1Chapter 4 8

Cash Flow Statement

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CHAPTER 8
STATEMENT OF CHANGES IN FINANCIAL POSITION - CASH FLOW STATEMENT

It iss a midsummer morning and Mr. Sriram of Sridevi Clothing Company, is worried over

7about the issue of redemption of debentures. He is looking through the past five year s B
8balance sheets Sheets of for his company, and seems to be looks even more confused. He is
9worried because his CFO had said to him that the amount available in the redemption reserve
10account would not be sufficient. His problem is how to find the required cash to redeem the
11debentures which the company raised five years beforeearlier.
12
13Is the cash balance that veryso very important for an organization?
14Why do firms like Sridevi, which are profit- rich, are not cash- rich?
15How do such firms manage their short and long term cash requirements?
16
17LEARNING OBJECTIVES
18
19After learning studying this chapter you should be able to:
20

1. Understand the importance of positive cash balance in a firm.

21

2. Prepare a Ccash Fflow Sstatement.

22

3. Interpret the Ccash Fflow Sstatements.

23
24LO1: POSITIVE CASH FLOWS
25
26

A Cash Flow Statement is a statone that depictsement depicting a change in the cash

27position, from one period to another. For example, if the cash balance of a company like Sridevi
28is shown to be Rs. 2,00,000 by on its Balance Sheet on 31st December 2002, at Rs. 2,00,000
29while the cash balance is Rs. 3,00,000 as peron its Balance Sheet on 31st December, 2003 is
30Rs. 3,00,000, this means that there has been an net inflow of cash of Rs. 1,00,000 in during the
31year 2003. as compared to the year 2002. The Cash Flow Statement cash flow statement
32explains the reasons for such inflows or outflows of cash, whateveras the case might be. It also
33helps management in making plans for the immediate future. A Projected Cash Flow Statement
34will enable the management in ascertaining how much cash will be available to meet obligations
35to trade creditors, to pay bank loans, and to pay dividends to the shareholders. A pProper
36planning of the cash resources will enable the management to have cash available whenever
37needed and, in the case of surplus available cash, to put it to some a profitable or productive use
38in case there is surplus cash available.
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40

The term Cash here stands for cash and bank balances. The term Funds, in a

41narrower sense, is also used to denote cash, which isas explained in the next chapter. In such a
42case, the term Funds will exclude from its purview all other current assets and current liabilities ,

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Cash Flow Statement

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1and the terms Funds Flow Statement and Cash Flow Statement will have be synonymous

2meanings. However, for the purpose of this text, we are calling this part of studyrefer to Cash
3Flow Analysis, and not Funds Flow Analysis.
4
5LO2: PREPARATION OF CASH FLOW STATEMENT
6

A Cash Flow Statement is prepared to provide information about the cash receipts and

8cash payments of a business firm for during an accounting period. It also provides information
9about the business firms financing and investing activities during thate period. Thus it helps the
10investors, creditors, bankers and management to base their decisions regarding the companys
11ability to repay short- and long-term loans, its need for bank finance, and amount from
12operations. The change in the cash position from one period to another is computed by taking
13into account the Sources of cash as well as itsand Applications of cash.
14
15Sources of Cash
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17Internal Sources: Cash from operations is the main internal source of funds. The Net Profit

18shown by the Profit and Loss Account will have to be adjusted for non-cash items non-cash items
19for finding outin order to figure out how much cash is derived from operations. Some of these
20non-cash items are as follows:
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22

i.

Depreciation

23

ii.

Amortization of intangible assets

24

iii.

Losses on from sale of fixed assets

25

iv.

Gains from sale of fixed assets

26

v.

Creation of reserves

27
28

To find out the real cash from operations, adjustments will haveneed to be made for

29changes in current assets and current liabilities arising on account of operations. viz., trade
30debtors, trade creditors, bills receivable, bills payable etc.
31
32Format of a Cash Flow Statement
33
34A Cash Flow Statement cash flow statement can be prepared in the following form:
35
36
37

CASH FLOW STATEMENT

38

For the year ending on ..

Opening Balances :

Cash Balance

Bank Balance

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1Chapter 4 8

Cash Flow Statement

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Add :

Sources of Cash
Issue of Shares
Raising of Long-term Loans
Sale of Fixed Assets
Short-term Borrowings
Cash from Operations :
Profit as per Profit and Loss Account
Add/Less: Adjustment for Non-cash items
Add : Increase in Current Liabilities
Decrease in Current Assets
Less : Increase in Current Assets
Decrease in Current Liabilities
Total Cash Available (1)
Less : Application of Cash :
Redemption of Redeemable Preference Shares
Redemption of Long-term Loans
Purchase of Fixed Assets
Decrease in Deferred Payment Liabilities
Cash outflow on Account of Operations
Tax paid
Dividend paid
Decrease in Unsecured Loans, Deposits, etc.,
Total Applications (2)
Closing Balances* :
Cash Balance
Bank Balance
1* It sShould tally with the balance as shown by in (1) (2)

2
3Calculation of Cash from OperationALCULATION OF CASH FROM OPERATION
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5

The overall effect of stock, debtors, creditors, outstanding expenses, income received in

6advance, prepaid expenses and accrued income can be calculated as shown belowin the form of
7the following formula:
8

Cash from Operation

Amount

10

Closing balance of P & L A/c.

11
12

Amount

Add :

Decrease in Debtors

13

Decrease in Stock

14

Decrease in Prepaid Expenses

15

Decrease in Accrued Income

16

Increase in Creditors

17

Increase in Outstanding Expenses

18
19

Less : Increase in Stock

20

Increase in Prepaid Expenses

21

Increase in Accrued Income

22

Decrease in Creditors

23

Decrease in Outstanding Expenses

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Cash Flow Statement

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1

Opening balance of Profit and Loss Account & L A/c.

2
3
4Example of a Cash Flow Statementcash flow statement
5
6An example of a Cash Flow Statement cash flow statement is presented below. Cash outflows

7are shown in parentheses.

8

SRIDEVI CLOTHING CENTRE

Statement of Cash Flows

10

for the period endingEnded on March 31, 2004

11

Cash flows from operating activities :

Rs.
Rs.
Cash received from customers
7,65,000
Interest and dividends received
20,000
Cash provided by operating activities
7,85,000
Cash paid to suppliers and employees
(6,40,000)
Interest paid
(38,000)
Income taxes paid
(42,000)
Ccash disbursed for operating activities
(7,20,000)
Net cash flows from operating activities
65,000
Cash flows from investing activities:
Purchases of marketable securities
(45,000)
Proceeds from sales of marketable securities
60,000
Loans made to borrowers
(20,000)
Collections on loan
15,000
Purchases of plant assets
(1,55,000)
Proceeds from sales of plant assets
65,000
Net cash flows from investing activities
(80,000)
Cash flows from financing activities:
Proceeds from short-term borrowing
85,000
Payments to settle short-term debts
(55,000)
Proceeds from issuing Debentures
1,00,000
Proceeds from issuing capital stock
1,00,000
Dividends paid
(40,000)
Net cash flows from financing activities
1,90,000
Net Increase (decrease) in cash
1,75,000
Cash and cash equivalents April, 1
10,000
Cash and cash equivalents December, 31
1,85,000
12
13LO3: INTERPRETATION OF CASH FLOW STATEMENT:
14
15The cash flow statement is basically sub-divided into three parts: sub-divisions.
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17
1) The first sub-divisionpart, involves cCash flows from operating activities, covers the

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24

business operations of the firm and therefore has items like cash received from customers,
interest and dividend received as items of cash inflows. The cash outflows are include cash
paid to suppliers and employees, interest paid and taxes paid. The If the difference between
cash inflows and outflows in this section iswhen positive, it is referred to is called as cash
from operation, and if it is and when negative, it is called cash lost in operation. A positive
figure indicates better performance of the firm: the and higher this number is, the and higher
the figure it is better for the firm.

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Cash Flow Statement

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2

Cash from operations also indicates whether the firm earns a return from the day-to-day

3
4
5

activities of the business. A firm should always aim at getting a returns on the its day-to-day
activities, and thisit should also be seen in the form of cash, so that there will beis enough
money to runto support the routine activities.

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2) The second sub-divisionpart involves is cash flows from investing activities. In terms of

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cash outflows, it covers the investments made in plant assets, marketable securities and
loans to borrowers as cash outflows, whereas cash inflows cover and proceeds from sale of
all such assets, both long- and short-term in nature as cash inflows. If the investments made
are less than the sale proceeds received, then the cash flows from investing activities will be
a profit figure. When the investments made are more than the receipts of cash through the
sale of investments, there will be a negative figure representing the as cash flows from
investing activities. A firm need not worry for about a negative figure because investments
will always fetch returns, either in the long- term or in the short- term.

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3) The third sub-division ispart involves cash flows from financing activities. A corporate

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entity raises money through debt and equity, and it will also hasve short-term financing
activities. Cash inflows on these items, minus cash outflows on payments to settle loans and
payment of dividends, will getgives the net cash flows from financing activities. If this number
is This figure when positive, it will indicates an expansion, and if when negative it will
indicates that the firm has reached the maturity level. What is good and what is bad will
always depend on what the firm aims at: i. If the firm is on an expandingsion and is expecting
to make more money in the future, it is better to have a positive figure; and if otherwise, it is
good to have a negative figure so that the future burden is reduced.

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27
28UTILITY OF CASH FLOW ANALYSIS
29
30A cash flow analysis is an important financial tool for the management. Its chief advantages
31
are as follows :
32

33

It hHelps in efficient cash management

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It hHelps in internal financial management

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It dDiscloses the movements of cash

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It dDiscloses the success or failure of cash planning

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38LIMITATIONS OF CASH FLOW ANALYSIS

39Cash flow analysis is a useful tool in financial analysis. However, it has its own

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Cash Flow Statement

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1limitation. There are three major limitations, as listed belowse limitations are as under:
2
3

4
5

1) A 1. Cash Fflow Sstatement cannot be equated with the an Income Statement. An

Statement takes into account both cash as well as non-cash items, and, therefore,but net

cash flow does not necessarily mean net income of the business.

Income

9
10
11

2) 2. The Ccash Bbalance as disclosed by the Ccash Fflow Sstatement may not represent

12

and other payments.

the real liquid position of the business since it can be easily influenced by postponing
purchases

13

14

3) The 3. Cash Fflow Sstatement cannot replace the Income Statement or the Funds Flow

15

Statement. Each of them has a separate function to perform.

16
17In spite of these limitations, it can be said that the Ccash Fflow Sstatement is a useful

18supplementary instrument. It discloses the volume, as well as the speed, at which the cash flows
19through the different segments of the business. This helps the management in knowingto know
20the amount of capital tied up in a particular segment of the business. The technique of cash
21Cash Fflow Aanalysis, when used in conjunction with a ratio analysis, measures the profitability
22and financial position of the business.
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24
25Illustration 7.1 Mr. Maran, the owner of Kani Ice Ccreams, a local ice cream manufacturing unit,

26had requested that an auditor to prepare the final accounts for his unit.
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28

The following is the Balance Sheet as on 01-01-2003 and 31-12-2003.

29
30

Liabilities
Creditors
Mrs. As Loan
Loan from Bank
Capital

01-01-2003
Rs.
4,00,000
2,50,000
4,00,000
12,50,000

31-12-2003
Rs.
4,40,000
-5,00,000
15,30,000

23,00,000

24,70,000

Assets
Cash
Debtors
Stock
Machinery
Land
Building

01-01-2003
Rs.
1,00,000
3,00,000
3,50,000
8,00,000
4,00,000
3,50,000
23,00,000

31-12-2003
Rs.
70,000
5,00,000
2,50,000
5,00,000
5,00,000
6,00,000
24,70,000

31
32

During the year, a machine costing Rs. 1,00,000 (accumulated depreciation Rs. 30,000)

33was sold for Rs. 50,000. The provisions for depreciation against Machinery as on 01-01-1993

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Cash Flow Statement

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1was

Rs. 2,50,000, and on 31-12-2003 Rs. 4,00,000 on 31-12-2003. Net Profit for the year

22003 amounted to Rs. 4,50,000.

3

Mr. Maran, who is not an expert in a layman in accountings wasis unable to follow the

5financial statements. He wanteds to know what is his cash position. Let uss try to help him out.
6

CASH FLOW STATEMENT

7
8

Rs.
Add :

Less :

Cash Balance as on 01-01-2003

Sources :
Cash from Operations
Loan from Bank
Sale of Machinery

1,00,000
5,90,000
1,00,000
50,000

Applications :
Purchase of Land
Purchase of Building
Mrs. As Loan repaid
Drawings
Cash Balance as on December 31, 2003

1,00,000
2,50,000
2,50,000
1,70,000

7,40,000
8,40,000

7,70,000
70,000

9
10Working Notes :
11
12(i) CASH FROM OPERATIONS :
13

Add :

Less :

Profit made during the year

Depreciation on Machinery
Loss on Sale of Machinery
Decrease in Stock
Increase in Creditors

4,50,000
1,80,000
20,000
1,00,000
40,000

Increase in Debtors
Cash from Operations

3,40,000
7,90,000
2,00,000
5,90,000

14
15(ii) MACHINERY ACCOUNT (AT COST)

To

Particulars
Balance c/d

Rs.
10,50,000

By
By

Particulars
Bank
Loss on Sale of

By
By

Machinery
Provision for Depreciation
Balance c/d

By
By

Particulars
Balance b/d
P & L A/c (Depreciation

10,50,000

Rs.
50,000
20,000
30,000
9,50,000
10,50,000

16
17(iii) PROVISION FOR DEPRECIATION
18

To
To

Particulars
Machinery A/c
Balance c/d

Rs.
30,000
4,00,000

Rs.
2,50,000
1,80,000

charged balancing figure)

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Cash Flow Statement

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4,30,000

4,30,000

1
2Illustration 78.2 During his interview with KPL Logistics Ltd., Arun of II MPIB attended an

3interview with KPL Logistics Ltd., and claimed that his strengths are accounting and finance were
4particular strengths of his.
5

The Finance Manager Mr. Suresh, who conducted the interview, put the summarized

7balance sheet of his company before Arun and asked him to figure out to find the cash flows.
8
9
10
11

The following are the summarized Balance Sheets of KPL Logistics Ltd.,
as on 31st December, 2002 and 2003.
Liabilities :

2002

2003

Share Capital
General Reserve
Profit and Loss
Bank Loan (Long-term)
Sundry Creditors
Provision for Taxation

2,000,000
500,000
305,000
700,000
1,500,000
300,000
5,305,000

2,500,000
602,000
306,000
-1,350,000
350,000
5,108,000

Land and Buildings

Machinery
Stock
Sundry Debtors
Cash
Bank
Goodwill

2,000,000
1,500,000
1,000,000
800,000
5,000
--5,305,000

1,900,000
1,690,000
740,000
642,000
6,000
80,000
50,000
5,108,000

Assets :

12
13Additional Information :
14
15During the year ended 31st December, 2003
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17

1. Dividend of Rs. 230,000 was paid in dividends.

18

2. Assets of another company were purchased for a consideration of Rs. 500,000, payable

19

in shares.

20
21The following assets were purchased : Stock Rs. 200,000 : Machinery Rs. 250,000
22
23

3. Machinery was further purchased for

Rs. 80,000

24

4. Depreciation written off of for machinery was

Rs. 120,000

25

5. Income-tax provided during the year

Rs. 330,000

26

6. Loss on sale of machinery, Rs. 2000 was written off to

27

A general reserve

Rs. 2000.

28

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Cash Flow Statement

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1

You areArun was required to prepare the Cash Flow Statement, and he prepared the

following:.

Arun had prepared the following cash flow statement.

4
5
6

CASH FLOW STATEMENT

For the year ending 31st December 2003

8
9

Cash Balance as on 1st Jan. 2003

Add : Sources of Cash :
Sale of Machinery
Cash from Operations :
Funds from Operations
Add : Decrease in Stock
Decrease in Debtors
Less :

Decrease in Creditors

5,000
18,000
883,000
460,000
158,000
1,501,000
148,000
1,353,000
1,376,000

10
11

Applications of Cash :
Payment of Dividend
Purchase of Machinery
Tax paid (See Note. iv)
Mortgage Loan repaid

230,000
80,000
280,000
700,000

1,290,000
86,000

(Cash in hand Rs. 6000 + Cash at Bank Rs.

80,000)
12
13Working Notes :
14(i) CASH FROM OPERATION
15

Add :

Less :

Particulars
Closing Balance of P & L A/c
Dividends
Depreciation on Building
Depreciation on Machinery
Provision for Tax
Transfer to General Reserve

Rs.
306,000
230,000
100,000
120,000
330,000
102,000

Opening Balance of P & L A/c

Cash from Operation

882,000
1,188,000
305,000
883,000

16
17(ii) MACHINERY ACCOUNT

Add :

Particulars
Opening Balance
Purchases :
Paid by Stock
Paid by Cash

3PSG Institute of Management

Rs.
1,500,000
250,000
80,000

330,000

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Cash Flow Statement

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1,830,000
Less :

Depreciation
Sale of Machine :
Bank
General Reserve Written off
Closing Balance

120,000
18,000
2,000

140,000
1,690,000

1
2(iii) GENERAL RESERVE

Less:
Add:

Particulars

Rs.
500,000
2,000
498,000
102,000
600,000

Particulars

Rs.
300,000
280,000
20,000
330,000
350,000

Opening Balance
Loss on Sale of Machinery
Transfer from P & L A/c
Closing Balance

3
4(iv) PROVISION FOR TAXATION

Less:

Opening Balance
Tax paid

Provision for Current year (Balance figure)

Closing Balance
5(v) DECREASE IN STOCK

Less:

Particulars
Stock as on 31-12-2002
Stock as on 31-12-2003
(after deducting stock purchased by issuing shares)
Increase in cash

Rs.
1,000,000
540,000
460,000

6
7Please check whether or not Aruns Arun would like to check with you whether his statement is

8correct.
9
10EXERCISES:
11
121.
The owner of Anus Boutique is unable to follow the following Trading, Profit and loss
13Aaccount provided below:.
14
15
Trading and Profit & Loss Account of Anus Boutique
16
For the Year ending 31st March 2004
17
To Purchase
200,000
By Sales
300,000

To

Wages

50,000

To

Gross Profit c/d

50,000
300,000

300,000

To

Salaries

10,000

By

Gross Profit b/d

To

Rent

10,000

By

Profit on Sale of Building :

To

Depreciation on Plant

10,000

Book

To

Loss on sale of Furniture

5,000

Value

100,000

To

Goodwill written off

10,000

Sold for

150,000

To

Net Profit

55,000

3PSG Institute of Management

50,000

50,000

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1Chapter 4 8

Cash Flow Statement

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100,000

100,000

1
2

He says to his accountant, Kumar Bhai! Who needs all this? Please tell me what the

3cash is which has arisend from business operations, is and what is the amount of cash is which
4came in through other sources.
5
6

Help Mr. Kumar to calculate the cash from operations.

7
82.

VG Electric (P) Ltd., manufacturers of electric switches and cables, are is planning anre

9acquisition. They are looking forward to buying the company SJ Electrical company for a price of
10Rs. 5,00,000/-. Before proceeding further, tThe general manager of VG would like to know the
11cash position before proceeding further.
12
13

Help him out in calculateing the cash flows.

14
15
16
17

The following are the Balance Sheets of VG Electric (P) Ltd. are provided below,:

Liabilities

2002
Rs.

2003
Rs.

Equity Share Capital

3,000,000

4,000,000

8% Redeemable

Assets

2002
Rs.

2003
Rs.

Goodwill

1,150,000

900,000

Land and Buildings

2,000,000

1,700,000

800,000

2,000,000

1,600,000

2,000,000

1,500,000

1,000,000

General Reserve

400,000

700,000

Debtors

Profit
&
Account

300,000

480,000

Stock

770,000

1,090,000

Proposed Dividend

420,000

500,000

Bills Receivable

200,000

300,000

Creditors

550,000

830,000

Cash in Hand

150,000

100,000

Bills Payable

200,000

160,000

Cash at Bank

100,000

80,000

400,000

500,000

6,770,000

8,170,000

6,770,000

8,170,000

Preference
Capital

Provision
Taxation

Share

Loss

for

Plant

18
19Additional Information :
20
21
(a) Depreciation of Rs. 100,000 and Rs. 200,000 have beenwere charged on Plant and

22

Land and Buildings respectively in 2003.

23

(b) An interim dividend of Rs. 200,000 has beenwas paid in 2003.

24

(c) Rs. 350,000 in Income Tax was paid during the year 2003.

25
26
273.

Ajju Toys Limited manufacturers of Toys are planning an explanation. The managing

28director Mr. Hari is quite confused after looking at the following Balance Sheets for the years
29ending on 31st December 2002 and 2003.

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1

Liabilities

2002
Rs.

2003
Rs.

Equity Share Capital

1,00,000

1,00,000

General Reserve

14,000

Profit & Loss Account

16,000

Sundry Creditors

8,000

5,400

Outstanding
Expenses

1,200

800

16,000

18,000

400

600

Provision for Taxation

Provision
Debts

for

Bad

Assets

2002
Rs.

Goodwill

12,000

12,000

18,000

Land

40,000

36,000

13,000

Building

37,000

36,000

Investments

10,000

11,000

Inventories

30,000

23,400

Accounts Receivable

20,000

22,200

6,600

15,200

1,55,600

1,55,800

Bank Balance

1,55,600
1,55,800
2
3The fFollowing additional information has also been supplied to you:
4

(i)

A piece of land has also been sold for Rs. 4000

(ii)

Depreciation amounting to Rs. 7000 has been charged on Building

(iii)

Provision for taxation has been made for Rs. 19,000 during the year.

7
8

2003
Rs.

As an engineer who had passed graduated out from PSG Tech twenty years

9beforeearlier, Mr. Hari has approached your Professor, for help with the calculations of Cash
10flows. Your Professor requestedt that ires you to help Mr. Hari, by preparing a Cash Flow
11Statement for the year ended 31st December 2003.
12
13
144.

Sri Devi Textiles Ltd., is planning for a takeover of a sick textile unit at Palladam. The

15Executive Director Mr. Rajesh is not sure about the cash position for the current year and h.
16
175.

He assigns the task of preparing a cash Cash Fflow Sstatement to his accounting

18department.
19Mr. Murali, th
20The chief Chief accounting Accounting officer Officer,Mr. Murali who is your neighbour, and

21requests that requires you to assist him in completing the task.

22
23
24
25

The following are the Balance Sheet of a Company as on 31st December 2002
and 31st December 2003 :
Liabilities

Equity
Capital

Share

General Reserve
Profit
&
Account

Loss

2002
Rs.

2003
Rs.

7,000,000

8,000,000

Fixed Assets

5,000,000

6,000,000

4,500,000

6,000,000

Additions

1,000,000

800,000

6,000,000

6,800,000

Depreciation

2,000,000

3,200,000

Net Fixed Assets

4,000,000

3,600,000

1,730,000

Current
Liabilities :

3PSG Institute of Management

2,330,000

Assets

2002
Rs.

2003
Rs.

88

1Chapter 4 8

Cash Flow Statement

2
Trade Creditors

7,000,000

9,000,000

Bank Overdraft

11,500,000

14,000,000

800,000

920,000

1,970,000

3,700,000

1,500,000

1,500,000

36,000,000

45,450,000

Creditors for
Expenses
Provision
Taxation
Proposed
Dividends
1
2

for

Investments

1,200,000

Current Assets :
Debtors

13,000,000

21,850,000

Stock at cost

17,800,000

20,000,000

36,000,000

45,450,000

The profit for the year 2002 as per the Profit and Loss Aaccount, after providing for

3depreciation, amounted in Rs. 7,000,000; this which was further adjusted as follows :
4

Opening Balance in Profit and Loss a/c

Profit after Depreciation
Add : Profit on sale of Investments
Less : Provision for Taxation
Transfer to Reserve
Proposed Dividend

1,730,000
7,000,000
200,000
8,930,000
3,600,000
1,500,000
1,500,000

Closing Balance in Profit & Loss a/c

6,600,000
2,330,000

5
6
7You are informed that
8
9
(i)
The sales and purchase of the year 2003 amounted to Rs. 80,000,000 and

10
11

12

Rs. 65,000,000 respectively.

(ii)

In arriving at the profit from the sales referred to already, the cost of sales and
administration and selling expenses were deducted.

13
14You are required to prepare :
15
16
(a) A Funds Flow Statement showing details of changes in Working Capital
17

(b) A Cash Flow Statement

18
19

3PSG Institute of Management

89