital changes 35,000
Increase in Debtors (outflow) - 65,000
Increase in Creditors (Inflow) + 20,000
Increase in Accruals (Inflow) + 8,000
Increase in Accs-salary (Inflow) + 5,000 32,000
Operating Cash Flow 3,000
Kk Enterprises
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Investing Activities
Activities related to acquisition and disposalof long-term assets and other investments,which are not taken into considerationunder the cash equivalents head areinvesting activities
Also includes investments made bybusiness entities in other company¶s sharesand debentures
Examples of investment activities include
cash payments or receipts to acquire or dispose fixed assets, shares, debtinstrument, etc.
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Illustration - Kanishk
The following transactions occur at Kk Enterprises:
Particulars Amount
(Rs.)Purchased a machinery for 1,50,000
Sold shares worth 2,00,000
Received interest on debentures
purchased earlier 10,000
Received dividend on shares held 20,000
Sold old machinery (including profit on
sale 13,000)
50,000
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Solution
Cash Flow from Investing Activities:
Sale of Shares 2,00,000
Interest received 10,000
Sale proceeds of old machinery 50,000
Dividend received 20,000
2,80,000
Less: Outflow on a/c of machine purchase 1,50,000
Cash flow from Investing Activities 1,30,000
Kk EnterprisesCash Flow Statement
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Financing Activities
The activities that result in the change in size andcomposition of the long-term capital employed in thefirm are known as financing activities
Includes both owner(s) capital and long-term borrowingof the entity
Example: cash received from issue of share capital,issue of loans and cash payment on dividend,redemption, etc.
Supposing during the year Kk Enterprises has taken aloan of Rs 1,50,000 and paid an interest of Rs 2,500
thereon, the cash flow from financing activities for theyear comes to Rs 1,47,500 (i.e., 1,50,000 - 2,500)
Thus Net Cash Flow for Kk Ent. = CFO (3,000) + CFI(1,30,000) + CFF (1,47,500) = 2,80,500
Adjusting for Opening cash balance say Rs 5,000
would give closing cash balance of Rs 2,85,500
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Recap
Proceeds from the sale of equipment used in thebusiness ± A/B/C or supplemental info
The loss on sale of equipment as above
Declaration and payment of dividends on
company's stock
An increase in the balance in retailer'smerchandise
Retirement of long term bonds payable
The amortization of the cost of an intangibleasset
The exchange/conversion of long-term bonds
into common stock
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Recap
A corporation reported the following information for the past year:
Net Income $200,000
Depreciation Expense 30,000
Gain on Sale of Truck 5,000Proceeds from Sale of Truck 8,000
Decrease in Accounts Receivable 10,000
Assuming these are the only facts, what amount will thecorporation report as the CFO on the cash flowstatement?
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Items that do not figure in cash flow
statement
The following transactions have noimpact on cash flow:
± Issue of bonus shares
± Conversion of loan to equity ± Acquisition of business with shares
± Purchase of Fixed assets on credit
All the above items have no immediatecash impact
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Issues
Interest received on long-term investments vis-à-
vis interest received on short-term investments
(including interest on trade advances and
operating receivables)
Interest paid on loans and debts vis-à-vis interest
paid on working capital loan
Dividend received in case of financial enterprises
vis-à-vis dividends received by any other type of
enterprise
Dividend paid is always classified as financing
activity
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Cash Flow statement: A simple
illustrationBalance Sheet as on 31/03/07 31/03/06
SOURCES OF FUNDS:
Paid up share capital 300 250
Share premium 50 0
General reserve 200 150
Profit & Loss Account 75 50
Loans 275 200
TOTAL S OUR CES 900 650
APPLICATION OF FUNDS:
Gross block 900 700
Less: Accumulated Depn. -425 -350
Net Block 475 350
Investments 100 150
Net current assets 250 100
(excl. cash and bank balances)
Cash and bank balances 75 50
TOTAL APPLI C ATION 900 650
Investments are sold at a profit of Rs. 25
Interim dividend paid Rs.20
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Pattern of cash flows
Most of the financially strong companieswill have positive CFO
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Cash flow statement: How to inter pret?
Identify the major sources of cashinflows and cash outflows.
Compare capital expenditure with
depreciation number. See how operating cash flows are being
utilized.
Find out whether the enterprise isgrowing. If yes, whether organically or inorganically.