Chapter-21 Cash Flow Analysis

CHAPTER 14
CASH FLOW ANALYSIS

The objective of financial statements of a business enterprise is to provide information about the financial position,
performance and cash flows that is useful for economic decision-making by the stakeholders including the
management involved in managing the business, potential investors existing and potential lenders and other
creditors who are not in a position to demand reports tailored to meet their particular information needs.
Presentation of a statement of cash flows is required because users of financial statements find that information
useful. Information about the historical cash flows of an entity provides users of financial statements with a basis to
assess the ability of the entity to generate and utilize cash and cash equivalents for the liquidity of the business
enterprise. In the previous lesson, you have learnt various types of analysis of financial statements and its tools
such as comparative statements, common size statement and trend analysis, etc. You have also learnt various
kinds of accounting ratios such as liquidity, activity, profitability, solvency, etc. You have learnt that accounts are
mainly maintained on accrual basis but cash also plays significant role. Cash is mainly generated for operating
activities which is buying assets and discharging liabilities. Cash is also raised from the issue of shares and
debentures or loans but adequate cash should be available for use in time and no cash should remain idle. For this
another tool of analysis is used which is cash flow statement.
LEARNING OBJECTIVES
In this lesson, you will learn about:

 Understand the meaning of Cash Flow Statement
 Know the Accounting Standard -3 and its application
 Identify the transactions which cause inflow or outflow of cash
 Differentiate between Funds Flow Statement and Cash Flow Statement.
LEARNING OUTCOMES
The purpose of this chapter is to examine the type of information provided in this statement and see how it is used in
decision making. After completing this chapter, you should be able to:
 Collect the information required for Cash Flow Statement, organise it and use for decision making.
 Calculate the different types of cash flows from different activities that are important for decision makers
 Report cash flows in the financial statements of your organization.
 Use Cash Flow Statement for future planning and decision making.
STRUCTURE
14.0 Introduction
14.1 Meaning of Cash Flow Statement
14.2 Advantages of Cash Flow Statement
14.3 Fund Flow Statement Vs. Cash Flow Statement
14.4 Direct and the Indirect Methods
14.5 Accounting Standard 3
14.6 Cash Flow from Operating Activities
14.7 Cash from Investing Activites
14.8 Cash from Financing Activities
14.9 Utility of Cash Flow Statement
14.10 Limitations of Cash Flow Statements
14.11 Common adjustments
14.12 Determination of Cash Flow
14.13 Share Capital
14.14 Purchase or Sale of Fixed Assets
14.15 Cash Flow and Return
14.16 Solved Illustrations
14.17 Summary
14.18 Key Terms
14.19 Suggested Answers
14.20 Test Your Understanding
14.21 Apply Your Knowledge
14.22 Problem, Evaluation, Decision Making
14.23 Case Study
14.24 Project Work
14.0 INTRODUCTION
Historical cash flow information is an important source of information about an organisation’s cash which has its impact on
the profitability of the business. When used in concurrence with other financial statements, the statement of cash flows
provides information that enables users to evaluate the changes in net assets of an entity, its financial structure including
its liquidity and solvency and its ability to affect the amounts and timing of cash flows in order to adapt to changing
circumstances and opportunities.
A cash flow statement can be used to assess the timing, amount and predictability of future cash flows and it can be used
as the basis for budgeting. The cash flow statement can be used to answer the questions like, ‘Where did the money come
from?’ ‘Where did it go?’ A cash flow statement is also a key to understanding the investment and financing beliefs of a
borrower. It will be used by the banker of the enterprise to answer the question, “Does this company have enough cash to
make payments on a loan?”
14.1 MEANING OF CASH FLOW STATEMENT

The purpose of the cash flow statement is to represent how cash is generated and used and in projecting whether cash will
be generated from those sources in the future and in assessing the organisation’s future cash needs. When presenting
cash flow statements, most companies combine cash and cash equivalents because short-term investments classified as
cash equivalents are used primarily as a substitute for cash. A statement of cash flows is required by Generally Accepted
Accounting Principles to be included in annual financial statements every year.
14.2 ADVANTAGES OF CASH FLOW STATEMENT

The importance of cash to a business enterprise can be explained with importance of blood to a human body. A firm needs
cash to make payment to its suppliers, to incur day-to-day expenses and to pay salaries, wages, interest and dividends etc.
The business enterprise needs to maintain an adequate balance of cash considering the nature, volume and existing
circumstances. For example, a business enterprise operating in profitably is not able to pay dividends as it does not have
sufficient cash. What message does it convey to the shareholders and public in general?. Thus, management of cash is
very essential. The management should focus on movement of cash and its equivalents. Cash means, cash in hand and
demand deposits with the bank. Cash equivalent consists of bank overdraft, cash credit, short term deposits and
marketable securities.
14.2.1 Information on Cash Cash flow statement provides information about the cash receipts and payments of a
inflows and outflows business enterprise for a given period. The statement deals with the historical changes in
cash and cash equivalents of an enterprise which classifies cash flows during the period from
operating, investing and financing activities. This statement is additional information to the
users of Financial Statements. The statement also represents the capability of the enterprise
to generate cash and utilise it.
14.2.2 Analyse the Transactions which increase the cash position of the entity are called as inflows of cash and
components bringing those which decrease the cash position as outflows of cash. Cash flow Statement shows the
changes in the cash different sources which bring in cash such as cash from operating activities, sale of current
flows and fixed assets, issue of share capital and debentures etc. and applications which cause
outflow of cash such as loss from operations, purchase of fixed assets, redemption of
debentures, preference shares and other long-term debt for cash
14.2.3 Planning the future Cash flow statement helps in planning the repayment of loan schedule and replacement of
payments fixed assets, etc.
14.2.4 Future financial Cash is the centre of all financial decisions. It is used as the basis for the projection of future
planning investing and financing plans of the enterprise. It helps in efficient and effective management
of cash. Cash flow statement helps to ascertain the liquid position of the firm in a better
manner. Banks and financial institutions mostly prefer cash flow statement to analyse liquidity
of the borrowing enterprise.
14.3 DISTINCTION BETWEEN FUND FLOW STATEMENT AND CASH FLOW STATEMENT
Some of the main difference between a fund flow statement and a cash flow statement are described below :
14.3.1 Concept of funds A fund flow statement is prepared on the basis of a wider concept of funds which is based on
net working capital whereas cash flow statement is based on narrower concept of funds
based on cash only.
14.3.2 Basis of accounting A fund flow statement is prepared on the basis of accrual basis of accounting, whereas a
cash flow statement is based upon cash basis of accounting. Due to this reason, adjustments
for incomes received in advance, incomes Outstanding, prepaid expenses and outstanding
expenses are made to compute cash earned from operations of the business. No such
adjustments are made while computing funds from operations in the funds flow statement.
14.3.3 Method of preparation A fund flow statement depicts the sources and application of funds. If the total of sources is
more than that of applications then it represents increase in net working capital and on the
contrary if the total of applications of funds is more than that of sources then the difference
represents decrease in net working capital.
A cash flow statement depicts opening and closing balance of cash, and inflows and outflows
of cash. In a cash flow statement, to the opening balance of cash all the inflows of cash are
added and from the resultant total all the outflows of cash are deducted. The resultant
balance is the closing balance of cash.
14.3.4 Adjustment of current While preparing a funds flow statement the changes in current assets and current liabilities
assets and current are not directly represented in the funds flow statement as these changes are shown in a
liabilities separate statement known as schedule of changes in working capital. In a cash flow
statement no distinction is made between current assets and fixed assets, and current
liabilities and long-term liabilities. All changes are summarised in the cash flow statements.
14.3.5 Nature of planning A cash flow statement aims at helping the management in the process of short term financial
planning. A cash flow statement is useful to the management in assessing its ability to meet
its short term obligations such as trade creditors, bank loans, interest on debentures, and
dividend to shareholders and so on. A fund flow statement on the other hand is very helpful in
intermediate and long-term planning, because though it is difficult to plan cash resources for
two, three or more years ahead yet one can plan adequate working capital for future periods.
14.4 PRESENTING CASH FLOWS STATEMENT USING THE DIRECT AND THE INDIRECT METHODS
The direct method presents operating cash flows by major classes of gross cash and gross payments. In contrast, the
indirect method calculates operating cash flows by adjusting profit or loss for the effects of income and expenses 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. The choice of method relates only to the presentation of
operating cash flows. The amounts presented for net cash from (or used in) operating activities is unaffected by the
accounting policy elected. The presentation of cash flows from investing and financing activities is unaffected by the
manner in which operating cash flows are presented.
Direct Method
Particulars
1 Cash flows from operating Activities
1.1 Operating Cash Receipts
Cash Sales
Cash received from customers
Trading commission received
Royalties received
1.2 Less: Operating cash Payments
Cash purchases
Cash paid to creditors
Cash payments for business expenditures
1.3 Cash generated from Operating Activities ( 1.1-1.2)
1.4 Less: Income tax paid
1.5 Cash flow before extra ordinary item
1.6 Adjusted extra ordinary items (+/-) Receipts or Payments
1.7 Net cash flow from ( or used in ) operating activities
2 Cash from investing accounting

Net cash from (or used in) investing activities
( Calculation is same as in the Indirect Method) +
3 Cash flows from financing activities
Net cash from (or used in) financing activities
( Calculation is same as in the Indirect Method)
4 Net increase/Decrease in cash and cash equivalent (1 +2 +3)
Add : cash and cash equivalents in the beginning of the year
cash in hand
cash at bank(Bank overdraft)
short term deposit
marketable securities
cash and cash equivalents at the end of the year

cash in hand
short term deposit
cash flow from operation
Indirect Method
Format of Cash Flow Statement for the year ended ................
As per Accounting Standard - 3 (Revised)
Particulars
1 Cash flows from operating Activities
Net Profit as per Profit and Loss A/c or difference between closing balance and opening balance
of Profit and Loss A/c
Add: Transfer to reserve
Proposed dividend for current year
Interim dividend paid during the year
Provision for tax made during the current year
Extraordinary items, if any, debited to Profit and Loss A/c
Less: Extraordinary Items, if any, credited to Profit and Loss A/c
Refund of Tax credited to Profit and Loss A/c
Net profit before taxation and Extra ordinary items
Add: Depreciation
Preliminary expenses
Discount on issue of shares and debentures written off
Interest on borrowings and debentures
Loss on sale of fixed assets
Less: Interest income/received
Dividend income received
Rental income received
Profit on sale of fixed asset
Operating profits before working capital changes
Add: Decrease in current assets and increase in current liabilities
Less : Increase in current assets and decrease in current liabilities
Cash generated from operations (D + E – F)
Less : Income tax paid (Net tax refund received)
Cash flow from before extraordinary items
Adjusted extraordinary items (+/–)
Net cash from operating activities
2 Cash from investing activities
Add: Proceeds from sale of fixed assets
Proceeds from sale of investments
Proceeds from sale of intangible assets
Interest and dividend received
Rent income
Less: Purchase of fixed assets
Purchase of investment
Purchase of intangible assets like goodwill
Advanced extraordinary items (+/–)
Net cash from (or used in) investing activities
3 Cash flows from financing activities
Add: Proceeds from issue of shares and debentures
Proceeds from other long term borrowings
Less: Final dividend paid
Interim dividend paid
Interest on debentures and loans paid
Repayment of loans
Redemption of debenture preference shares
Adjust extraordinary items (+/–)
Net cash from (or used in) financing activities
4 Net increase/Decrease in cash and cash equivalent (i + ii + iii)
Add : cash and cash equivalents in the beginning of the year
cash in hand
short term deposit
marketable securities
cash and cash equivalents at the end of the year

cash in hand
short term deposit
cash flow from operation
14.5 CASH AND RELEVANT TERMS AS PER AS-3 (REVISED)
AS-3/IAS-7/IndAS-7 deals with preparation of Cash flow Statement.

AS-3 applies to the enterprises:
Having turnover more than Rs. 50 Crores in a financial year.
Listed companies.
There are three sections to a cash flow statement, operating activities, investing activities and financing activities.
Together, the three sections of the cash flow statement work together to show the net change in cash for the period. Here
is what a completed cash flow statement looks like. It is compiled according to the indirect method. In June 2016, the
Securities and Exchange Board of India “SEBI” amended Clause 32 of the listing agreement requiring every listed
companies to give along with the balance sheet and profit & loss account, a cash flow statement prepared in the prescribed
format, showing cash flows from operating activities, investing activities and financing activities, separately. Recognizing
the importance of cash flow statement, The Institute of Chartered Accountants of India (ICAI) issued AS-3 revised Cash
flow statements in March 1997. The revised accounting standards supersede AS-3 changes in financial position, issued in
June 1981.
During a specified period of time, a cash flow statement describes the inflows and outflows of the cash and cash
equivalents in an enterprise. A cash flow statement shows the net effect of various business transactions on cash and cash
equivalents and consideration of receipts and payments of cash. Cash flow is a summary of change in cash position in
between the dates of two balance sheets and revenue statements. The important terms used in a cash flow statement are
as follows:
Cash
The meaning of cash is cash in hand and cash at bank including deposits.
Cash and Cash Equivalents

Here, cash and cash equivalents imply readily convertible, highly liquid investments, the value of which in cash is well-
known to us without risk of change in its realization amount. The purpose of keeping cash equivalents is to meet our
current and short-term commitment rather than for investments. Only those investments having short maturity terms
qualify as cash equivalents. Short maturity means maturity within three months.
Cash Flows
There are two types of flows: inflows and outflows. If the increase in cash is the effect of transactions, it is called inflows of
cash; and if the result of transactions is decrease in cash, it is called outflows of cash.
Note: If decrease in cash is due to cash management rather than its operating, investing, and financing activities, it will be
excluded from cash outflows. Cash management means investment of cash in cash equivalents.
The statement of cash flow shows three main categories of cash inflows and cash outflows, namely: operating, investing
and financing activities.
14.6 CASH FLOW FROM OPERATING ACTIVITIES
Operating activities are the main revenue generating activities of the enterprise. The operating section of the cash flow
statement is most important because it deals with the cash generated or used by the entity’s primary activities. The cash
flow from operating activities from the financial statements can be calculated by direct or indirect methods. The direct
method will be introduced first but it is not common method as the indirect method is used by the most of business
enterprises. The choice of method does not change the amount of cash flow reported from operating activities.
Cash flow from operating activities involve producing and delivering goods and providing services in the normal course of
the business. These cash flows are generally routine and recurring. .Inflow of cash from operating activities represents the
level of sufficient cash generation necessary to maintain operating capability without recourse to external resource of
financing. Cash provided or used by operations reflects the effect of an entity’s main activities. Understanding operating
cash flows, along with related adjustments, permits decision makers to better anticipate future recurring cash flow
requirements
Examples of cash Flows from operating activities:
 Cash sale (goods or services)

 Cash receipts from commission, fees and royalties income etc.
 Cash payments to workers or employees in form of salary or wages.
 Cash payments to supplier of goods or services.
 Cash payments in form of claims, annuity and other benefits.
 Cash receipts and payments of an insurance enterprise for premium and claims, annuities and other polity
benefits
 Cash payments or refunds of income-taxes unless they can be specifically identified with financing and investing
activities
 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 etc
 Cash receipts from the repayment of advances and loans made to third parties (other than advances and loans
of a financial enterprise)
Note: Cash receipt on sale of plant and machinery comes under category of investing activities
Most companies present the operating section of the cash flow statement using an indirect approach under which they start
with accrual-basis net income and adjust that figure to obtain the cash generated or used by operations. Although accrual-
basis income is regarded as the best measure of operating success, it does not tell us the amount of cash flows from
operating and must be adjusted for all items that affect income and cash differently. Thus, this section of the cash flow
statement includes the following adjustments to net income to determine the cash generated or used by operations:
Expenses that reduced net income this period but did not use cash must be added back. (Outstanding expenses)
Cash payments made this period for expenses of other periods must be deducted.(Prepaid expenses)
Revenues that did not result in cash inflows during the current period must be deducted. (Accrued incomes)
Cash collections for revenues earned in other periods must be added. (Unexpired incomes)
Items reported in the income statement but not directly related to normal operations must be removed. (Non-Oerating
incomes)
14.11 COMMON ADJUSTMENTS TO NET INCOME NEEDED TO CONVERT TO A CASH BASIS

14.11.1 Depreciation and Amortization
Under accrual accounting, income is reduced for the cost of an operating asset’s service potential used up during the
period. As we have seen earlier, depreciation, or the amount of cost recognized during the period under the matching
concept, is an allocation of the original cost of the asset. The depreciation expense recognized during a period is not a
cash expense; it does not result in a decrease in the cash balance. Cash was reduced initially when the asset was first
acquired. The expense is simply an accountant’s allocation of a cost incurred previously. Therefore, while income for the
period is decreased by the amount of the depreciation expense, cash is not If we are interested in the amount of cash
generated by a company’s operations, then we need to add back the amount of depreciation expense to the company’s
net income. In other words, if all other revenues and expenses were cash items, net income would understate cash
generated by the amount of the depreciation expense
Because depreciation is added back to net income to get the cash generated from operations, financial analysts
sometimes mistakenly refer to depreciation as a source of cash. But this is not correct because firms cannot generate
cash just by depreciating. The addition of depreciation in the cash flow statement is simply a way of adding back an
amount that was deducted from income but did not use cash. Depreciation is neither a source nor a use of cash . Some
analysts also believe that, because depreciation is deducted from income but does not use cash, this creates a ‘reserve’
for replacing assets when they are worn out or obsolete. This reasoning is faulty, however, because it assumes that the
new assets will cost exactly the same as the old and that cash equal to the depreciation is set aside for replacement. In
actuality, both assumptions are usually incorrect.
The amortization of intangible assets and the depletion of natural resources also result in noncash expenses. As with
depreciation, these expenses are deducted to get net income, but do not use cash. Therefore, they are added back to net
income to get the amount of cash generated from operations.
14.11.2 Extraordinary Items
Inflow or outflow of cash is classified according to the nature of activities that may be operating, investing, or financing
activities. Cash flow due to extraordinary items should be shown separately in the cash flow statement to enable users to
understand its nature and effect on the cash flow statement.
Extraordinary items
Ex. loss by Fire
The cash flows associated with extraordinary items should be classified as arising from Operating, Investing or Financing
activities as appropriate and separately disclosed.
Example:
Insurance claim received against loss of stock or profits is extraordinary operating cash inflow. Insurance
claim received against loss of fixed assets is extraordinary investing cash inflow.
14.11.3 Interest
Interest Received
Received on investment – it is investment inflow.
Received from short term investment classified, as cash equivalents should be considered as cash inflows from
operating activities.
Received on trade advances and operating receivables should be in operating inflows. For
financial enterprises – in operating inflow.
Interest Paid
On loans/debts is financing activities.
On working capital loan or loan taken to finance operating activities are included in operating inflows.
For financial enterprises – in operating outflow.
14.11.3. Payment of Interim Dividends

1
The following procedure is followed
(i) The amount of interim dividend paid during the year is shown as outflow of cash in cash flow statement.
(ii) It will be added back to the profits for the purpose of calculating cash provided from operating activities.
(iii) No adjustment is necessary if the cash provided from operating activities is calculated on the basis of
revised figure of net profit
14.11.3.2 Proposed dividend
The dividend is always declared in the general meeting after the preparation of Balance Sheet. It is therefore, a non-
operating item which should not be permitted to affect the calculation of cash generated by operating activities.
Thus, the amount of proposed dividends would be added back to current years profit and payments made during the year
in respect of dividends would be shown as an outflow of cash
Dividend Received
For non-financial enterprises – investing inflow.
For financial enterprises – operating inflow.
Dividend Paid
Always classified as financing inflow.
14.11.6 Amortization of debt discount and premium
Debt discount arises when debt is issued for less than its maturity value. Because the debt ultimately must be repaid at
maturity value, the actual (effective) interest costs are higher than the current cash interest payments. A portion of the
discount is charged to interest expense each period under accrual accounting. However, the amount of discount
expensed each period represents a noncash charge against income. When will cash actually be paid? When the debt
matures, its maturity value will be paid in cash. Because the company’s interest expense contains a noncash portion, the
net income figure must be adjusted to arrive at the cash generated from operations. Thus, when interest expense has
been increased by the amortization of bond discount, an amount must be added to net income in the cash flow statement
to determine the amount of cash generated from operations. If interest expense has been decreased by the amortization
of bond premium, an amount must be deducted from net income in the cash flow statement to arrive at cash generated
from operations.
14.11.7 Gains and losses
Companies often include in their income statements gains and losses that are not directly related to their regular
operations. For example, companies often report gains and losses from disposing of investments or fixed assets, and
from retiring debt. Because these gains and losses are not related to regular operations, they must be eliminated from the
operating section of the cash flow statement. Gains must be deducted from net income in the operating section of the
cash flow statement to arrive at cash generated from operations, and losses must be added back. The cash effects of the
transactions giving rise to the gains and losses are reported in the investing or financing sections of the cash flow
statement
Foreign currency transactions
The effect of change in exchange rate in cash and cash equivalents held in foreign currency should be reported as
separate part of the reconciliation of cash and cash equivalents.
Unrealized gain and losses arising from changes in foreign exchanges rates are not cash flows.
Investments in subsidiaries/ associates
Only the cash flow between enterprise itself and the investee is required to be reported. Example:
Cash flow relating to dividends and advances.
Acquisitions and disposals of subsidiaries/other businesses
Cash flow on acquisition and disposal of subsidiaries and other business units should be :
Presented separately, Classified as investing activities. Total

purchase and disposal should be disclosed separately.
The position of the purchase / disposal consideration discharged by means of cash and cash equivalents should
be disclosed separately.
Non-cash transactions
These should be excluded from the cash flow statement.

These transactions should be disclosed in the financial statements.
Examples
Acquisition of assets by assuming directly related liabilities.
Acquisition of an enterprise by means of issue of equity shares.
Conversion of debt to equity.
14.11.1 Provision for Taxation

2 Taxes on Income
Taxes on income should be separately disclosed and should be classified under operating activities in most of the cases
except where we can easily identify the taxes according to nature of income but if total amount of tax is given, then it
should be classified as operating activities. It is a non-operating expenses or an item of appropriation in the Income
statement/Profit and Loss Account and therefore should not be allowed to reduce the cash provided from operating
activities. Hence, if the profit is given after tax and the amount of the provision for tax made during the year is given, the
same would be added back to the current year profit figure.
Treatment of tax
Cash flow for tax payments / refund should be classified as cash flow from operating activities.
Tax deducted at source against income are operating cash outflows if concerned income are operating.
Cash flow for tax payments identified with a specific investing or financing flow should be classified as investing or
financing flow respectively.
E.g. Dividend Tax is recognised as financing flow.
Changes in the deferred income taxes
Companies must report income tax expense on an accrual basis by matching tax expense to reported income. If temporary
differences exist between the income reported in the income statement and that reported on the tax return, a deferred tax
liability or asset is affected. In addition, the tax expense reported in the income statement is different from cash tax
payments. Therefore, the cash flow statement must report an adjustment to bring net income to the amount of cash
generated from operations
Changes in current assets and current liabilities
Current assets and current liabilities are important in the operations of a company and facilitate the flow of resources
through the operating cycle. Changes in receivables, inventories, payables, and other current accounts can affect the
amount of cash received. Because current assets and liabilities play such an important role in the way that cash moves
through the operating cycle, changes in these items must be considered in determining the cash generated from
operations. For example, sales increase income, but if the sales are on credit and the receivables are not immediately
collected, no cash is generated. Thus, the cash generated from operations during the period can be determined only after
adjusting net income for the change in receivables during the period: if receivables increase, less cash is collected than if
receivables decrease.
Similarly, if a company does not pay its bills as quickly as in the past, and payables in-crease, less cash is used in
operations. Because the expenses reduce income even though the cash has not been paid, the cash flow statement
reports an adjustment added to net income in the cash flow statement to reflect more cash being generated from
operations. A decrease in trade payables would indicate that more cash was being used to pay off bills and less was
generated by operations. This would call for a negative adjustment to be reflected in the cash flow statement. Changes in
current liabilities not directly related to sales or normal operating expenses, such as short-term bank loans or dividends
payable, are reported in the financing section of the cash flow statement.
Accounts Receivable
If accounts receivable decreased during the time period, this means that customers have paid off some accounts, (that is,
the company received cash payments) and so, net income should be increased by the amount accounts receivable
decreased during the period. Conversely, if accounts receivables increased during the period, net income will be reduced.
This adjustment shows that net income overstates cash because it includes both cash sales and sales on
Inventory
If inventory increased during the period, this means the company either used cash to purchase the inventory, in which case
net income would be decreased or, if the inventory was purchased on account, then accounts payable will have increased.
As such positive changes in inventory will be deducted from net income
Accounts Payable
If there is an increase in accounts payable, the amount of the change is added to net income. If there is a decrease in
accounts payable, the amount of the change is subtracted from net income
14.12 DETERMINATION OF CASH FLOW FROM OPERATING ACTIVITIES
There are two stages for arriving at the cash flow from operating activities
Stage-I
Cash from operations = operating profit before working capital changes + Net decrease in current assets + Net Increase in
current liabilities – Net increase in current assets – Net decrease in current liabilities.
Stage-II
After getting operating profit before working capital changes as per stage I, adjust increase or decrease in the current
assets and current liabilities.
The following general rules may be applied at the time of adjusting current assets and current liabilities.
A. Current assets
(i) An increase in an item of current assets causes a decrease in cash inflow because cash is blocked in current
assets.
(ii) A decrease in an item of current assets causes an increase in cash inflow because cash is released from the sale
of current assets.
B. Current liabilities
(i) An increase in an item of current liability causes a decrease in cash outflow because cash is saved.
A decrease in an item of current liability causes increase in cash out flow because of payment of liability
CASH FROM INVESTING ACTIVITIES

Investing activities include the acquisition and disposal of long-term assets and other investments not included in cash
equivalents. Cash flows related to investing reflect how an organisation’s cash is used to provide future benefit and how the
enterprise is making capital expenditures to acquire property and equipment for expansion such as through the purchase of
new plant and equipment, and investing in bonds and securities. Lending money and receiving loan payments are also
considered investing activities. . The following are examples of cash flows arising from investing activities
1. Cash payments to acquire fixed assets including intangible assets, construction of assets and capitalization of
research and development costs.
2. Cash payments for investment in 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
3. Cash receipts from disposal of fixed assets, including intangible assets and long term investments.
4. Cash receipts from disposal of 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)
5. 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
Cash advances and loans made to third parties other than advances and loans made by a financial enterprise
CASH FROM FINANCING ACTIVITIES
As we have seen, much of an existing company’s financing may come from operations. However, many companies,
especially new ones and those that are expanding rapidly, need to rely on other sources to provide a stable financing base
this type of financing comes either through borrowing or by selling ownership interests. The financing section of the cash
flow statement reports on the cash effects of (1) borrowing (other than trade payables), (2) repaying debt, (3) issuing stock,
(4) repurchasing stock, and (5) paying dividends etc.
Cash flows related to financing reflect amounts received by borrowing or from issuing stock, as well as payments
made to retire debt, repurchase stock, and provide dividends to owners. Financing activities are activities that result in
changes in the size and composition of the owners' capital (including preference share capital in the case of a
company) and borrowings of the enterprise. Following are the examples of cash flows arising from financing activities:
1. Cash proceeds from issuing shares or other similar instruments
2. Cash proceeds from issuing debentures, loans notes, bonds and other short-term bowing
3. Cash repayments of amounts borrowed
Payment of dividend
14.13 SHARE CAPITAL
The increase in share capital is regarded as inflow of cash only when there is a increase in share capital. For example, if a
company issues 10000 equity shares of Rs.10 each for cash only, Rs. 100,000 would be shown as inflow of cash from
financing activities. Similarly, the redemption of preference share is an outflow of cash. But where the share capital is
issued to finance the purchase of fixed assets or the debentures are converted into equity shares there is no cash flow.
Further, the issue of bonus shares does not cause any cash flows.
14.14 PURCHASE OR SALE OF FIXED ASSETS

The figures appearing in the comparative balance sheets at two dates in respect of fixed assets might indicate whether a
particular fixed asset has been purchased or sold during the year. This would enable to determine the inflows or outflows of
cash. For example, If the plant and machinery appears at Rs 60,000 in the current year and Rs.50,000 in the previous year,
the only conclusion, in the absence of any other information is that there is a purchase of fixed assets for Rs.10000 during
the year. Hence, Rs.10000 would be shown as outflow of cash.
Activity The net Income reported in the Income Statement for the year was Rs. 2,20,000 and depreciation of fixed assets for the
year was Rs. 84,000. The balances of the current assets and current liabilities at the beginning and end of the year are as
follows. Calculate cash from operating activities
Particulars 01.04.2017 31.03.2018

Current Assets
Cash 1,30,000 1,40,000
Debtors 2,00,000 2,80,000
Inventories 2,90,000 1,00,000
Prepaid expenses 15,000 12,000
Current Liabilities
Accounts Payables 1,42,000 1,16,000
Unexpired rent 18,000 24,000
Solution Particulars Detail Amount

Net Income 2,20,000
Adjustment for non cash and Non-operating items
Add: Depreciation 84,000
Operating Profit before working capital changes 3,04,000
Add: Decrease in Current Assets 1,90,000
Inventories 3,000
Prepaid Expenses
Add: Increase in Current Liabilities
Unexpired Rent 6,000
Less: Increase in Current Assets 1,99,000
Debtors 5,03,000
80,000
Less: Decrease in Current Liabilities
Accounts Payable
26,000
1,06,000
Cash from Operating Activities 3,97,000

Activity From the following information calculate the cash flow from investing activities
Particulars 01.04.2017 31.03.2018
Machinery at Cost 4,00,000 4,50,000
Accumulated Depreciation on Machinery 1,20,000 1,60,000
Copy Rights 2,80,000 1,30,000
Additional Information:
(i) During the year a machine costing Rs 60,000 with this accumulated depreciation Rs 24000 was sold for Rs
20,000
(ii) Copy Rights were written off to the extent of Rs 30,000 and some were sold at a profit of Rs 20,000
Solution Cash Flow from Investing Activities
Particulars Amount
Inflow from sale of Machinery 20,000
Inflow from sale of Copy Rights 1,40,000
1,60,000
Less: Outflow from purchase of Machinery 1,10,000
Cash Flow from Investing Activities 50,000
Accumulated Depreciation Account

Particular Amount Particulars Amount
To Machinery Disposal A/c 24,000 By balance b/d 1,20,000
(Depreciation on Machinery sold) By Profit and Loss A/c 64,000
To Balance c/d 1,60,000 (Depreciation charged Balancing
Figure)
1,84,00 1,84,000
0
Machinery Account at Cost

To balance b/d 4,00,000 By Machinery Disposal A/c 60,000
To Bank A/c (Purchase during the year) 1,10,000 (Cost of Machinery sold)
(Balancing Figure) By Balance c/d 4,50,000
5,10,000 5,10,000
Machinery Disposal Account

To Machinery Account 60,000 By Provision for Depreciation A/c 24,000
(Cost of Machinery sold) (Depreciation on Machinery sold)
By Bank A/c (Sale during the year) 20,000
By Profit and Loss A/c 16,000
(Loss on sale of Machinery)
60,000 60,000
Copy Rights Account

To balance b/d 2,80,000 By Profit and Loss A/c 30,000
To Profit and Loss A/c 20,000 ( Amount written off)
(Profit on sale of Copy Rights) By Bank A/c 1,40,000
(Balancing Figure) (Sale of Copy Rights balancing
figure)
By Balance c/d 1,30,000
3,00,000 3,00,000
Activity From the following information, calculate the Cash from financing activities:
31.03.2017 31.03.2018
Particulars Rs Rs
Equity share capital 400,000 6,00,000
10% debentures 3,50,000 1,00,000
Securities premium 40,000 60,000
Additional Information: Interest paid on debentures Rs.35,000.
Solution Cash from Financing Activities
Particulars Detail Amount
Cash realised from issue of Shares 2,00,000
Cash realised from by issue of Shares at Premium 20,000
2,20,000
Less: Interest paid on Debentures 35,000
Redemption of 10% Debentures 2,50,000 2,85,000
Cash utilised in Financing Activities ( 65,000 )
UTILITY OF CASH FLOW STATEMENT
The cash flow statement represents the various sources which bring in cash, such as operations, sale of current and fixed
assets, issuance of share capital and long term borrowings etc. and the applications which cause outflow of cash, such as,
purchase of current and fixed assets, redemption of debentures, preference shares for cash and so on. It is very useful in
the evaluation of cash position of a firm to keep adequate cash in hand to meet day-to-day expenditures and to invest as
and when required in business. It has been observed several times by the enterprises that in spite of adequate profit in
business, they are unable to meet their taxes and dividends, just because of shortage of cash flow. So the cash flow
statement provide information to help potential investors and creditors and other users in assessing the amounts, timing
and uncertainty of prospective cash receipts from dividends or interest and proceeds from the sales, redemption or maturity
of securities or loans. Following are the advantages of cash flow statement
Reporting changes in financial position
Decision makers analyze changes in financial position so that future directions for a company’s operations are projected.
The statement of cash flows provides vital information about an organisations’s cash in-flows and outflows, but it also does
more. It bridges the gap between one balance sheet and the next. Decision makers want to know how an organization’s
financial position has changed during the reporting period, and the cash flow statement provides an explanation. Decision
makers can look at this year’s balance sheet, compare it with last year’s, and see the changes. But what brought about
those changes? Why did plant and equipment go up and investments go down? Why did short-term debt decrease and
long-term debt increase? Decision makers can trace through the changes in financial position with the statement of cash
flows
The statement of cash flows explains balance sheet changes from one period to the next and can help answer questions
such as these: Has the company’s management taken proper advantage of changing interest rates by substituting debt
with a different maturity for debt outstanding? Do the reported changes in plant and equipment include both increases and
decreases that partially offset? Why did intangible assets reported in the balance sheet decrease from last year to this
year? The income statement provides part of the explanation as to why financial position changed during the year. The
statement of changes in stockholders’ equity provides an additional part of the answer. But, only the cash flow statement
provides a comprehensive look at the changes in financial position during the period. A closer look at some common
transactions can help you better understand how the cash flow statement reports cash flows and re-flects all changes in
financial position.
Discloses Cash Movement
The primary function carried out by a cash flow statement is to disclose the inflow and outflow of cash. It indicates all
possible changes in cash position of a firm in quantitative terms accompanied by the reasons to support such changes.
Hence, a cash management can exercise full control over cash movement with the help of cash flow statement.
In many cases, the cash effects of a change in financial position can be determined easily. If, for example, the balance of
the land account increases by Rs.100,000 during the year, and only one transaction has occurred involving land, this would
seem to indicate that land was purchased for Rs.100,000; land increases and cash decreases by Rs.100,000. However,
suppose the company both bought and sold land during the period. Or, suppose the land was purchased in exchange for a
long-term note. The cash effects of changes in financial position are not always as simple as they seem. Therefore,
accountants must be careful to explain the changes in a company’s financial position and the effects on cash so decision
makers can understand what has occurred.
Helps in Financial Planning
It plays a vital role in short-term financial planning. It helps in forecasting cash requirements, determining the quantity of
required cash in advance, the amount that can be generated from internal sources and the volume expected to be acquired
from outside sources. Thus, the future course of action related to cash can be planned in the light of cash flow statement.
Helpful in Internal Financial Management
Cash flow statement is of great help to management in formulating policies related to internal financial management. Since,
any information relating to the availability of cash from operations can be obtained by means of cash flow statement. Thus,
a management can make important decisions involving dividend policy, replacement of assets, repayment of long-term
loans etc.
Discloses outcome of Cash Planning
It shows the extent of success or failure of cash planning. As a management may hold comparison of cash flow of current
year with projected cash budget of that period, variations, if any with relevant cause may be detected and necessary
remedial actions can be initiated.
Efficiency in Cash Management
Cash is essential for all business operations. Therefore, a projected cash flow statement provides sufficient guidelines to
the management for planning and coordinating financial operations properly, effectively and efficiently.
Estimation of flow of cash.

Projected cash flow statements help the management to determine the likely inflow or outflow of cash from operations and
the amount of cash required to be raised from other sources to meet the future needs of the business.
Supplemental to funds flow statement.

Cash flow analysis supplements the analysis provided by funds flow statement, as cash is a part of the working capital
Reliable tool of analysis

For payment of liabilities, which are likely to be matured in the near future, cash is more important than the working capital.
As such, cash flow statement is certainly a better tool of analysis than funds flow statement for short-term analysis.
LIMITATIONS OF CASH FLOW STATEMENTS

Cash flow statement is an important analytical tool. Yet, it is advised to employ this technique with care and precautions for
the purpose of analysis due to the limitations attached to it. The reason is that misleading conclusions might be found by
not properly relating net income figure to the cash flow. Some of the significant limitations of Cash Flow Statement are
given below:
Difficulty in accurate inter-industry comparison -
Cash flow statement does not measure the economic efficiency of one company in relation to another. Usually a company
with heavy capital investment will have more cash inflow. Therefore, inter-industry comparison of cash flow statement may
be misleading.
Misleading comparison over a period of time -
Just because the company's cash flow has increased in the current year, a company may not be better off than the
previous year. Thus, the comparison over a period can be misleading
Difficulty in inter-firm comparison-

The terms of purchases and sales will differ from firm to firm; Moreover, cash inflow does not always mean profit.
Therefore, inter-firm comparison of cash flows may also be misleading.
Effect on cash by managerial policies-
The cash balance as disclosed by the cash flow statement may to represent the real liquidity position of the business. The
cash can be easily influenced by purchases and sales policies, by making certain advance payments or by postponing
certain payments.
Cannot be equated with income statements-
Cash flow statement cannot be equated with the income Statement. An income statement takes into account both cash as
well as non-cash items. Hence ne: cash flow does not necessarily mean net income of the business.
Not a replacement of other statements-

Cash flow statement is only a supplement of funds flow statement and cannot replace the income statement or the funds
flow statement as each one has its own function or purpose of preparation.
Others
It is very difficult to precisely define the term ‘cash’ There are controversies over a number of items like cheques, stamps,
postal orders etc. to be included in cash or not.As the present business moves from the cash basis to accrual basis, the
prepaid and credit transactions might be represented an increase in working capital and it would be misleading to equate
net income to cash flow because a number of non cash items would affect the net income
Net cash flow does not necessarily imply the net income of the business. As unlike income statement, cash flow statement
takes into account only cash discarding non-cash items from its preview.
Cash flow statement no doubt depicts the cash position but the cash balance shown by cash flow statement may not be
the true representative of real liquid position of the business. As it can be easily influenced by postponing purchase and
other payments.
Despite the drawbacks, of cash flow statement, it is a useful supplementary accounting instrument serving as a barometer
in evaluating profitability and financial position of an enterprise
SOLVED ILLUSTRATIONS
Classify the following into cash flows from operating activities investing activities financing activities
i Cash sale of goods
ii Cash payments of salaries and wages to employees.
iii Cash paid to suppliers of raw material
iv Cash payment to acquire fixed assets
v Cash proceeds from issues of shares at premium.
vi Payment of dividend
vii Interest received on investment
viii Interest on debenture
ix Payment of income tax
x. Cash payment of a long term loan
Solution Cash Flow from operating Activities
Cash sale of goods Normal business activity of selling Inventories Cash Inflow
or goods
Cash paid to suppliers of raw materials Routine payments for purchasing the goods Cash Outflow
Cash payments of salaries and wages to employees Routine operating expenses Cash Outflow
Cash
Payment of Income Tax Payment of tax on business Income Cash Outflow
Cash Flow from investing Activities
Cash payment to acquire fixed assets Purchase of long term assets Cash Outflow
Interest received on Investment it is an Income on Investment Cash Outflow
Cash Flow from financing Activities
Cash proceeds from issuing shares at premium Share capital raised Cash Inflow
Payment of dividends Share of profit distributed to Cash
Interest paid on debentures shareholders Outflow
Cash payment of a long term loan Fixed liability attached to Debentures Cash
Repayment of the loan Outflow
Cash
Outflow
The comparative balance sheets of Bansal Private Limited at two different dates provide the following information.
2017 2018
Assets Amount (Rs) Amount (Rs)
Plant and machinery 13,90,000 15,40,000
It is informed that depreciation amounting to Rs. 80,000 has been provided during the year. During the a part of machinery
the written down value of which was Rs. 56,000 was sold for Rs.12,500. Find the changes that have taken place in the
asset and also state their effect on cash flows
Solution
In order to identify the transaction affecting the asset account, the proper procedure is to prepare the plant and machinery
account as shown below:
Plant and Machinery Account ( Written Down Value)
To balance b/d 13,90,000 By Bank A/c (Sale of Machinery) 12,500
To Bank A/c (Purchase during the year) 2,86,000 By Profit and Loss Account 43,500
(Balancing Figure) (Loss on sale of Machinery)
By Profit and Loss Account 80,000
(Depreciation on Machinery)
By Balance c/d 15,40,000
16,76,000 16,76,000
Note:
The Plant and Machinery Account is at Written Down Value, so Depreciation charged during the year is credited
to this account.
The Written Down Value of Machinery sold ( Rs. 12,500 sale value + Rs.43,500 loss on sale = Rs.56,000) is
adjusted in the account as it is also at W.D.V
In the comparative balance sheet of WELLDONE Pvt., the position of Building Account is given as under.
Liabilities 2017 2018 Assets 2017 2018
Accumulated Depreciation on Builiding 7,00,000 7,80,000 Building 58,40,000 69,80,000
Additional Information
A part of the building costing Rs. 7,40,000 was sold for Rs. 6,00,000. The accumulated depreciation on building sold was
Rs. 1,50,000. Analyse the transaction.
Solution The different transactions affecting the building account are to be identified by preparing the following accounts
Building Account at Cost
To balance b/d 58,40,000 By Building Disposal A/c 7,40,000
To Bank A/c (Purchase during the year) 18,80,000 (Cost of Building sold)
77,20,000 77,20,000
Accumulated Depreciation Account

To Building Disposal A/c 1,50,000 By balance b/d 7,00,000
(Depreciation on Building sold) By Profit and Loss A/c 2,30,000
To Balance c/d 7,80,000 (Depreciation charged on Building)
9,30,000 9,30,000
Building Disposal Account

To Machinery Account 7,40,000 By Provision for Depreciation A/c 1,50,000
(Cost of Machinery sold) (Depreciation on Building sold)
By Profit and Loss A/c 10,000 By Bank A/c (Sale during the year) 6,00,000
(Profit on sale of Building)
7,50,000 7,50,000
Note:
The cost of Building sold is adjusted from the Building Account as this Account is at cost.
The depreciation charged during the year on Building is not credited to Building Account as it is at
cost.
The following information is given to you about the provision for taxation for 2017 and 2018 of M/s Gill Private Limited.
Liabilities 2017 2018
Provision for taxation 20,000 30,000

Net Income for the year 2017-18 is Rs.90,000.
How would you deal with this item assuming it as non-current liability?
Solution Provision for the year 2017 is an outflow of cash.
Provision for the 2018 shall be dealt with as follows
Particulars Rs.
Net Income for the 2018 90,000
Add Provision for Taxation for 2018 30,000
1,20,000
Less: Tax paid during the year (Assuming Tax provision of 2017 paid) 20,000
Cash from Operating Activities
The following relevant Information is obtained from the book of Venugopalan Limited
Liabilities 2017 2018
Provision for Taxation 75,0001,20,000

The amount of tax paid during 2018 amounted to Rs.90,000. How would you deal with this item presuming to be non
current? The net profit after taxation was Rs.1,65,000
Solution Provision for Taxation Account

To Bank A/c 90,000 By balance b/d 75,000
(Tax paid during the year ) By Profit and Loss Account 1,35,000
To Balance c/d 1,20,000 ( Tax Provision made during the year)
2,10,00 2,10,000
0
Cash From Operating Activities
Particulars Amount in Rs.
Net Income for the 2018 1,65,000
Add Provision for Taxation made for 2018 1,35,000
3,00,000
Less: Tax paid during the year 90,000
From the summarised cash account of ABC Limited, prepare cash flow statement for the year ended 31 st March 2018 in
accordance with AS-3 (Revised) using the direct method and indirect method. The company does not have any cash
equivalents :
Particulars Amount Particulars Amount

Balance on 1.4.2017 50,000 Payment to Suppliers 20,00,000
Issue of equity shares 3,00,000 Purchase of fixed assets 3,00,000
Receipts from customers 28,00,000 Overhead expenses 2,00,000
Sale of fixed assets 2,00,000 Wages and salaries 1,00,000
Taxation 2,50,000
Dividend 50,000
Repayment of Bank Loan 3,00,000
Balance on 31.03.2018 1,50,000
33,50,000 33,50,000
Additional information: Net profit before tax for the year 2018 was Rs 5,00,000.
Cash flow statement of ABC Ltd(Indirect Method)

Cash flow from operating activities
Net profit before tax 5,00,000
Less: Income Tax paid (2,50,000) 2,50,000
Cash flow from investing activities
Sale of Fixed Assets 2,00,000
Purchase of Fixed Assets (3,00,000) (1,00,000)
Cash flow from financing activities
Issue of Equity Shares 3,00,000
Repayment of Bank Loan (3,00,000)
Dividend paid (50,000) (50,000)
Net cash flows 1,00,000
Add: Opening balance of Cash 50,000
Closing balance of Cash 1,50,000
Cash flow statement of ABC Ltd (Direct Method)

Cash flow from operating activities
Cash receipts from customers 28,00,000
Cash payments to suppliers (20,00,000)
Cash paid for wages and salaries (1,00,000)
Cash paid for overhead expenses (2,00,000)
Income tax paid (2,50,000)
Net cash from operating activities 2,50,000
Cash flow from investing activities
Sale of Fixed Assets 2,00,000
Purchase of Fixed Assets (3,00,000) (1,00,000)
Cash flow from financing activities
Issue of Equity Shares 3,00,000
Repayment of Bank Loan (3,00,000)
Dividend paid (50,000) (50,000)
Net cash flows 1,00,000
Add: Opening balance of Cash 50,000
From the following Information, you are required to prepare the cash flow statement of Impulse Ltd. for the year ended 31st
March (both methods)

Share Capital 7,00,000 9,00,000 Fixed Assets 5,00,000 11,10,000
Secured Loan 4,00,000 Stock 1,50,000 4,00,000
Creditors 1,40,000 3,90,000 Debtors 2,00,000 70,000
Tax Payable 10,000 30,000 Cash 30,000 2,00,000
Profit and Loss Account 70,000 1,00,000 Prepaid Expenses 40,000 40,000
9,20,000 18,20,000 9,20,000 18,20,000
Profit and Loss Account for the year ended 31 st March 2018

To Opening Stock 1,50,000 By Sales 10,00,000
To Purchases 9,80,000 By Closing Stock 4,00,000
To Gross Profit c/d 2,70,000
14,00,000 14,00,000
To General Expenses 1,10,000 By Gross Profit b/d 2,70,000
To Depreciation 80,000
To Provision for Tax 40,000
To Net Profit c/d 40,000
2,70,000 2,70,000
To Dividend paid 10,000 By Balance b/d 70,000
To balance c/d 1,00,000 By Net Profit b/d 40,000
1,10,000 1,10,000
Solution Cash Flow Statement ( Direct Method)

Particulars Amount Amount
(I) Cash Flow from Operating Activities
Cash collection from Debtors (Note:1) 11,30,000
Cash payments for
Payments to Suppliers (Note:2) (7,30,000)
General expenses (1,10,000) (8,40,000)
Tax paid during the year (20,000)
Net Cash from Operating Activities 2,70,000
(II) Cash Flow from Investing Activities
Purchase of Fixed Assets (6,90,000)
Net Cash used in Investing Activities (6,90,000)
(III) Cash Flow from Financing Activities
Issue of Share Capital 2,00,000
Raising of Secured Loans 4,00,000
Dividend paid (10,000) 5,90,000
Net Cash from Financing Activities
Net decrease in Cash ( I+II+III) 1,70,000

Opening balance of cash 30,000
Closing balance of cash 2,00,000
Working Notes:
Debtors Account

To balance b/d 2,00,000 By Cash received(Balancing Figure) 11,30,000
To Sales (Credit) 10,00,000 By balance c/d 70,000
12,00,00 12,00,000
0
Creditors Account
To Cash paid (Balancing Figure) 7,30,000 By balance b/d 1,40,000
To balance c/d 3,90,000 By Purchases (Credit) 9,80,000
11,20,00 11,20,000
0
Tax Payable Account

To Bank A/c 20,000 By balance b/d 10,000
(Tax paid during the year ) By Profit and Loss Account 40,000
To Balance c/d 30,000 ( Tax Provision made during the year)
50,000 50,000
Fixed Assets Account

To balance b/d 5,00,000 By Profit and Loss Account 80,000
To Bank A/c (Purchase during the year) 6,90,000 (Depreciation on Machinery)
11,90,000 11,90,00
0
Cash Flow Statement ( Indirect Method)
Particulars Amount Amount
(I) Cash from Operating Activities
Net profit as per P&L Account 40,000
Add: Provision for tax during the year 40,000
Add: Depreciation charged during the year 80,000 1,60,000
Operating Profit before Working Capital Changes
Add: Decrease in CA or Increase in CL
Decrease in Debtors 1,30,000
Increase in Creditors 2,50,000 3,80,000
Less: Increase in CA or Decrease in CL
Increase in Stock (2,50,000) (2,50,000)
Tax Paid 20,000
Net Cash from Operating Activities 2,70,000
(II) Cash Flow from Investing Activities
Purchase of Fixed Assets (6,90,000)
Net Cash used in Investing Activities (6,90,000)
(III) Cash Flow from Financing Activities
Issue of Share Capital 2,00,000
Raising of Secured Loans 4,00,000
Dividend paid (10,000)
Net Cash from Financing Activities 5,90,000
Net decrease in Cash ( I+II+III ) 1,70,000

Opening balance of Cash 30,000
14.15 CASH FLOW AND RETRUN

Operating cash flow per share ratio is the most common ratio which is related to cash flows of a business enterprise.
Normally the ratio is not encouraged as the cash flows do not follow accrual basis of accounting. However, this measure is
useful in assessing a company’s ability to pay dividends and reflects the effectiveness of operations of the enterrpsie.
14.15.1 Cash flow per share is computed as follows:
Cash Flow per Share=Net cash provided by Operations-Dividend on Preference Shares/Number of Equity Shares
14.15.2 Cash flow to total assets: This ratio is computed as follows:
Cash Flow to Total Assets=Net cash from Operations/Average total Assets
14.15.3 Free cash flow: This measure indicates the amount of cash that is generated by operations after maintaining productive
capacity. Free cash flow is measured as follows:
Free Cash Flow=Cash generated from Operations-Cash invested to maintain capacity
The resulting figure provides a measure of the cash flows that can be used for expansion, paying off debt, retiring stock, or
paying dividends to owners. Unfortunately, most companies do not report investments to maintain capacity separate from
expansion investments. Therefore, some estimate must be made of the portion of investment representing maintenance of
the status quo. Many times, however, the entire amount of cash invested in operating capacity is deducted, thus
understating the free cash flow.
14.15.4 Dividends to operating cash flow: Measures of cash flow related to safety typically have to do with how cash flows from
operations compare with some required or anticipated payment. One such measure is the ratio of dividends to operating
cash flow, which compares cash provided by operations with the current dividend to stockholders
14.16 SOLVED ILLUSTRATIONS

14.17 SUMMARY
There are different questions before the management- Has net income been adjusted for changes in accounts receivable,
inventory, accounts payable, wages payable, and income taxes?, Is every cash transaction to purchase equipment or other
assets represented?, If any loans were made by the company, are they reflected here?, Are all loan payments reported?,
Have all cash dividends been reported? And many more. All such questions are answered by the Cash Flow Statement.
Cash flow information also enhances the comparability of the reporting of operating performance by different enterprises by
eliminating the effects of using different accounting treatments for the same transactions and events. Managers, investors,
and creditors all need information about cash and cash flows so they can make decisions. A cash flow statement is
important for a business enterprise because it can be used to assess the future cash flows and it can be the basis for
budgeting. The purpose of the cash flow statement is to analyse the flow of cash through Operating, Investing and
Financing Activities which will help the management to plan for the future of the the business enterprise.
14.18 KEY TERMS
Cash Flow Statement
The purpose of the cash flow statement is to represent how cash is generated and used and it also helps in projecting
whether cash will be generated from those sources in the future and in assessing the organisation’s future cash needs
Cash Flow from Operating Activities

It represents the cash generated or used by the entity’s primary activities involving producing and delivering goods and
providing services in the normal course of the business. These cash flows are generally routine and recurring
Cash from Investing Activities

Investing activities include the acquisition and disposal of long-term assets and other investments which are not included in
cash equivalents.
Cash from Financing Activities
Inflows from the issue of Shares, Debentures, raising of long term loans and outflows from redemption of Debentures,
redemption of Preference Shares, repayment of long term loans or other arrangements through borrowing or by selling
ownership interests.
14.19 SUGGESTED ANSWERS FOR LIFE LONG REFERENCE
14.20 TEST YOUR UNDERSTANDING
Indicate whether each of the following items should be classified as an operating, investing, or financing activity when
reported in the statement of cash flows, classified in some other way, or excluded from the statement:
a. Payment of cash dividends on common stock.

b. Borrowing cash by issuing a long-term note.
c. Sale of a warehouse at book value.
d. Purchase of common stock of an affiliated company to ob-tain control of its operations.
e. Interest payments on an outstanding long-term note.

f. Collection of accounts receivable.
g. Purchase of treasury stock.
h. Conversion of outstanding bonds to shares of common stock.
i. Declaration (but not payment) of dividends on preferred stock.
j. Acquisition of land in exchange for common stock.
k. Purchase of operating equipment
Classify the following items into (i) Operating (ii) Investing and Financing activities.
(i) Refund of income tax

(ii) Payment of dividend to shareholder
(iii) Purchase of land and building
(iv) Purchase of plant
Interest paid on debentures.
1. Which of the following would be considered a cash-flow item from an Investing Activity?
a) Cash inflow from interest income
b) Cash inflow from dividend income.
c) Cash outflow to acquire fixed assets
d) All the above
2. According to the CFS, which of the following is a cash flow from a ‘financing’ activity?
a) Cash outflow to the government for taxes
b) Cash outflow to shareholders as dividends
c) Cash outflow to lenders as interest
d) Cash outflow to purchase bonds issued by another company
3. On an accounting statement of cash flows an ‘increase(decrease) in cash and cash equivalents’ appears as
a) A cash flow from operating activities.
b) A cash flow from investing activities
c) A cash flow from financing activities
d) None of the above
4. Uses of funds include a (an)

a) Decrease in cash.
b) Increase in any liability
c) Increase in fixed assets.
d) Tax refund
5. Which of the following is not a cash outflow for the firm?

a) Depreciation
b) Dividends
c) Interest payments.
d) Taxes
6. Which of the following would be considered a use of funds?

a) A decrease in accounts receivable
b) A decrease in cash
c) An increase in account payable
d) An increase in cash
7. How should payments of taxes on trading income be classified?

a) Operating outflow
b) Operating inflow
c) Investing outflow
d) Financing outflow
e)
8. Cash equivalents have each of the following characteristics except:
a) Short-term.
b) Highly liquid
c) Maturity of at least 3 months.
d) Little risk of loss
9. Stock dividends are reported in connection with a statement of cash flows as:
a) A financing activity.
b) An investing activity.
c) A noncash activity.
d) Not reported on the statement of cash flows.
10. Interest paid to bondholders is reported in connection with a statement of cash flows as:
a) An operating activity
11. Investment revenue is reported in connection with a statement of cash flows as

12. Which of the following current assets is included in the adjustment of operating profit to determine the cash flow
from operating activities?
a) Receivables i.e. trade debtors
b) Stocks
c) Prepayments
d) All of the above.
13. In determining cash flows from operating activities (indirect method), adjustments to net income
should not include:
a) An addition for depreciation expense
b) A addition for bond premium amortization.
c) An addition for a gain on sale of equipment.
d) An addition for patent amortization.
14. The Star Computers Company sold a printer with a cost of Rs.34,000 and accumulated depreciation of Rs.21,000 for
Rs.10,000 cash. This transaction would be reported as:
14. In a statement of cash flows (indirect method), a decrease in inventory should be reported as:
a) An addition to net income in determining cash flows from operating activities.
b) A deduction from net income in determining cash flows from operating activities.
c) An investing activity.
d) Not reported.
15. Which one of the following statements is false?

a) An outflow of cash can occur in a year in which a profit is made
b) An increase in accounts receivable represents amounts not yet collected in cash
c) An increase in accounts payable represents amounts not yet collected in cash
d) A change in depreciation rates will not lead to a change in reported cash flows from operating activities
16. Which of the following activities is not an investing activity?

a) borrowing money
b) purchasing plant assets
c) purchasing an investment
d) collecting the principal of a note receivable
17. A company issued common shares for land valued at Rs.5,00,000. The transaction would be reported on:
a) a statement of cash flows as both an investing and financing activity
b) a statement of cash flows as an investing activity, only
c) a separate schedule accompanying the statement of cash flows
d) a statement of retained earnings
18. Which of the following items would appear in a cash flow statement as an inflow of cash?
a) The revaluation of fixed assets
b) The gain on disposal of fixed assets
c) The purchase of fixed assets
d) The proceeds from the sale of fixed assets
19. Which Beginning balance of Accounts Receivable was Rs.65,000, and the ending balance was Rs.88,000. Sales
were Rs.6,70,000. What was the net cash inflow from customer receipts?
a) Rs.4,27,000
b) Rs.4,33,000
c) Rs.6,47,000
d) Rs.3,82,000
20 Which of the following activities is an operating activity?

a) issuing shares for a building
b) redemption of bonds at maturity
c) collecting the interest on an investment
d) purchasing the common shares of another corporation as an investment
21 Which of the following activities would not be reported as an investing activity on a statement of cash flows?
a) collection of a loan made to an officer of the company
b) purchase of a patent from an inventor
c) sale of a plant asset at a price equal to its book value
d) cash dividends received from an investment made in another company
22 Which of the following is an investing activity?

a) collecting the principal of a long-term note
b) withdrawals by a partner
c) issuing common shares for cash
d) issuing bonds at a discount
23 Which of the following events represents an investing activity on a statement of cash flows?
a) selling equipment for cash
b) issuing a short-term note to a bank for cash
c) collecting receivables from credit customers
d) purchasing a one-year insurance policy
24 The beginning balance of the Equipment account was Rs.45,000; the ending balance was Rs.54,000. The
beginning balance of the Accumulated Amortization account was Rs.24,000; the ending balance was Rs.33,000.
Equipment with a cost of Rs.6,000 and accumulated amortization of Rs.5,000 was sold for Rs.1,200 cash. What
was the amount of amortization expense for the year?
a) Rs.14,000
b) Rs.9,000
c) Rs.23,000
d) Rs.5,000
25. Which of the following activities would not be considered a financing activity?
a) retirement of preferred shares
b) issuing bonds payable
c) borrowing money by issuing a short-term note
d) purchasing land for cash
26. A Cash dividends of Rs.42,500 were declared. The beginning and ending balance of the cash dividends payable
account was Rs.10,000 and Rs.12,500, respectively. On the statement of cash flows, the cash dividend activity
would be shown as a(an):
a) investing activity of Rs.45,000
b) financing activity of Rs.40,000
c) financing activity of Rs.42,500
d) investing activity of Rs.12,500
27. Which of the following transactions would NOT be reported on a

statement of cash flows?
a) purchase of equipment
b) retirement of debt prior to maturity
c) exchange of common shares for equipment
d) sale of treasury shares at a price in excess of cost
28. Under the indirect method, the net cash provided by operating activities was Rs.92,000. Accounts receivable
increased Rs.4,000, merchandise inventory decreased Rs.10,000, accounts payable decreased Rs.8,000,
income taxes payable increased Rs.3,000. No other items except amortization were adjustments to reconcile net
income of Rs.80,000 to net cash provided by operating activities. What was the amount of the amortization
expense?
a) Rs.31,000
b) Rs.11,000
c) Rs.17,000
d) Rs.3,000
29. The cost of goods sold was Rs.190,000. Beginning merchandise inventory was Rs.14,000, and ending
merchandise inventory was Rs.22,000. During the year, prepaid expenses decreased by Rs.6,000, accounts
receivable increased by Rs.6,200, and accounts payable increased by Rs.3,000. The amount reported for cash
paid for merchandise would be:
a) Rs.201,000
b) Rs.195,000
c) Rs.198,000
d) Rs.185,000
30. The Prepaid Insurance account had a beginning balance of Rs.14,000 and an ending balance of Rs.24,000.
During the accounting period a 3-year policy was purchased for Rs.8,000. The Insurance Expense account has
an ending balance of Rs.9,000. What was the net cash flow related to insurance expense?
a) Rs.18,000
b) Rs.19,000
c) Rs.10,000
d) Rs.2,000
1. What is the trend in cash flow from operating activities for your company?
2. Is there a reason for any large increase in accounts receivable?
3. How do you expect the financing activities of your company to change in the next year and the next two years?
4. Why cash flow statements are called historical in nature.
5. State effect of payment of dividend on flow of cash.
6. Give one example of operation activity for a financial enterprise.
7. Sale of marketable securities at par would result in inflow, outflow of cash. Give your
answer with reason
8. How can you tell whether a company is expanding or contracting by reading its cash flow statement?
9. Explain what is meant by the statement that managing a company’s cash flow is, in part, a balancing of
profitability and liquidity
10. When is interest received considered as an investing activity?
11. Redemption of debentures would result in inflow, outflow or no flow of cash? Give your
answer with reason.
12. Profit made during the year 2008-09 by Bata Ltd. Was Rs. 2, 50,000 (after charging
deprecation on fixed assets Rs. (20,000).state cash flow from operating activities.
13. In a non- financial enterprise cash receipts from customers is Rs.2, 00,000 and cash paid to suppliers and
employees is Rs. 15,000. State the amount of cash flows from operating activity
14. In a non- financial enterprise cash receipts from customers is Rs.2, 00,000 and cash paid to suppliers and
employees is Rs. 15,000. State the amount of cash flows from operating activity
15. Give the meaning of cash flow statement?
16. Explain the limitation of cash flow statement?
17. What are two major inflows and two major outflows of cash from investing activities?
18. what is meant by “extraordinary items”?
19. Under normal circumstances, when a company in-creases its accounts receivable balance from the previous
year, it also increases its current assets, working capital, and current ratio. Does it also increase its cash inflows?
If so, how and when is the cash inflow increased?
20. Mutual Fund Company receives a dividend of Rs.25lakhs on its investments in other company’s shares. Why is it
a cash inflow from operating activities for this company?
21. If a company obtains needed cash through financing activities rather than operations, does this mean the com-
pany is in financial difficulty?
22. ABC Ltd. made profit of Rs.2, 60,000 before considering depreciation on machinery Rs. 10,000 and loss on sale
of furniture Rs. 25,000. State the amount to be shown as cash flows from operating activities.
23. State with reason whether the issue of 9% debentures to the vendors for the purchase of machinery of Rs.
50,000 will result in inflow, outflow or no flow of cash?
24. DPR Ltd made profit of Rs. 2, 50,000 after considering depreciation on fixed assets Rs. 30,000 and profit on sale
of building Rs. 20,000 .State the amount to be shown as cash flow from operating activities.
25. Classify the following into cash flows from investing activities \financing activities while
preparing a cash flow statement;
a. Fixed assets purchased
b. Dividend paid
c. Cash received from issue of equity shares
d. Net cash received from sale of investment.
26. Classify the following into cash flows from investing activities/financing activities while
preparing a cash flow statement;
(a) Redemption of preference shares
(b) Sales of fixed assets
(c) Receipt of dividend
(d) Interest Received
27. Calculate the cash flow from the given information:

Investments at the beginning of the period Rs.40,000
Investments at the end of the period Rs. 30,000
During the year company had sold 30% of its investments held in the beginning of the period at a profit of Rs. 6,000
28. Classify the following into operating, investing and financing activities
Issue of Share Rs. 2,00,000
Receipt of interest on Investment by a manufacturing Co. Rs.10,000
Sale of Goods Rs. 5,00,000
Receipt of interest on investment by a bank.
29. Classiy following into cash flows from investing activities/financing activities while preparing a
cash flow statements:
Redemption of debentures
Sale of fixed assets
Receipt of dividend
Interest received
30. X Ltd. made a profit of Rs. 1,00,000 after charging Depreciation of Rs. 20,000 on assets and a transfer to
General Reserve of Rs. 30,000 The goodwill written off was Rs. 7,000 and the gain on sale of Machinery was Rs.
3,000. The other information available to you (changes in the
value of Current Assets & Current Liabilities) is as follows:
At the end of the year Debtors showed an increase of Rs. 6,000, Creditors an increase of Rs.10,000, Prepaid expenses
an Increase of Rs. 200; Bills Receivable a Decrease of Rs. 3000; Bills Payable a decrease of Rs.4,000 and Outstanding
Expenses a decrease of Rs. 2,000. Ascertain the cash flow from the Operating Activities.
31. From the following information calculate cash from operating activities:
Opening cash balance Rs. 20000
Closing cash balance Rs. 24000
Decreasing debtors Rs. 10000
Increase in creditors Rs. 14000
Net profit of the year Rs. 40000
32. From the following information calculate cash from investing activities and financing
activities:
Opening cash balance Rs. 20000
Closing cash balance Rs. 25000
Decreasing debtors Rs. 8000
Increase in creditors Rs. 10000
Sale of fixed assets Rs. 50000
Redemption of debentures Rs. 22000
Dividend paid Rs. 68000

Net profit of the year Rs. 27000
33. Classify with reasons the following into cash flows from investing activities/ financing
activities while preparing a cash flow statement:
(a) Long term borrowings
(b) Sale of fixed assets
(c) Profit on sale of fixed assets
(d) Loss on sale of fixed assets
34. The following balances appeared in Plant Account and Accumulated Depreciation
Account In the books of Bharat Ltd:
31.3.2017 31.3.2018
Balances as on
Rs. Rs.
Plant 7,50,000 9,70,000
Accumulated Depreciation 1,80,000 2,40,000
Plant costing Rs. 1,45,000; accumulated depreciation thereon Rs. 70,000, was sold for Rs. 35,000.
You are required to:

a) Compute the amount of Plant purchased, depreciation charged for the year and loss on sale of plant.
b) Show how each of the Items related to the plant will be shown in the cash flow statement.
14.21 APPLY YOUR KNOWLEDGE
Calculate net-cash flows from operating activities from the following
Rs.
Profits made during 5,00,000
Transfer to General Reserve 1,00,000
Depreciation provided 2,00,000
Profit on sale of furniture 50,000
Loss on sale of machine 10,000
Preliminary expenses written off 20,000
2017 2018
Debtors 1,00,000 1,50,000
Bills Receivable 70,000 50,000
Stock 1,50,000 1,80,000
Prepaid Expenses 20,000 30,000
Creditors 2,00,000 1,80,000
Bills Payable 75,000 95,000
Outstanding Expenses 23,000 34,000
PQR Ltd. Had the following balances
Investment at the end of 2017 Rs. 4,00,000
Investment at the end of 2018 Rs. 3,35,000
During the year the company had sold 35% of its investment at the profit of Rs. 75,000. Calculate cash from
operating activities and investing activities if the company has earned a profit Rs. 80000 during the year.
The following balances appeared in Machinery Account and Accumulated Depreciation

Account in the books of Jai Bharat Ltd:
Balances as at 31.3.2017 31.3.2018

Machinery Account 78,15,640. 89,76,370
Accumulated Depreciation Account 17,78,595 24,55,456
Machinery costing Rs. 3,75,800 on which accumulated depreciation was Rs. 1,14254 was sold for Rs. 1,72,250.
You are required to:
a) Compute the amount of machinery purchased, depreciation charged for the year and loss on sale of machinery.
b) How shall each of the items related to machinery be shown in the Cash Flow Statement?
From the following statement, calculate the cash generated from operating activities:
Statement of profit for the year ending March 31 st 2018
Particulars Amounts Particulars Amounts
Salaries 10,000 Gross profit 85,000
Rent 5,000 Profit on sale of Machinery 5,000
Depreciation 20,000 Dividend Received 3,000
Loss on sale of Building 5,000 Commission Accrued 4,000
Goodwill written off 8,000
Proposed dividend 10,000
Provision for tax 15,000
Net profit 24,000
X Ltd made a profit of Rs.1,00,000 after charging depreciation of Rs.20,000 on assets and a transfer to General Reserve
of Rs.30,000 . The goodwill written off was Rs.7,000. And the gain on sale of Machinery was Rs.3, 000 .The other
information available to you (change in the value of Current Assets and Current Liabilities) is as follows:
At the end of the year, Debtors showed an increase of Rs.6,000 : creditors an increases of Rs. 10,000; prepaid expenses
an increase of Rs. 200; bills payable a decrease of Rs4,000 and outstanding expense a decrease or Rs.2,000. Ascertain
the cash flow from the operating activities.
On March 31st, 2018 Ramesh and Co. indicated a profit of Rs. 1,45,700, after considering
the following:
Depreciation on buildings 25,000
Depreciation on plant and machinery 45,000
Amortization of goodwill 20,000
Gain on sale of machinery 10,000
The current assets and current liabilities at the beginning and the end of the year are:
01-04-2017 31-03-2018
Rs. Rs.
Accounts Receivable 35,000 45,000
Stock on hand 75,000 55,000
Cash in hand 16,000 30,000
Accounts payable 20,000 32,000
Expenses payable 10,000 8,000
Bank overdraft 50,000 35,000
Ascertain the net cash (cash flow) from operating activities.
From following Balance Sheet of Harshit Ltd. And the additional information given, make
out a cash Flow Statement:
Liabilities 31.03.2017 31.03.2018 Assets 31.03.2017 31.03.2018
Equity share capital 3,00,000 4,00,000 Goodwill 1,15,000 90,000
Pref. share capital 1,50,000 1,00,000 Land and Building 2,00,000 1,70,000
General Reserve 40,000 70,000 Plant 80,000 2,00,000
Profit and loss A/c 30,000 48,000 Debtors 1,60,000 2,00,000
Proposed dividend 42,000 50,000 Stock 77,000 1,09,000
Creditors 55,000 83,000 Bills Receivable 20,000 30,000
Bills payable 20,000 16,000 Cash in hand 15,000 10,000
Provision for taxation 40,000 50,000 Cash at Bank 10,000 8,000
6,77,000 8,17,000 6,77,000 8,17,000
Depreciation of Rs. 24,600 and Rs.20,500 have been charged on plant account and land and building account
respectively in 2007-08
An interim dividend of Rs. 80,000 has been paid in 2017-18 Income tax Rs. 65,000 was paid during the year 2017-18. You
are required to answer:
Why are operating cash flows critical in evaluating the ability of the company to pay future cash dividends?
If an investor wishes to determine if Rajshree Company has generated cash by issuing additional stock, which portion of
the cash flow statement would provide the information?
Is it possible for a company to report a positive cash flow for the period even though it has a negative cash flow from
operations? Explain.
The following balances appeared in Plant Account and Accumulated Depreciation

Account in the Books of Bharat Ltd.
Balances as at 31 .3.2017 31.3.2018
Plant 7, 50,000 9, 70,000
Accumulated depreciation 1, 80,000 2, 40,000’
Plant costing Rs. 1,45,000 : accumulated depreciation thereon 70,000, was sold for Rs.35,000.
You are required to
• Compute the amount plant purchased , depreciation charged for the year and loss on sale of plant
• Show how each of the item related to the plant will be shown in the cash flow statement
Prepare cash flow statement of Rajshree Ltd from the following information for the year ended 31.03.2018
Particulars 31.3.2017 31.3.2018
Investment 1,80,000 2,40,000
Fixed Assets(at cost) 2,10,000 4,00,000
Equity share capital 10,00,000 14,00,000
Long term loan 8,00,000 4,45,000
Cash 64,000 44,000
• Cash flow from the operating activities after tax and extraordinary items Rs. 3,80,000
• Depreciation on fixed assets Rs. 85,000

• Interest received Rs. 45,000
Dividend paid during the year Rs. 1,60,000

The following is the position of current assets and current liabilities of Ashish Enterprises Ltd.
Particulars 31.3.2017 31.3.2018
Creditors 4,20,000 6,15,000
Debtors 6,30,000 7,20,000
Bills receivables 1,18,000 1,29,000
Prepaid insurance 20,000 15,000
The company incurred a loss of Rs. 6000 during the year. Calculate cash from operating activities.
From the following balance sheet of Home Decor Ltd. Prepare cash flow statement:
Equity share capital 20,00,000 30,00,000 Fixed assets 40,00,000 60,00,000
Profit and Loss A/c 16,00,000 20,00,000 Stock 13,00,000 15,00,000
Bank loan 10,00,000 8,00,000 Debtors 10,00,000 6,00,000
Acc. Depreciation 9,40,000 11,30,000 Bills Receivable 2,00,,000 3,00,000
Creditor 16,60,000 14,70,000 Bank Balance 8,00,000 2,20,000
Proposed dividend 2,00,000 3,00,000 Goodwill 1,00,000 80,000
74,00,000 87,00,000 74,00,000 87,00,000
Shree Balaji Company’s cash flow statement for the current year contained the following information on cash flows
provided by operations:
Net income Rs. 87,000

Rs.
Depreciation and amortisation 42,000
Increase in accounts receivable (15,000)
Decrease in inventory 7,000
Increase in accounts payable 12,000 46,000
Cash provided by operations Rs.103,000
1 Why must noncash expenses such as depreciation be added to net income in computing the cash provided by
operations?
2 If Shree Balaji Company had reported depreciation expense of Rs.62,000 rather than Rs.42,000, what impact would this
change have on cash provided by operations for the year? Which of the above totals would change? By what amounts?
3 In what way does an increase in accounts payable represent a cash savings?
Why is the computation used above in determining Shree Balaji’s cash provided by operations described as the indirect
method
4 Why must noncash expenses such as depreciation be added to net income in computing the cash provided by
operations?
5 If Shree Balaji Company had reported depreciation expense of Rs.62,000 rather than Rs.42,000, what impact would this
change have on cash provided by operations for the year? Which of the above totals would change? By what amounts?
6 In what way does an increase in accounts payable represent a cash savings?
Why is the computation used above in determining Shree Balaji’s cash provided by operations described as the indirect
method
YogiZi Company reported the following net cash flow from investing activities in its cash flow statement:
If YogiZi Company is expanding, would the cash flows from investing activities be expected to be positive or neg-ative?
Explain why.
a) Does YogiZi Company appear to be expanding or contracting its operations? How do you know?
b) Is it possible to determine if a gain or loss was recorded on the sale of equipment by looking at the cash flow state-
ment? Where would this amount be disclosed?
Does the Rs.40,000 reported from the sale of equipment rep-resent the cash received or the carrying value of the equip-
ment at the time of sale
In light of YogiZi’s cash flows from investing activities, would you expect YogiZi to be generating cash flows from financing
activities? Explain
1. Which of the following decisions are likely to be influenced as much or more by cash flows from operations than by
reported net income?
a. Whether the company will have to enter the capital markets to finance its planned expansions.
b. Whether the new product line added this year is prof-itable enough to improve the overall gross margin.
c. Whether the company should reduce its investment in inventory in accordance with its plans for a just-in-time
inventory management system.
Whether the company would improve its liquidity by changing to an accelerated depreciation method for fi-nancial
reporting.
Statement Classification Indicate whether the
(1) operating, (2) investing, or (3) financing section of the statement of cash flows is most likely to contain the information
needed to answer the following questions. If the information is in more than one section, so indicate. If information from
other financial statements is needed, so indicate.
1. Will there be enough cash to pay the accounts payable when they are due?
2. Are there unpaid wages, and will cash be available to make the payments?
3. Will there be enough cash to pay off the long-term debt when it is due without additional borrowing?
4. Does the company consistently generate enough cash to pay dividends?

5. How dependable are the company’s sources of cash?
6. Has the company expanded in the past year and, if so, how was the expansion financed?
7. Does the company have sufficient cash inflows to make required interest payments?
8. Is the amount of cash generated through operating activi-ties greater than the amount reported as net income?
9. Are receivables being collected on a timely basis?
How are the cash flows affected by unusual transactions or events such as losses from restructuring or write-offs of
obsolete production facilities
Classification of Activities Indicate whether each of the following items should be classified as an operating, investing, or
financing activity when reported in the statement of cash flows, classified in some other way, or excluded from the
statement:
a. Payment of cash dividends on common stock.

b. Borrowing cash by issuing a long-term note.
c. Sale of a warehouse at book value.
d. Purchase
e. Issue of common stock of an affiliated company to ob-tain control of its operations.
Interest payments on an outstanding long-term note.
Collection of accounts receivable.
Purchase of treasury stock.
Conversion of outstanding bonds to shares of common stock.
Declaration (but not payment) of dividends on preferred stock.
Acquisition of land in exchange for common stock
EXPERT REMARKS
Dividend distribution tax will be classified as financing activities.
Cash flows from acquisition and disposal of subsidiaries and other business units:
Cash flow arises due to acquisition or disposal of subsidiary should be shown separately and classified as investing
activities. This transaction should be easily identifiable in cash flow statement to enable users to understand the effect of
it. The case flow of disposal is not deducted from cash flow of acquisition.
Foreign Currency
Items appearing in a cash flow statement should be shown in local currency value, applying actual foreign currency rate of
the particular day on which cash flow statement is going to be prepared. Effect on value of cash and cash equivalents as
reflected in the cash flow statement due to change in rate of foreign currency should be shown separately as a
reconciliation of changes.
Due to change in foreign currency rate, unrealized gains and losses are not cash flows. However, effect on cash and cash
equivalents held or due in foreign currency are reported in cash flow statement in order to reconcile the cash and cash
equivalents at the beginning and at the end of the period.
Non-Cash Transactions
Some investing and financing activities do not have any direct impact on cash flows. For example, conversion of debt to
equity, acquisition of an enterprise by means of issuance of share, etc.
14.22 PROBLEM SOLVING, EVALUATION AND DECISION MAKING
The Lewers Company is starting a fried fish delivery service to local restaurants. Lewers buys fish in bulk, cooks it, and
delivers it to local restaurants. Joe Lewers figures that he will have a low overhead operation. He will do the deliveries and
hire only one employee, the cook. The fish will be bought on credit, with payment due in ten days, and Joe will give his
customers thirty days to pay him. Because it will be a credit operation, Joe figures he won’t need much money. He figures
all he will have to use cash for is gas and repairs on the van he will use for delivery. Do you think Joe can make a go of it?
What would be the elements of Joe’s cash flow statement for the first month? Would you lend Joe money to help his
business grow? Explain
CASE STUDY
Using Cash Flow Information The operating section of Mahendra Custom Manufacturing Company’s cash
flow statement is shown at the bottom of the page
Net income 4,44,000
Adjustment for depreciation 2,30,000
Adjustment for gain on sale of operating assets (14,000)
Adjustment for change in current assets other than cash (1,20,000)
Adjustment for change in current liabilities 80,000
Cash provided by operations 6,20,000
Cash flows from investing activities:

Purchase of operating assets (12,00,000)
Sale of operating assets 3,00,000
Cash used in investing activities (9,00,000)
Cash flows from financing activities

Issuance of capital stock 20,00,000
Retirement of bonds (13,00,000)
Dividends paid (2,50,000)
Cash provided by financing activities 4,50,000
Increase in cash 1,70,000

Net income 7,32,000
Adjustment for depreciation 3,20,000
Amortization of bond discount 27,000
Adjustment for change in current assets other than cash (80,000) 9,99,000
Adjustment for change in current items
Accounts receivable (2,60,000)
Inventory (20,000)
Prepaid expenses 5,000
Accounts payable 95,000
Trade notes payable 2,000 (1,78,000)
Cash provided by operations 8,21,000
Cash Balance April 01 1,76,000
Cash Balance March 31 9,97,000
Using this information, answer the following questions. If a question cannot be answered from the information given,
indicate why
Have accounts receivable increased or decreased this year?
If Mahendra has had only a single bond issue outstanding dur-ing the year, are those bonds reported at an amount above or Or below
par value in the company’s year-end balance sheet?
Does the company appear to be more or less inclined to prepay expenses than in the past? Does this help or hurt its cash position?
Explain
a. Has inventory increased or decreased this year? Explain why this affects cash.
Compared with last year, does the company seem to be re-lying more or less heavily on trade credit to finance its activities
a. Has depreciation expense increased from last year?
b. If you were a potential creditor of Mahendra, do you see any warning signs in the cash flow statement that you
would want to investigate further before lending the company money? Explain.
Mahendra has Rs.2,000,000 of bonds maturing on January 12, 2002. Mahendra does not have a bond sinking fund established to pay
off the bonds. Do you think Mahendra will be able to meet its obligation to pay off the bonds without additional long-term financing
Discuss.
14.24 PROJECT WORK
Compare the cash from operating activities of a manufacturing company and the other company providing financial services.
Make a presentation and discuss with the students of your class. In your comparison, you should highlight the accounting
Treatment of different components of the cash flows of three main activities of the Cash Flow Statement.

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CHAPTER 14

CASH FLOW ANALYSIS

In this lesson, you will learn about:

14.1 MEANING OF CASH FLOW STATEMENT

14.2 ADVANTAGES OF CASH FLOW STATEMENT

2 Cash from investing accounting

cash and cash equivalents at the end of the year

Format of Cash Flow Statement for the year ended ................

As per Accounting Standard - 3 (Revised)

cash and cash equivalents at the end of the year

14.5 CASH AND RELEVANT TERMS AS PER AS-3 (REVISED)

AS-3/IAS-7/IndAS-7 deals with preparation of Cash flow Statement.

Cash and Cash Equivalents

 Cash sale (goods or services)

 Cash payments to workers or employees in form of salary or wages.

 Cash payments to supplier of goods or services.

 Cash payments in form of claims, annuity and other benefits.

14.11 COMMON ADJUSTMENTS TO NET INCOME NEEDED TO CONVERT TO A CASH BASIS

Ex. loss by Fire

14.11.3. Payment of Interim Dividends

14.11.3.2 Proposed dividend

14.11.6 Amortization of debt discount and premium

14.11.7 Gains and losses

Foreign currency transactions

Investments in subsidiaries/ associates

Acquisitions and disposals of subsidiaries/other businesses

Presented separately, Classified as investing activities. Total

These should be excluded from the cash flow statement.

Conversion of debt to equity.

14.11.1 Provision for Taxation

E.g. Dividend Tax is recognised as financing flow.

Changes in the deferred income taxes

Changes in current assets and current liabilities

CASH FROM INVESTING ACTIVITIES

14.14 PURCHASE OR SALE OF FIXED ASSETS

Particulars 01.04.2017 31.03.2018

Solution Particulars Detail Amount

Cash from Operating Activities 3,97,000

Accumulated Depreciation Account

Machinery Account at Cost

Machinery Disposal Account

Copy Rights Account

UTILITY OF CASH FLOW STATEMENT

Estimation of flow of cash.

Supplemental to funds flow statement.

Reliable tool of analysis

LIMITATIONS OF CASH FLOW STATEMENTS

Difficulty in inter-firm comparison-

Not a replacement of other statements-

Liabilities 2017 2018 Assets 2017 2018

Accumulated Depreciation on Builiding 7,00,000 7,80,000 Building 58,40,000 69,80,000

Accumulated Depreciation Account

Building Disposal Account

Liabilities 2017 2018

Provision for taxation 20,000 30,000

Provision for Taxation 75,0001,20,000

Solution Provision for Taxation Account

Particulars Amount Particulars Amount

Cash flow statement of ABC Ltd(Indirect Method)

Cash flow statement of ABC Ltd (Direct Method)

Liabilities 2017 2018 Assets 2017 2018

Particular Amount Particulars Amount

Solution Cash Flow Statement ( Direct Method)

Net decrease in Cash ( I+II+III) 1,70,000