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