1

Chapter: 8The Cash Flow Statement

LEARNING OBJECTIVES

After you have studied this chapter, you should be able to understand the following Need for a cash flow statement Difference between profit and cash Different types of cash flows Meaning of cash from operating activities, cash from financing activities,

cash from investing activities Relationship between cash from operating activities and operating profit Impact of changes in working capital on profit Format for presenting cash flow statement

2

INTRODUCTION

The basic objective of a cash flow statement (CFS) is to provide relevant information as regards cash receipts and cash payments of an enterprise during the accounting period. CFS shows the movement of cash of an enterprise. It records all cash flows occurred during a particular period.

The Accounting Standard (AS)-3 is the relevant standard for preparing the cash flow statement. According to the AS-3, information about the cash flows of an enterprise is useful in providing users of financial statements with a basis to assess the ability of the enterprise to generate cash and cash equivalents and the needs of the enterprise to utilise those cash flows. The economic decisions that are taken by users require an evaluation of the ability of an enterprise to generate cash and cash equivalents and the timing and certainty of their generation.

PROFIT ALONE NOT SUFFICIENT:In the previous chapter we saw that the profit is determined using the accrual concept and matching concept. So the profit earned during the period may not be same as the cash genereated during the period. Tabbl 8.1 shows cash from operations and the operating profit of some of the well known Indian companies.

Table 8.1Cash and Profit (2006) ( in crores)

 Operating Profit

Cash from Operations

Hindustan Petroleum Corpn. Ltd. -3306.33 521.09Sun Pharmaceutical Inds. Ltd. -26.51 326.18Suzlon Energy Ltd. 875.74 -267Bajaj Auto Ltd. 995.11 1568.04Tata Motors Ltd. 1224.73 217.48

Moreover, the income statement is influenced by the accounting assumptions. Whereas the cash flow is not influenced by the acounting assumptions.

Example 8.1Sales and other relevant financial information are as follows:

Purchased goods for cash = 10,000 Purchased plant on credit = 50,000 Sold goods for cash = 40,000 Paid rent for the period = 5000 Paid for advertisement = 5000

3

Table 8.2 shows the income statement and the cash flow statement.

Table – 8.2: Income Statement and Cash Flow Statement Income Statement Cash Flow Statement

 Assumption

IAssumption

IIAssumption

III    Sales 40,000 40,000 40,000 Sales 40,000         COGS 10,000 10,000 10,000 Less  Rent 5,000 5,000 5,000 Purchases 10,000Depreciation 5,000 10000 16667 Rent 5,000Advertisement 1000 1250 2500 Advertisement 5,000  21,000 26,250 34,167 Total Payment 20,000         Profit 19,000 13,750 5,833   CIH 20,000

Table Above examples shows that the profit decreased by more that 65% from assumption-I to assumption -III where as there was no change in the cash flows.. The change in profit is solely due to the change in the accounting treament of depreciation and amortisation of advertisement.

Assumption-I : life of the plant assumed to be ten years for depreciation. Advertisement cost amortised over five years

Assumption-II: life of the plant assumed to be five years for depreciation. Advertisement cost amortised over four years

Assumption-III: life of the plant assumed to be three years for depreciation. Advertisement cost amortised over two years

Therefore, cash flow information together with the income statement help investors and other users to understand the ability of an enterprise to:

convert profit into cash; meet its obligations; short term and long term; pay dividend make investments in the short run

CASH FLOW STATEMENT Cash flow statement is prepared as the per AS-3. According to the AS-3, a company should prepare a cash flow statement and should present it for each period for which financial statements are presented. It captures all the cash transactions undertaken during a particular period.

CFS records both revenue and capital items: Income statement shows only the revenue incomes and revenue expenses, balance sheet shows the capital receipts and expenditures, whereas, the cash flow statement shows all types of cash flows. The distinction between capital and revenue is not relevant while preparing CFS. For example: Salary paid (revenue expense), Purchased Plant (capital expense), Advertisement for launching a new product (deferred revenue expense) all are shown in the cash flow statement for the period.

It records all cash flows even if it previous years, or future years. For example: Advance premium paid (relating to the next year), Arrear salary paid (relating to the previous year) both are recorded

4

in the cash flow statement. Table 8.3 shows some typical cash inflows (receipts) and cash outflows (payments).

Cash and Cash Equivalents: The term cash and cash flows are not uniquely defined. Cash includes cash and cash equivalents. According to AS-3, Cash equivalents are held for the purpose of meeting short-term cash commitments rather than for investment or other purposes. For an investment to qualify as a cash equivalent, it must be readily convertible to a known amount of cash and be subject to an insignificant risk of changes in value. Therefore, an investment normally qualifies as a cash equivalent only when it has a short maturity of, say, three months or less from the date of acquisition.

COMPONENTS OF CASH FLOW STATEMENTThe cash flow statement should report cash flows during the period classified by operating, investing and financing activities. Cash flow statement explains the reasons for changes in cash and cash equivalents detailing out cash flow on various heads. Three are important components of the CFS are:

Cash flow from financing activities. Cash flow from investing activities; Cash flow from operating activities;

Cash flow from financing activities (CFF)Financing activities are those activities that result in changes in the size and composition of the equity capital and borrowing of the enterprise. Cash inflows from financing activities include the following:

Proceeds from issuing equity instruments; Proceeds from issuing bonds, mortgages, notes and from other short or long term

borrowing.

Cash outflows from financing activities include the following

Repayment of amount borrowed; Capital element of finance lease payments; Buyback of shares; Payment of expenses or commissions on any issue of shares, debentures, loans, notes,

bonds and other financing.

Cash from financing activities may be negative or positive. Negative CFF means the company has paid off loans or redeemed capital or bought back capital or distributed dividend. Positive cash flows may be due to raising of funds in the form of capital or loans.

5

S

Exhibit 8.1 shows the cash from financing activities of NALCO

Source: Annual Report of NALCO

It can be seen from the Exhibit 8.1 that during the year 2006, NALCO did not raise any funds from the market. However, during 2005, the company redeemed more than Rs. 650 crores. Negative cash from financing activities of NALCO was due to distribution of dividend.

Example 8.1ABC started business with capital of Rs. 10,000. It took 12% loan of Rs. 200,000; from IDBI bank . Used the funds to purchase stock of goods. Sold entire stock for 400,000. Interest for the year was fully paid. The company also paid 25,000 towards other expenses. Table 8.3 shows the cash from financing activities.

Table 8.3Cash Flow From Financing ActivitiesReceipts  Capital 100,00012% Loan 200,000

Total Receipts 300,000Payments  Interest 24000

Total Payments 24000CFF 276,000

Example 8.2Assets and sources of ABC ltd as on 1st April 2006 were as follows:

Capital : 100,000 12% Loan: 200,000 Cash: 50,000 Other assets : 250,000

During the year, the company declared 20% dividdend and distributed the amount. At the beginning of the year (on 1st May) repaid 50% of loan. Interest on balance amount paid on time. Table 8.4 shows the cash from financing activities.

6

Exhibit 8.1: (Rs. in crores) 2006 2005

Table 8.4 Cash Flow From Financing ActivitiesReceipts  

Total Receipts 0Payments  Loan repaid 100000Interest 13000Dividend paid 20000

Total Payments 133000CFF -133,000

Cash flow from investing activities (CFI)

Investing activities relate to the acquisition and disposal of long term assets and other investments not included in cash equivalents. Cash inflows from investing activities include the following:

Sale of shares of other companies Sale of bonds and ,debentures of other companies Dividend received Interest received. Receipts from sale of property, plant equipment and other productive assets; Receipts from derivative transactions

Cash outflows from investing activities include the following:

Purchase of shares of other companies Purchase of bonds and ,debentures of other companies Purchase of property, plant equipment and other productive assets; Payments for derivative transactions

Cash from investing activities may be negative or positive. Negative CFI means the company has paid for acquiring assets. Positive cash flows may be due to the sale of assets or due to the receipt of dividend and interest on the investments made.

7

Exhibit 8.2 shows the cash from investing activities of NALCO

Exhibit 8.2 shows that NALCO increased continued to acquire fixed assets. During the last two years the company did not make any non-operating investment. The negative CFI in 2006 is exclusively due to the acquisition of fixed assets.

Example 8. 3On 1st April 2005, ABC started business with capital of Rs. 10,000. It took 12% loan of Rs. 200,000; from IDBI bank . Used the funds to purchase stock of goods for Rs. 50,000. It acquired plant costing 100,000 on credit and shares costing 100,000 for cash. Sold entire stock for 400,000. Interest for the year was fully paid. The company also paid 25,000 towards other expenses. Sold 50% of the shares at Rs. 60,000. During the year it also received Rs. Rs. 5000 as dividend. Table 8.5 shows the cash flow from investing activities (CFI).

Table 8.5Cash Flow From Investing Activities

Receipts  Sale of share 60000Dividend received 5000   

Total Receipts 65000Payments  Purchase of shares 100000   

Total Payments 100000CFI -35,000

Example 8. 4

8

Exhibit-8.2: Rs. in crores 20052006

Refer to the example 8.3.During 2006, company received dividend of Rs. 10,000. No other transactions. Table 8.6 shows the cash from investing activities (CFI).

Table 8.6Cash Flow From Investing Activities

Receipts     Dividend received 100000   

Total Receipts 100000Payments  Purchase of shares 0   

Total Payments 0CFI 100,000

Example 8. 5

Transactions of ABC ltd for the year 2005 were as follows. Started business with capital 100,000 Took 12% loan on 1st July 200,000 Purchased plant on credit 50,000 Purchased stock for cash 50,000 Purchased furniture for cash 10,000 Purchased stock on credit from X 100,000 Sold 50% stock for cash 200,000 Rent per month 2,000 Purchased 12% Bonds of Z ltd 25,000 Rent paid 24,000 Interest on bonds received 3000 Dividend paid : 20,000 Interest on loan paid 24,000

Table 8.7 shows cash flow from financing and cash from investing activities.

Table 8.7

9

Cash Flow From Investing Activities Cash Flow From Financing ActivitiesReceipts   Receipts  Interest received on bonds 3,000 Capital received 100,000    12% Loan 200,000

Total Receipts 3,000 Total Receipts 300,000Payments   Payments  Purchase of bonds 25,000 Interest paid 24,000Purchase of furniture 10,000 Dividend paid 20,000

Total Payments 35,000 Total Payments 44,000CFI -32,000   CFF 256,000

Observe that interest received on bonds is cash from investing activities, whereas interest paid on loan is cash from financing activities.

Issues of shares is a financing activities, whereas purchase of shares of another company purchased is an investing activity.

Dividend paid is a financing activity, whereas dividend received is an investing activity.

Cash flow from operating activities (CFO)Operating activities are principal revenue producing activities of the enterprise and other activities that are not investing or financing activities. Some example of cash flow from operating activities:

Cash receipts from the sale of goods and the rendering of services; Cash receipts from royalties, fees, commissions and other revenue; Cash receipts and payments from contracts held for dealing or trading

purposes; Cash payments to suppliers for goods and services; Cash payment to and on behalf of employees; Cash payments for income tax and refunds of income tax unless

specifically identified with financing or investment activities.

According to the AS-3, a company can prepare cash flows from operating activities using either:

the direct method, whereby major classes of gross cash receipts and gross cash payments are disclosed; or

the indirect method, whereby net profit or loss is adjusted for the effects of transactions of a non-cash nature, any deferrals or accruals of past or future operating cash receipts or payments, and items of income or expense associated with investing or financing cash flows.

Direct approach – Under direct approach operating cash flow information is obtained from the cash book- cash receipts and payments can be classified and aggregated under the usual heads of accounts.

Cash from Operations : = (Cash Sales + Collections from Customers) less ( Payment for purchase of revenue goods and Payment towards revenue expenses)

10

Example 8.6Refer to the 8.5. Table 8.8 shows cash from operating activities using the direct method.

Table 8.8Cash Flow From Operating ActivitiesReceipts  Cash sales 200,000   Total Receipts 200,000Payments for stock 50,000Rent paid 24,000Dividend paid 0Total Payments 24,000CFO 176,000

Example 8.7

Some of the transactions of ABC for the year ending March 2006 were as follows: Started business with capital 100,000 Purchased goods for cash 80,000 Paid salaries 20,000 Sold 20% of goods for cash 40,000 Paid rent 8,000

Table 8.9 shows the cash from operating activities.Table 8.9

Cash Flow From Operating ActivitiesReceipts  Cash sales 40,000   Total Receipts 40,000Payments for stock 80,000Rent paid 8,000   Total Payments 88,000

CFO -48,000

Though the cash from operating activities is negative, profit for the period is positive as shown by the table 8.10.

Table 8.10Income Statement

Income  

11

Sales 40,000   Total Income 40,000COGS 16,000Rent paid 8,000

Total Expenses 24,000Profit 16,000

Indirect Approach –Direct method is most appropriate for deriving operating cash flow because major heads of cash receipts and payments are disclosed. However, the SEBI has recently notified to follow indirect method only. Indirect method helps in reconciling the cash with profits. Table 8.11 shows cash from operating activity and profit before taxes.

Table 8.11Cash from Operations and Profit of NALCO

(in crores)  2006 2005Profit before Taxes 2753 2359Cash from Operations 1965 1723

Why is Cash from operations different from profit? We had seen in the previous chapter that every receipt is not an income and every payment is not an expense. So profit, which is the excess of income over the expense, may not be equal to the cash in hand. Some of the reasons may be as follows:

Depreciation Financing charges (interest) Provisions Change in Creditors/Debtors Capital losses or profit (profit/loss on sale of assets )

Under indirect cash approach cash flow form operating activities can be derived as follows:

Net profit or loss Add : Non-cash charge such as depreciation, provisions, deferred taxes,

unrealized foreign exchange losses; Add: Charges which are classified as part of investment or financing activities; Less : Non-cash income such as depreciation and other write backs; Less : Income which are classified as part of investment or financing activities. Add/Less : Changes in inventories, operating receivables and payables.

Exhibit 8.3 shows CFO of NALCO (Rs. in crores)

12

Source: Annual Report of NALCO

In the indirect method effort is being made to reconcile profit with cash from operating activities. We had discussed in the chapter 7 that Profit is determined on the basis of the accrual concept and matching concept. Profit in the income statement also shows income and expense relating to other non-operating activities. Figure 8.1 shows the relationship between CFO and profit for the period.

Non-cash items: While preparing the income statement some non-cash items are also recorded. Some of the common non-cash items are: depreciation, amortisation, writing off research expenses, provisions for doubtful debts.

Changes in working capital: Income statement is prepared on the basis of the accrual concept. So expenses due but not paid and incomes due but not received are also recorded in the income statement. Such items are reflected through current assets and current liabilities. Difference between current assets and current liabilities is called working capital.

Example 8.8

13

CFO =CFO = Profit Profit Non cash items

Non cash items

Changes in working capital

Changes in working capital

+ or

-

+ or

-

Following are the assets and corresponding sources of ABC ltd.: Capital= 20,000; 12% loan = 50,000; Debtors = 30,000; and Furniture = 40,000 as on 1st April 2006. During the first quarter of 2006 the company had the following transactions:

Purchased stock on credit = Rs. 30,000 Sold 50% of the stock for cash = Rs. 30,000 Paid rent = Rs. 3,000 Collection from the debtors = Rs.20,000 Interest due but not paid

Table 8.12 shows the profit for the first quarter and the corresponding cash from operating activities using the direct method.

Table 8.12Income Statement for the quarter CFO for the quarterIncome   Receipts  Sales 30,000 Cash sales 30,000Total Income 30,000 Collections 20,000COGS 15,000 Total Receipts 50,000Rent 3,000 Payments for stock 0Depreciation 2000 Rent paid 3,000Interest 1,500    Total Expenses 21,500 Total Payments 3,000

Profit 8,500   CFO 47,000

Now let us find CFO using the indirect method and reconcile profit with CFO. However, to determine the CFO through indirect method we the opening and closing balance sheet. Table 8.13 show the opening and closing balance sheet.

Table 8.13Balance sheet of ABC ltd.

  Opening ClosingCapital 20,000 20,000Loan 50,000 50,000Profit   8,500Creditors   30000Outstanding Interest   1,500  70,000 110,000Debtors 30,000 10,000Furniture 40,000 38,000Cash   47,000Stock   15,000  70,000 110,000

We had discussed in the previous paragraph that the to determine CFO from profit, we have to find the determine the non-cash item, non-operating, and working capital changes.

Non cash items = Depreciation =Rs. 2,000 Non operating items= Interest = 1,500 Working capital change

o Increase in creditors = 30,000o Decrease in debtors = 20,000

14

o Increase in stock = 15,000

Table 8.14 shows the CFO using the indirect method

Depreciation is a non-cash item. While calculating profit, it has been deducted so it has to added back to be profit to determine the cash from operating activities.

Interest is a non-operating item. While calculating profit, interest has been deducted so it has to be added back to profit to determine the cash from operating activities.

Decrease in debtors. Debtors decreased from 30,000 to 10,000 due to collections. However, collection is not an income of the current year. It has not been shown while calculating the profit. So it has to be added to the profit to determine the cash flow.

Increase in creditors. COGS is shown as an expense. However, money had not been paid. Increase in creditors show that the company has purchased goods on credit. So it has to be added to the profit to determine the CFO.

Example 8.9Following are the relevant financial transactions of ABC ltd for the year ending March 2006.:

Table 8.14 Cash Flow from Operating Activities

Profit 8,500Add Non Cash item  

Depreciation 2000Add Non-Operating Item  

Interest 1,500Change in the working capital  Add  

Increase in creditors 30,000Decrease in debtors 20,000

Less  Increase in stock 15,000

CFO 47,000

15

CFO = 47,000

CFO = 47,000

Profit 8,500Profit 8,500 Non cash items2000

Non cash items2000

Changes in working capital35,000

Changes in working capital35,000

+ +

Non Operating

items1500

Non Operating

items1500

+

Increase in Current Assets reduces CFODecrease in Current Asset increases CFODecrease in Current Liabilities reduces CFOIncrease in Current Liability increases CFO

Started business with Capital 50000 Took 12% loan 50000 Purchased stock on credit 50000 Sold 50% of stock for cash 50000 Purchased furniture for cash 20000 Purchased shares for cash 20000 Depreciation on furniture 2000 Expenses for the year 10000 Expenses paid 6000 Dividend received 10000 Dividend distributed 5000

Table 8.15 shows different cash flows

Table 8.15

Cash from Financing (CFF)Cash from Investing Activities

(CFI)Cash from Operating

Activities(CFO)Capital 50,000     Sales 50,00012% Loan 50,000 Dividend 10,000    

Total Receipts 100,000 Total Receipts 10,000 Total Receipts 50,000Less          Dividend distributed 5,000 Payment for furniture 20,000 Expenses 6,000    Payment for shares 20,000    

Total Payments 5,000 Total Payments 40,000 Total Payments 6,000           

CFF 95,000   CFI-

30,000   CFO 44,000

PATTERN OF CASH FLOWSTable 8.16 summarises the patterns of cash flows. Most of the financially strong companies will have positive CFO. Cash generated from operations can be used for reducing loan reduction or capital reduction.

Table 8.16

 Situation

1Situation

2Situation

3Situation

4Situation

5Situation

6

Cash from Operation (CFO) Negative Positive Positive Negative Positive Negative

Cash from Financing (CFF) Positive Negative Negative Positive Positive Negative

Cash from Investing (CFI) Positive Positive Negative Positive Positive Negative Which is the best combination and why?

INTERRELATIONSHIP BETWEEN INCOME STATEMENT, CASH FLOW STATEMENT, AND BALANCE SHEET

16

Cash flow statement, Income statement, and balance sheet are interrelated. Change in the balance sheet on two dates can be explained with the income statement and cash flow statement. Let us take the following transactions and see the impact on the financial statements:

Capital: Increase or decrease: Will affect the cash flow statement Expenses: Paid: affects cash flow statement and income statement Expenses due but not paid: affect income statement and balance sheet. No effect on the

cash flow statement Income received: affects cash flow statement and income statement Income due but not received: affects income statement and balance sheet Purchase of asset for cash: affects cash flow statement and balance sheet Purchase of assets on credit: affects balance sheet Interest paid: affects income statement and cash flow statement Interest due but not paid: affects income statement and balance sheet

One can prepare the cash flow statement if the opening and closing balance sheet and the income statement for the period are given.

Example 8.10Balance sheet of ABC ltd is as follows:

Balance Sheet

 31st March

0631st March

07Capital 50,000 100,00012% Loan 50,000 30,000Profits 50,000 70,000Creditors 50,000 50,000  200,000 250,000Cash 50,000 40,000Debtors 50,000 20,000Plant 50,000 45,000Shares 50,000 145,000  200,000 250,000

Several items of the balance sheet changed during the year. Income statement and cash flow statement can explain the change in the balance sheet.

Capital increased by 50,000: Cash flow item Loan decreased by 20,000: Cash flow item No change in creditors. No purchases or payment can be assumed. Debtors decreased by 30,000: Cash flow item Plant decreased by 5000: Expense or loss: Income statement item Shares increased by 95,000: Cash flow item Profit increased by 20,000: Income statement item. However, there is depreciation of Rs.

5000. so it can be assumed that the company earned an income (commission received, dividend received) of Rs. 25,000.

Table 8.10Income Statement Cash Flow Statement

17

Dividend 25,000 Opening Balance 50,000    Dividend 25,000Total Income 25,000 Capital 50,000    Collection 30,000Depreciation 5,000 Total Receipts 155,000    Payment  Total Expense 5,000 Loan 20,000    Shares 95,000    Total Payments 115,000Profit 20,000   Closing Balance 40,000

Example 8.10

ABC ltd. lost several documents and reports due to fire. The accounts officer could put lay his hands on the opening and closing balance sheet as shown by table 8.10

Table 8.10Balance Sheet of ABC ltd.

  Opening ClosingCapital 50,000 70,000Reserves 20,000 30,000Loan 20,000 10,000  90,000 110,000Fixed Assets 40,000 38,000Stock 30,000 20,000Cash 20,000 22,000Debtors   30,000  90,000 110,000

He also collected the following data from his team members: Sales 30,000 Rent paid : 5000 Interest paid: 1000 Tax paid : 1000

The accounts office was asked to prepare the cash flow statement and income statement for the period.

a. Capital

o Opening Capital + Money Raised = Closing Capitalo 50,000 + 20000 = 70,000

b. Loan

18

o Opening Loan - Money Repaid = Closing Loano 20,000 – 10,000 = 10,000

c. Reserveso Opening Reserves + Current Profit = Closing Reserveo 20,000 + 10,000 = 30,000

d. Fixed Assetso Opening Assets - Depreciation = Closing Asseto 40,000 -2,000 = 38,000

e. Stock o Opening stock – COGS = Closing stocko 30,000 – 10,000 = 20,000

f. Casho Opening + Receipts – Payments = Closing casho 20,000 + 20,000 – 18,000 = 22,000

g. Debtorso Opening + Credit Sales – Receipts = Closing Casho 0 + 30,000 – 0 = 30,000

Table 8.11 shows the relevant financial statements

Table 8.11 Opening Balance Sheet Cash Flow Statement for the yearCapital 50000 Receipts  Reserves 20000 Capital 20000Loan 20000 Total Receipt 20000

Total 90000 Loan 10000Fixed Assets 40000 Rent 5000Stock 30000 Interest 1000Cash 20000 Tax 2000    Total Payments 18000

Total 90000 CIH 2000     Closing Balance Sheet Income Statement for the yearCapital 70000 Sales 30000Reserves 30000 COGS 10000Loan 10000 Rent 5000

Total 110000 Depreciation 2000Fixed Assets 38000 Interest 1000Stock 20000 PBT 12000Cash 22000 Tax 2000Debtors 30000    

Total 110000   PAT 10000

19

KEY TERMS

Cash flow statement: Cash flow statement is prepared as the per AS-3. CFS shows all cash inflows and outflows for a particular period. CFS records both revenue and capital items: Income statement shows only the revenue incomes and revenue expenses, balance sheet shows the capital receipts and expenditures, whereas, the cash flow statement shows all types of cash flows.

Cash equivalents: Cash equivalents are held for the purpose of meeting short-term cash commitments rather than for investment or other purposes. For an investment to qualify as a cash equivalent, it must be readily convertible to a known amount of cash and be subject to an insignificant risk of changes in value.

Financing activities: Financing activities are those activities that result in changes in the size and composition of the equity capital and borrowing of the enterprise.

Investment activities: Investing activities relate to the acquisition and disposal of long term assets and other investments not included in cash equivalents.

Operating activities: Operating activities are principal revenue producing activities of the enterprise and other activities that are not investing or financing activities.

Operating profit: Excess of operating income over the operating expenses is operating profit.

Cash from financing activities(CFF): CFF is result of the financing activities. Cash from financing activities may be negative or positive. Negative CFF means the company has paid off loans or redeemed capital or bought back capital or distributed dividend. Positive cash flows may be due to raising of funds in the form of capital or loans.

Cash from investing activities (CFI): CFI is the result of the investing activity of a company. Cash from investing activities may be negative or positive. Negative CFI means the company has paid for acquiring assets. Positive cash flows may be due to the sale of assets or due to the receipt of dividend and interest on the investments made.

Cash from Operating activities (CFO): CFO is the result of the operating activity of a company. CFO depends profit generating ability of a company. CFO can be determined by direct method or by using indirect method.

Direct method of determining CFO: Under direct approach operating cash flow information is obtained from the cash book- cash receipts and payments can be classified and aggregated under the usual heads of accounts.

Indirect method of determining CFO: Under indirect method effort is being made to reconcile profit with cash from operating activities. Profit is adjusted for non-cash items, non-operating items and changes in the working capital

20

Theoretical Questions1. What is cash equivalents?2. Distinguish between cash and profit.3. Classify the cash flows.4. What is cash from operating activities (CFO)?5. What is the treatment of dividend and interest received and paid?6. Distinguish between cash from operating activities and operating profit.7. Examine the relationship between profit and cash from operating activities.8. Why is cash generated during the year generally not equal to profit for the year?9. Briefly explain the provisions of the Accounting Standard (AS)-310. Examine the impact of the changes in the working capital on the cash from operating

activities. 11. When will the cash from investing activities (CFI) be negative?12. Explain with example the impact of depreciation on the cash from operating activities.13. Examine the implications of having positive CFF, negative CFI, and negative CFO.14. Can a company have positive profit and huge negative CFO?15. Examine the implications of having negative CFF, negative CFI, and positive CFO.16. A company having profit will always have positive cash from operating activities (CFO).

Comment.17. Changes in working capital will no effect on CFO. Comment.18. Buy back of shares will increase the cash from financing activities (CFI).19. Dividend paid and dividend received will affect the cash from financing activities (CFF).

Comment.20. Examine the impact of the following transaction of CFO:

a. Paid salariesb. Purchased goods on creditc. Interest receivedd. Interest paide. Profit on the sale of fixed assetsf. Issued capital at a premiumg. Collections from old debtors.h. Buy back of shares

Numericals 1. Following are the transactions of XYZ ltd for the year ending March 2006:

Started business with capital = 200,000 Issues shares to the public = 10000 shares of Rs. 10 at a premium of 50% Took 10% loan = 100,000 Purchased plant on credit = 50,000 Purchased stock of goods for cash = 50,000 Purchased shares of MN ltd. = 50,000 Sold 50% of shares of MN ltd for Rs. 40,000 Interest due but not paid = 10,0000 Sold 50% of stock of goods for cash = 50,000 Expenses for the period = 20,000 Expenses paid = 15,000

Required: Cash flow statement. 2. Following are the transactions of XYZ ltd for the year ending March 2006:

21

Issues shares to the public = 20000 shares of Rs. 10 at a premium of 50% Took 10% loan = 200,000 Purchased plant for cash = 50,000 Purchased stock of goods on credit = 50,000 Purchased shares of XY ltd. = 150,000 Sold 50% of shares of MN ltd at a profit of 50% on cost Interest paid = 10,0000 Sold 50% of stock of goods for cash = 50,000 Expenses for the period = 20,000 Expenses paid = 15,000 Depreciation = 10%

Required: Cash from investing activities, cash from financing activites, and cash from operating activities.

3. Following transactions are entered into by A & Co. during January 2006. Prepare the necessary financial statements. Show the CFO, CFF, CFI.

(i) Started business with furniture valued at Rs. 12,000(ii) Owners introduced Rs. 100,000 in cash(iii) Issued 10000 shares of Rs.10 at a premium of Rs.50.(iv) Purchased goods for sale for Rs. 50,000 from B & Co. on credit(v) Purchased goods for cash: Rs.50,000(vi) Sold goods costing Rs. 20,000, at Rs. 30,000 on cash basis (vii) Sold goods costing Rs. 40,000, to C & Co. for Rs. 75,000 on credit(viii) Paid Rs. 1,000 towards freight and paid Rs. 5,000 towards salary.(ix) Lost goods for sale for Rs. 10,000 due to fire.(x) Interest accrued but not due on 10% IDBI Loan: Rs. 1,000(xi) Paid Rs. 12,000 towards annual insurance premium .(xii) Realized Rs. 47,000 from C & Co. in full and final settlement.(xiii) Charged depreciation on furniture Rs. 100(xiv) Paid the money due to B&Co and received discount of Rs. 5,000(xv) Conveyance charges paid to the staff Rs. 500

4. Following are the transactions of XYZ ltd. for the year ending March 2006:

Started business with Capital 50000 Took 12% loan 50000 Purchased stock on credit 50000 Sold 50% of stock for cash 50000 Purchased furniture for cash 20000 Purchased shares for cash 20000 Depreciation on furniture 2000 Expenses for the year 10000 Expenses paid 6000 Dividend received 10000 Dividend distributed 5000

Required: Cash from investing activities, cash from financing activites, and cash from operating activities.

5. Following are the transactions of XYZ ltd. for the year ending March 2006: Started business with Capital 150,000

22

Took 12% loan 150,000 Purchased stock on credit 150,000 Sold 50% of stock for cash 150,000 Purchased furniture for cash 20,000 Purchased shares for cash 20,000 Depreciation on furniture 2000 Expenses for the year 10,000 Expenses paid 20000 Dividend received 10000 Dividend distributed 5000

Required: a) Cash from investing activities (CFI), cash from financing activites (CFF), and cash from

operating activities (CFO).b) Reconcile profit with cash from operating activities (CFO)

6. Following is the balance sheet of XYZ limited as on 31st March 2006:Balance Sheet

Capital 100,00012% loan 150,000  250,000Stock 70,000Debtors 80,000Furniture 40,000Plant 50,000Cash 10,000  250,000

Transactions during the first quarter of 2006 are given below: Purchased stock on credit 30,000 Sold 50% of the stock for cash 80,000 Paid rent 3,000 Collection from the debtors 20,000 Salaries for a month2,000 Salaries paid 24,000 Insurance premium for the year paid 6,000

Required: All Financial statements CFO using indirect method

7. Share capital on 1.1. 99 = 200,000, Share capital on 1.1.2000 = 500,000Bonus shares issued during the year = 50000Debentures converted into share = 100,000Buy back of share = Rs. 200,000Find Cash from financing activities

8. ABC ltd. issued 10,000 shares of Rs. 10 at 25. Took 12% loan of Rs. 200,000. Money raised was used as follows: 20% to buy stock of goods;

23

30% to buy plant 40% to shares of XYZ ltd. Balance was retained as cash

During the first quarter, sold the entire stock on credit for Rs. 80,000 and sold the shares of XYZ ltd. at a profit of 50% for cash. Depreciation for the year =10,000; Required: Cash flow statement 9. Net profit after depreciation and tax is Rs. 35000. Depreciation is 15000. A total sale was Rs.

Rs. 1,00,000 of which 60% was on credit. Cost of the goods was 25% of the sales. Entire purchase was on credit. Find Cash from Operation.

10. Following are some of the financial statements of ABC ltd.

TableBalance Sheet as on30th June 02

Sources     Assets    Share capital 500,000 550,000 Fixed assets 600,000 540,000

Reserves and surplus 250,000 127,500 Bonds 50,000 012% Long term borrowings 150,000 100,000 Stock 200,000 150,000

Outstanding Salary   20,000 Debtors 200,000 145,000

Accrued Interest   4,500 Advance Rent 0 12,000

Creditors 200,000 200,000 CIH 50,000 155,000

TOTAL 1,100,000 1,002,000   1,100,000 1,002,000

Cash Flow Statement for Apr- June 02

Receipts Amount Payments Amount

Opening Cash 50,000 12% Long term borrowings 50,000

Cash Sales 250,000 Creditors 100,000

Collections from customers 150,000 Salaries 60,000

Dividend Received 2,000 Rent 36,000

Fixed Assets   Fixed Assets 100,000

Interest on Bonds 5,000 Electricity Charges 6,000

Investments 60,000 Dividend Paid 10,000

    CIH 155,000

  517,000   517,000

The CEO of the company, Ms. K, is very happy as the cash position improved considerably. We

have increased our cash by 3 times, whereas our competitor1 has lost cash. That's a big jump, she

thought. She had big plans for expansion and is planning to approach her friends to sell the shares

of the company. However, for further clarity she consulted Ms. J, the financial controller of her 1

24

company. J gave her an enigmatic smile and said the devil is in the income statement, K. Bad

Debts during the quarter were Rs.5000.

Prepare the Income Statement and check whether you would be interested to buy the shares. You

are also required to prepare CFS as per the AS-3.

11. ABC is a sports equipment sales company. During 1999, the company replaced Rs. 18000 of its fully depreciated equipment with new equipment costing Rs. 23000. Although a mid year dividend of Rs. 5000 was paid, the company found it necessary to borrow Rs.5000 from its bank. Further borrowing may be needed since cash account is dangerously low at the year-end. The president of the company, Ms. Saha was not happy with the financial position. To get a clear picture of the business, she collected the following Income Statement and a rough statement of cash flows.

25

Income Statement (1999-2000)Items AmountSales 1,95,000Cost of Goods Sold 1,40,000Operating Expenses and taxes 49,700

Net Profit 5,300

Cash Flow (1999-2000) : Rough StatementItems AmountCash Received :

a) Net Income: 5,300b) Depreciation: 5,000

Cash from Operation: 10,300c) Loan from Bank 5,000

d) Debentures Raised 16,000TOTAL CASH GENERATED 31,300

Cash Paida) New Equipment 23,000

b) Dividends 5,000TOTAL PAYMENT 28,000

INCREASE IN CASH 3,300

Ms. Saha seeks your help. Specifically, she wants to know why the cash flow statement shows net cash generated during the year as Rs. 3,300, when the cash balance decreased from Rs. 15,000 to Rs.500 during the year. Also, why is depreciation shown as cash received? She asked you to see the company’s balance sheet if required.

Balance SheetItems Amount Amount

Cash 500 15,000Debtors 17,800 13,200

Stock 28,500 17,500Prepaid Expenses 700 300

26

Equipment 40,000 35,000Less Depreciation -11,000 -24,000

TOTAL ASSETS 76,500 57,000Creditors 8,700 10,000

Outstanding Expenses 600 1,100Bank Loan 5,000 -Debentures 16,000 -

Share Capital 40,000 40,000Retained Earnings 6,200 5,900

TOTAL LIABILITIES 76,500 57,000

Required: (a) Correct Cash Flow Statement showing why the company is having such a difficult time

keeping sufficient cash on hand.(b) Answer the president’s questions.

12. Transactions of XYZ ltd for the year ending March 06: Started business with capital 100,000 Took 12% loan on 1st July 200,000 Purchased plant on credit 50,000 Purchased stock for cash 50,000 Purchased furniture for cash 10,000 Purchased stock on credit from X 100,000 Sold 50% stock for cash200,000 Rent per month 2,000 Purchased 12% Bonds of Z ltd 25,000 Rent paid 24,000 Interest on bonds received 3000 Dividend Paid 20000 Interest on loan paid 24000

Required: Cash flow statement using the AS-3

13. On 1st April 2006 A, B, and C floated a company “Buy N Sell” with own funds of Rs. 50,000 each and immediately issued 10,000 shares of Rs.100 issued at premium of 10% to their friends. The company purchased 100 shares of Microsys (@ Rs.2500) on 20th April and deposited the balance money in a Short Term (9 months) Deposit Scheme of Zltd. The rate of interest on the deposit is 18% per annum. Sold the shares on 15th June 01 @ Rs. 3650. Declared and distributed dividend of 10%

Transactions for the first quarter of 2006 were as follows:

27

Purchased 10% bonds of XY ltd. for Rs. 1 lakhs and 10000 shares of SAIL @

Rs.4

Purchased the right to buy a building by paying Rs. 100000 and sold the right

within a week a hefty premium of 85%.

Gave short-term advance to another company: Rs. 50000. Collected Rs. 60000

after 15 days.

Bought two old maruti cars @ Rs. 2.5 lakhs from Delhi and sold one of them at

profit of 25%.

Gave Rs. 20,000 to the MD of a company. MD became insolvent. Only 10% of

the money given could be collected.

Commission paid to the agents: Rs.25000. Rent and other expense per month

Rs.10000

Purchased a piece of land at Rs.5 lakhs and sold the same to a housing company

at a profit of 20% on the sales. Tax paid: 2% on the sales proceed.

Purchased 100 shares of Satyam at Rs. 250.

Sold all shares of SAIL @ Rs.6.50.

Purchased a car for office use: Rs.5 lakhs

A visited Singapore to explore new business avenues: Expenses incurred

Rs.50000.

Sponsored the local cricket match: Rs.25000

Purchased the right to sell tickets for the match for Rs. 100000. Expenses

incurred for selling the tickets Rs.30000. Sale proceeds from the tickets Rs.

220000.

Paid Rs. 20 000 to an accountant to prepare the necessary financial statements.

Required: Cash flow statement and Income statement

1. You are given : The Balance Sheets of a company as on 31st Mar 01/ 31st Mar 02 and the Income Statement of the company for the year 2001-2002. Depreciation : Plant and Machinery 20%, Furniture 5%, Computer 20%

28

Balance Sheet as on 31st March, 2001Liabilities In Rs. Assets In Rs.

Capital ACapital BShare CapitalLoan from ICICI at 10%Creditor X ltd.Interest AccruedOutstanding ExpensesProfit

50,00050,000

1,50,00060,00020,0006,0004,000

20,000

Plant & MachineryFurnitureComputer for office useDebtor C ltd.Investment SAIL at 25%Rent paid in advanceStockCash in hand

50,0005,000

30,00019,00050,00012,000

1,50,00044,000

Total 3,60,000 Total 3,60,000

Income Statement for 2001-2002Expenses In Rs. Incomes In Rs.

Cost of Goods soldDepreciation :

Plant & MachineryFurniture

ComputerBad debtsRentInterest (ICICI)

100,000

10,000250

6,0005,000

12,0006,000

SalesInterest (SAIL)Loss

1,25,00012,5001,750

Total 1,39,250 Total 1,39,250

Balance Sheet as on 31 st March, 2002

Liabilties In Rs. Assets In Rs.Capital ACapital BShare CapitalShare PremiumLoan from ICICI at 10%Creditor X ltd.Outstanding ExpensesProfit- Loss

50,00050,000

2,00,00060,00060,00020,0004,000

20,0001,750

Plant & Machinery (-Depr.)FurnitureComputer for office useInvestment SAIL at 25%StockCash in hand

40,0004,750

24,00050,00050,000

2,93,500

Total 4,62,250 Total 4,62,250

Required: Cash Flow Statement for the year 2001-2002

From the following Balance Sheets And Income Statement of XYZ Ltd., prepare a Cash Flow Statement:

29

Balance Sheet as on 31st March 2001

Sources Rs. Applications Rs.

Share capital 239000 Fixed Assets 180000

Reserves and Surplus 32800 Investments 45900

Loan from IDBI 51300 Inventories 24000

Short term loans 8300 Debtors 62000

Creditors 6000 Cash and Bank 25500

337400 337400

Balance Sheet as on 31st March 2002

Sources Rs. Applications Rs.

Share Capital 251000 Fixed Assets 210000

Reserves and Surplus 48450 Investments 64400

Loan from IDBI 56000 Inventories 24000

Short term loans 7750 Debtors 57500

Creditors 6500 Cash and Bank 16800

Salaries due but not paid 3000

372700 372700

Income Statement

Expenses Rs. Incomes Rs.

Opening Stock 24000 Sales:

Purchases: Cash 148700

Cash 48000 Credit 32000

Credit 30400

Depreciation 24000 Income From Investments 5800

Interest 7500

Salary 35000

Rent 15500

Advertising Expenses 8500

Telephone Charges 1950

Profit 15650

186500 186500

1. Following are the balance sheet and income statement of Altd. Balance Sheet

Sources Assets

30

  2001 2002   2001 2002

Share Capital 100000 200000 Plant and Machinery 100000 120000Debentures 70000 30000 Investments 30000 80000

Creditors 28000 82000 Debtors 10000 40000Tax Payable 0 6000 Cash 40000 10000Profit and Loss A/c 16000 20000 Prepaid Expenses 4000 8000      Stock 30000 80000

  214000 338000   214000 338000

During the year debentures were converted into share

Income StatementSales 200000  Less COGS Other Expenses

Opening Stock 30000 General Expenses 22000Purchase 196000 Depreciation 16000

Closing Stock 80000 Taxes 8000  146000 Total Expenses 46000

Profit after Tax 8000Dividend 4000

Required: Cash flow statement as per Accounting Standard-3

31

Real Life Questions1. Satyam Computer Services Ltd. of Hyderabad was incorporated in 1987 as a private limited

company. The company was set up with the objective of providing software development and consultancy services to large corporations. In 1991, it was converted into a public limited company. To become an end-to-end IT solutions player in the areas of consulting, systems integration, products, application development and maintenance services, Satyam Computers merged its three subsidiary companies. The merger was with effect from April 1, 1999. As on that date the assets and liabilities are as follows (Rs. Crore):

a) Gross Fixed Asset = Rs. 338.17, Accumulated Depreciation = 93.30, b) Investments = Rs. 39.02 , Debtors = 132.24c) Share Capital = 166.92, Reserves and Surplus = 140.90d) Borrowings = 248.27, Creditors = 28.79

Following is the abstract of Income Statement and Cash Flow Statements of Satyam Computer Services Ltd.

Income Statement 1st April 99 to 31st 2000 Cash Flow Statement

1st April 99 to 31st 2000Items Amt. (Rs. crores)Sales 677.07Other Incomes 1.94Salaries 269.82Repairs Expenses 9.59 Items Amt. (Rs.crores)Advertising 33.53 Opening

Cash168.75

Other Expenses 117.58 Collection from Customers

524.49

Excise Duty 0.61 Raised Capital 58.24Interest 40.88 Raised Loans 46.60Depreciation 71.02 Purchase of F.

Assets94.82

Tax 6.00 Purchase of Investments

53.18

Profit After Tax 129.98 Interest paid 39.78Tax paid 5.9

Dividends 12.78 Dividend paid 12.24Dividend Tax 1.41 Closing Cash 592.16Retained Profit 115.79

Required: Balance sheet of Satyam Computer Services Ltd. as on 31st March 2000.

32

2. Following are the cash transactions and other relevant information of Nalco for year ended 31st March 2005: Source: http://www.nalcoindia.com

a. Opening cash in hand: 98.34 croresb. Cash purchase of fixed assets = 126.72c. Cash sale of investments = 200d. Cash redemption of debentures= 214e. Repayment of loans = 440f. Interest income for the period: 12g. Interest received = 21h. Interest for the period = 60i. Interest paid = 69j. Increase in inventories = 61k. Increase in debtors = 69l. Decrease in creditors = 88m. Dividend paid = 437n. Tax paid = 636o. Profit before tax (PBT) = 1870p. Depreciation = 459q. Non- cash expenses = 13r. Loss on sale of assets = 1.0

Required : Cash Flow Statement

3. Cash Flows of some Indian companies:

  India Cements ACC Madras CementsCash from Operation 85.74 84.22 66.77  Cash from Financing 419.17 -83.04 -64.54  Cash from Investing -584.13 -15.61 -44.09  

Give your comments.

33

34