Cash Flow Statement- All about Cash Flow Statement, Methods of preparing Cash Flow Statements, Classification of activities for preparing Cash Flow Statement etc.

TABLE OF CONTENTS

  1. What is a cash flow statement?
  2. What are cash flows?
  3. Cash Flow Statement- an essential management tool
  4. Objectives of cash flow statement
  5. Format of cash flow statement
  6. Classification of activities for preparing cash flow statements
    1. Cash flow from operating activities
    2. Cash flow from investing activities
    3. Cash flow from financing activities
  7. Benefits of cash flow statement
  8. Methods of preparing cash flow statement
    1. Direct Method
    2. Indirect Method
  9. A comprehensive example of a cash flow statement

1. What is a cash flow statement?

Cash flow statement is simply an analytical statement that exhibits the flow of incoming and outgoing cash and cash equivalent. It assesses the ability of the enterprise to generate cash and utilise cash. A Cash Flow Statement is one of the tools for assessing the liquidity and solvency of the enterprise.

A cash flow statement is a required financial statement under US GAAP and IFRS whenever a company presents its results of operations for a period. A Cash Flow Statement is considered to be a summarized statement showing sources of Cash Inflows and the application of cash outflows of an enterprise during a particular period of time. It is prepared on the basis of the published data as disclosed by the financial statements of two different financial periods.

2. What are cash flows?

Cash Flows’ implies the movement of cash in and out due to some non-cash items. Receipt of cash from a non-cash item is termed as cash inflow while cash payment in respect of such items as cash outflow. For example, purchasing machinery by paying cash is cash outflow while sale proceeds received from the sale of machinery are cash inflow. Other examples of cash flows include the collection of cash from trade receivables, payment to trade payables, payment to employees, receipt of dividends, interest payments, etc.

Cash management includes the investment of excess cash in cash equivalents. Hence, the purchase of marketable securities or short-term investment which constitutes cash equivalents is not considered while preparing a cash flow statement.

Recommended read: What is Capital Asset Pricing Model (CAPM)

3. Cash flow statement- an essential management tool

A cash flow statement is an essential tool for managerial decision-making. Cash Flow reports the management Net Cash Flow (i.e., cash inflow less cash outflow or vice versa) from each activity of the enterprise as well as of the overall business of the enterprise. The management of the enterprise gets a picture of the movement of cash resources from the Cash Flow Statement and can assess the stronger and weaker area of movement of cash for different activities of the business for drawing up future planning.

4. Objectives of Cash Flow Statement

A Cash flow statement shows the inflow and outflow of cash and cash equivalents from various activities of a company during a specific period. The primary objective of the cash flow statement is to provide useful information about cash flows (inflows and outflows) of an enterprise during a particular period under various heads, i.e., operating activities, investing activities and financing activities.

This information 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.

Recommended read: All about Weighted Average Cost of Capital (WACC)

5. Format of Cash Flow Statement

A cash flow statement is broadly represented as follows 

Cash flow statement of XYZ Co for the period/ year ended 31 Dec 2021

Particulars

Amount $

   

A.     Cash flow from operating activities

xxx

B.     Cash flow from investing activities

xxx

C.     Cash flow from financing activities

xxx

   

Net increase in cash and cash equivalents (A+B+C)

xxx

   

Add: Cash and cash equivalents at the beginning of the period

xxx

   

Cash and cash equivalents at the end of the period

xxx

6. Classification of Activities for preparing cash flow statement

The various activities of an enterprise that result in cash flows (inflows or receipts and outflows or payments) which is the subject matter of a cash flow statement, are to be classified into three categories:

  • Cash flow from operating activities,
  • Cash flow from investing activities, and
  • Cash flow from financing activities so as to show separately

Such a classification of activities helps the users of the cash flow statements to assess the impact of these activities on the financial position of an enterprise and also on its cash and cash equivalents.

cash flow statement

 

a) Cash flow from operating activities

This includes all the cash inflows and outflows generated by the revenue-generating activities of an enterprise like the sale & purchase of raw materials, goods, labour cost, building inventory, advertising, and shipping the product etc.

Following are examples of cash flows from operating activities:

    • Cash receipts from the sale of goods and the rendering of services;
    • Cash receipts from royalties, fees, commissions, and other revenues;
    • Payments of cash to suppliers for goods and services;
    • Cash payments to and on behalf of employees;
    • Receipts and payments of cash of an insurance enterprise for premiums and claims, annuities and other policy benefits;
    • Cash payments or refunds of income taxes unless they can be specifically identified with financing and investing activities; and
    • Cash receipts and payments relating to future contracts, forward contracts, option contracts, and swap contracts when the contracts are held for dealing or trading purposes.
b) Cash flow from investing activities

These activities include all cash inflows and outflows involving the investments that the company made in a specific time period such as the purchase of a new plant, property, equipment, improvements capital expenditures, and cash involved in purchasing other businesses or investments.

The following are examples of cash flows arising from investing activities:

    • Cash payments to acquire fixed assets (including intangibles). These payments include those relating to capitalised research and development costs and self-constructed fixed assets;
    • Cash receipts from disposal of fixed assets (including intangibles);
    • Payments of cash to acquire shares, warrants, or debt instruments of other enterprises and interests in joint ventures (other than payments for those instruments considered to be cash equivalents and those held for dealing or trading purposes);
    • Cash receipts from disposal of shares, warrants, or debt instruments of other enterprises and interests in joint ventures (other than receipts from those instruments considered to be cash equivalents and those held for dealing or trading purposes);
    • Advances and loans in cash made to third parties (other than advances and loans made by a financial enterprise);
    • Cash receipts from the repayment of advances and loans made to third parties (other than advances and loans of a financial enterprise);
    • Receipts and payments of cash relating to future contracts, forward contracts, option contracts, and swap contracts except when the contracts are held for dealing or trading purposes, or the transactions are classified as financing activities
c) Cash flow from financial activities

This activity includes the inflow of cash from investors such as banks and shareholders by getting loans, offering new shares etc, as well as the outflow of cash to shareholders as dividends as the company generates income. They reflect the change in capital & borrowings of the business.

Following are examples of cash flows arising from financing activities:

    • Cash proceeds from issuing common shares preferred equities or other similar instruments;
    • Cash proceeds from issuing debentures, loan notes, bonds and other long-term and short-term borrowing.
    • Repayments of cash of amounts borrowed i.e. redemption of debentures, bonds etc.
    • Cash payments to redeem preference shares.
    • Payment of dividend. 

In simple words, there can be cash inflow or cash outflow from all three activities i.e. operation, investing and finance of a company. The sum of the total cash flows from all these activities can tell how much the company’s total cash inflow/outflow is in a specific period of time.

7. Benefits of Cash Flow Statement

A cash flow statement provides the following benefits:

  • A cash flow statement when used along with other financial statements provides information that enables users to evaluate changes in the net assets of an enterprise, its financial structure (including its liquidity and solvency) and its ability to affect the amounts and timings of cash flows in order to adapt to changing circumstances and opportunities.
  • Cash flow information is useful in assessing the ability of the enterprise to generate cash and cash equivalents and enables users to develop models to assess and compare the present value of the future cash flows of different enterprises.
  • It also enhances the comparability of the reporting of operating performance by different enterprises because it eliminates the effects of using different accounting treatments for the same transactions and events.
  • It also helps in balancing its cash inflow and cash outflow, keeping in response to changing conditions. It is also helpful in checking the accuracy of past assessments of future cash flows and in examining the relationship between profitability and net cash flow and the impact of changing prices.

8. Methods of preparing cash flow statement

There are two methods widely used to prepare cash flow statements and the differences in the methods are basically for ascertaining the cash flow from operating activities. Operating activities are the main source of revenue and expenditure in an enterprise. Net profit/loss as reported in the Statement of Profit & Loss is different from the net cash flow from operating activities as the financial statements are generally prepared on the accrual basis of accounting under which the net income will not indicate the net cash provided by or net loss will not indicate the net cash used in operating activities.

In order to calculate the net cash flows in operating activities, it is necessary to replace revenues and expenses with actual receipts and payments in cash. This is done by eliminating the non-cash revenues and/or non-cash expenses from given earned revenues and incurred expenses. There are two methods of converting net profit into net cash flows from operating activities:

(i) Direct method, and

(ii) Indirect method.

(i) Direct Method

Under the direct method, cash receipts from operating revenues and cash payments for operating expenses are arranged and presented in the cash flow statement. The difference between cash receipts and cash payments is the net cash flow from operating activities. It is in effect a cash basis Statement of Profit & Loss. In this case each cash transaction is analysed separately and the total cash receipts and payments for the period is determined. We may convert accrual basis of revenue and expenses to equivalent cash receipts and payments. Make sure that a uniform procedure is adopted for converting accrual base items to cash base items.

(ii) Indirect Method

Under Indirect Method, the net profit or loss is duly adjusted for the effects of (1) transactions of a non-cash nature, (2) any deferrals or accruals of past/future operating cash receipts, and (3) items of income or expenses associated with investing or financing cash flows. It is important to mention here that under indirect method, the starting point is net profit/loss before taxation and extra ordinary items as per Statement of Profit and Loss of the enterprise. Then this amount is for non-cash items, etc., adjusted for ascertaining cash flows from operating activities.

Accordingly, cash flow from operating activities can be determined using either the Direct method or the Indirect method.

9. Cash Flow Statement- comprehensive example

Problem

From the following information, prepare a Cash Flow Statement for Sample Co INC.

Balance Sheet of Sample Co INC., as on December 31, 

Particulars

2021

2020

Amount $

Amount $

I. Equity and Liabilities

   

    Common Stock (Equity)

700,000

500,000

    Retained Earnings

420,000

250,000

2. Non-current Liabilities

   

    Long-term borrowings- Bank Loan

50,000

100,000

3. Current Liabilities

   

    a)     Trade payables

45,000

50,000

    b)    Other current liabilities

7,000

5,000

    c)     Short-term provisions

50,000

30,000

Total Equity and Liabilities

1,272,000

935,000

     

II. Assets

   

1. Non-current Assets

   

    a)     Property, plant and equipment

   

            Equipment

230,000

200,000

            Furniture

270,000

300,000

     b)    Intangible assets

95,000

100,000

     c)     Non-current Investments

100,000

2. Current Assets

   

     a)     Inventories

130,000

50,000

     b)    Trade Receivables

120,000

80,000

     c)     Cash and cash equivalents

327,000

205,000

Total Assets

1,272,000

935,000

Additional Information

During the year 2021, equipment costing $80,000 was purchased. Loss on sale of equipment amounted to $5,000. Depreciation of $15,000 and $3,000 charged on equipment and furniture. The loan $50,000 was repaid on 31.12.2021. The proposed dividend for the year 2021 was $50,000.

Solution

Cash flow statement of Sample Co INC for the year ended 31 Dec 2021

Particulars

$

   

I. Cash flow from operating activities

 

    Net profit before taxation and extraordinary items

270,000

    Add: Depreciation on equipment

15,000

    Depreciation on furniture

30,000

    Patents written-off

5,000

    Loss on sale of equipment

5,000

    Interest on bank loan

10,000

    Operating profit before working capital changes

335,000

    (-) Decrease in trade payables

(5,000)

    (+) Increase in outstanding rent

2,000

    (-) Increase in trade receivables

(40,000)

    (-) Increase in inventories

(80,000)

Cash generated from operating activities

212,000

    (-) Tax paid

(30,000)

A. Cash Inflows from Operating Activities

182,000

   

II. Cash flows from Investing Activities

 

    Proceeds from the sale of equipment

30,000

    Purchase of new equipment

(80,000)

    Purchase of investments

(100,000)

B. Cash used in Investing Activities

(150,000)

   

III. Cash flows from Financial Activities

 

    Issues of equity share capital

200,000

    Repayment of bank loan

(50,000)

    Payment of dividend

(50,000)

    Payment of Interest on bank loan

(10,000)

C. Cash Inflows from Financing Activities

90,000

   

Net increase in cash & cash equivalents(A+B+C)

122,000

(+) Cash and Cash Equivalents at the beginning of the year

205,000

Cash and Cash Equivalents at the end of the year

327,000

Working Notes

1. Equipment Account

Opening balance

200,000

Add: new purchase

80,000

Total

280,000

   

Bank (Sale of equipment)

30,000

Income Statement (Loss on sale)

5,000

Closing balance

230,000

Depreciation (balancing figure)

15,000

Total

280,000

2. Patents of $5,000 (i.e., $100,000-$95,000) were written-off during the year

3. Depreciation on furniture was $30,000. ($300,000-$270,000)

4. It is assumed that a dividend of $50,000 and tax of $30,000 provided in 2020 has been paid during the year 2021. Hence, the proposed dividend and provision for tax during the year amount to $70,000 and $50,000 respectively.

5. Retained earnings

 

$

Profit and Loss at the end

420,000

(-) Profit and Loss in the beginning

(250,000)

Net Profit during the year

170,000

+ Provision of tax during the year

50,000

+ Proposed dividend

50,000

Net Profit before taxation & extraordinary items

270,000

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