Accounting Standard (AS) - 3

CASH FLOW STATEMENTS

Introduction
Cash flow statement is additional information to user of financial statement This statement exhibits the flow of incoming and outgoing cash

This statement assesses the ability of the enterprise to generate cash and cash equivalents
It also assesses the needs of the enterprise to utilise the cash and cash equivalents generated It also assesses the liquidity and solvency of the enterprise.

Applicability
This standard applies to the enterprises:
Having turnover more than Rs. 50 Crores in a financial year; Listed companies;
Cash flow statement of listed companies shall be presented only under the indirect method as prescribed in AS 3

Who cares about a Cash Flow Statement?

Executives want to know if the cash generated by the company will be sufficient to fund their expansion strategy Stockholders want to know if the firm is generating enough cash to pay dividends Suppliers want to know if their customers will be able to pay if offered credit Investors want to evaluate future growth potential Employees are interested in the overall viability of their employer as indicated by its ability to fund its operations

Definitions
Cash comprises cash on hand and demand deposits with banks. Cash equivalents are short term, highly liquid investments that are readily convertible into known amounts of cash and which are subject to an insignificant risk of changes in value. Cash flows are inflows and outflows of cash and cash equivalents. Operating activities are the principal revenue-producing activities of the enterprise and other activities that are not investing or financing activities.

Investing activities are the acquisition and disposal of longterm assets and other investments not included in cash equivalents.
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.

Cash and Cash Equivalents

Cash Equivalents
Held for meeting short term commitments It is readily convertible into known amounts of cash It has a very insignificant risk Short maturity (say 3 months maximum)

Cash flows exclude

Movements between cash and cash equivalents

Cash management includes the investment of excess cash in cash equivalents

Features of Cash Flow Statement

The cash flow statement should report cash flows during the period classified by
Operating, Investing and Financing activities.

Sum of these three types of cash flow reflect net increase or decrease of cash and cash equivalents.

THE NEED FOR A CASH FLOW STATEMENT

Profit represents the increase in net assets in a business during an accounting period. This increase can be in : ---Cash ---Non-current assets ---Receivables ---Inventory

 Or the liabilities of the business may have decreased ,i.e more cash has been spent this year in paying off suppliers than was the case last year.

A cash flow statement is needed because of the differences between profits and cash. It achieves the following: -- Provides additional information on business activities -- Helps to assess the current liquidity of the business. -- Allows the user to see the major types of cash flows into and out of the business -- Helps the user to estimate future cash flow -- Determines cash flows generated from trading transactions rather than other cash flows.

 CASH FLOW STATEMENT FOR THE PERIOD ENDED

 Cash flows from operating activities :begins with the profit before tax as shown in the income statement. The figures below are the adjustments necessary to convert the profit figure to the cash flow for the period. Depreciation
Interest expense

Increase in trade receivables

Added back to profit because it is a non-cash expense Added back because it is not part of cash generated from operations (the interest actually paid is deducted later) Deducted because this is part of the profit not yet realized into cash but tied up in receivables

Decrease in inventories Decrease in trade payables

Interest paid Dividends paid Income taxed paid

Added on because the decrease in inventories liberates extra cash Deducted because the reduction in payables must reduce cash

These are the amount actually paid in the year

 Cash flows from investing activities :cash spent on non-current assets, proceeds of sale of noncurrent assets and income from investments.

Cash flows from financial activities: the proceeds of issue of shares and long-term borrowing made or repaid.

Net increase in cash and cash equivalents :the overall increase or decrease) in cash and cash equivalents during the year. Add the cash and cash equivalents at the beginning of the year to give the final balance of cash and cash equivalents at the end of the year.

PREPARATION OF A CASH FLOW STATEMENT Direct method :figure for the cash statement derived from the accounting records or form the other financial statements. Indirect method: figures derived from the other financial accounting statements: ---Balance sheets for the current year end and the previous period ---Income statement for the period.

 The alternative reconciliations are as follows

Direct method $000 X (X) (X) (X) Indirect method $000

Cash received from customers Cash payments to suppliers Cash paid to and on behalf of employees Other cash payments

Profit/(loss) before tax X/ (X)

Depreciation charges X

(Increase)/decrease (X)/X in inventories (Increase)/decrease (X)/X in receivables (Increase)/decrease (X)/X in payables

Net cash inflow/(outflow) from operating activities X/ (X)

Net cash inflow/(outflow) from operating activities X/ (X)

 Indirect method - You are usually presented with two balance sheets: for the end of the prior period and for the end of the current period. - All the differences between the opening and closing balances are various types of cash flow, or are otherwise needed to produce the cash flow statement. - To calculate the operating cash flow: (1) Find the profit figure:

Take it from operating cash flow, or Calculate the increase in retain profit and
add back the periods dividends and tax charge to arrive at profit before tax.

(2)Adjust the profit figure for:

receivables and payables.

Non cash expenses like depreciation, and Movements in working capital items such as inventory,

(3)where there are sales of non- current assets you will need to find figures for additions or disposals, and depreciation on disposals.

Set up three T accounts for non-current asset

cost, aggregate depreciation and disposal

Enter the opening and closing balances from

the balance sheets.

Do the double entry in the ledger accounts and the cash

flow statements for all additional information given to you in the question

The balancing figures will give you the figures you need

 (4) set up a format as follows, leaving plenty of space between the headings, then go through the given balance sheets from the top entering the differences in the correct positions in the format.

Cash flows from operating activities Cash flows from investing activities Cash flows from financing activities

to give to give to give

Net cash from operating activities

Net cash used in investing X activities Net cash used in financing X activities X X

Net increase in cash and cash equivalents Cash and cash equivalents balance at beginning of year (from prior period balance sheet) Cash and cash equivalents balance at end of year (agree to closing balance sheet)

 Direct method ---Gross cash flows can be derived: (1) from the accounting record: total the cash receipts and payments directly, or (2) for net cash flow from operating activities, from the opening and closing balance sheets and income statements for the year by constructing summary control accounts for:

Sales (to derive cash received from

customers)

Purchases (to derive cash payments to

suppliers)

Wages( to derive cash paid to and on

behalf of employees)

(W1) Receivables ledger control $ Balance b/d X Cash receipts (b/f)

Sales revenue X Balance c/d X

$ X X X

(W2)Payables ledger control (excluding non-current asset purchases) $ $ Cash paid (bal fig) X Balance b/d X Balance c/d X Purchases -Cost of sales X -Administration X X X

(W3)Wages control
Net wages paid (bal fig) Balance c/d $ X X X Balance b/d Cost of sales Administration $ X X X X

Alternatively, the figure for net cash flows from operating activities could be derived from the reconciliation shown above. A further working for non- current assets may be required. (W4) Non-current assets (NBV) $ $ Balance b/d X Depreciation charge X Addition (bal fig) X Balance c/d X X X

INTERPRETATION USING THE CASH FLOW STATEMENT

The cash flow statement reveals: ---Whether the overall activities reveal a positive cash flow ---Whether the operating activities yield a positive cash flow ---The manner in which capital expenditure has been financed (for example, whether it has come from internally-generated resources, borrowings, issue of shares or from cash balance)

 Cash flow statements allow users to evaluate: ---How the enterprise generates and uses cash and cash equivalents. ---Changes in net assets, financial structure (including liquidity and solvency) and the ability of the enterprise to adapt to changing circumstances. ---The ability of the enterprise to generate cash ---Between different enterprises, because the effects of using different accounting treatments are eliminated ---Forecasts of future cash flows ---The accuracy of past assessments of future cash flows.