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Module 1: Cash Flow Statement

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Namaste to all of you, we have started with a new statement that is Cash Flow Statement.I hope you all liked it and you are excited about it.So, can you tell: now what is a cash flow statement?It is a statement which lists the cash inflows and outflows.Now naturally with the question comes is why do you need this statement.Now why is it required, what are your two other important statements?The first statement was balance sheet the second statement was P and L account.Balance sheet gives you what?It gives you the financial position of the enterprise; P and L gives you the income andexpenditure.But both these statements are not able to tell you how much is cash generated or spentthat is why third important statement was introduced around in 1995 that is known ascash flow statement.It gives you inflows and outflows of cash not only that, it gives you those flows underthe three heads what are the three heads?One is operating, next is investing, third is financing.In our last session we have discussed what is operating, today we will go into investingand financing.Now before that what do you mean by cash that is a first question, because we are talkingabout cash flow.So, what is a cash?So, cash includes cash plus cash equivalent, particularly in cash you are having cash andbank balances in cash equivalent what do you cover in cash equivalent?You include extremely short term investments which are highly liquid and are not exposedto loss of value because of market forces.So, something like money at call with banks or money in certain securities, but no changeof value is expected there only few restricted securities can be included in cash equivalent.Now any moment of cash is considered as a cash flow, but there is an exception if thereis a movement within cash and cash equivalent items do not consider them as cash flow.So, what is such example?So, if you deposit money in bank, you withdraw money from bank this is a change within thecash and cash equivalent; one cash item is coming down other cash item is increasing.So, we will not consider as a cash flow and we will not show it in cash flow statement.So, here you are got cash and cash equivalent items taken together and there are severalother items.If because of any transaction cash and cash equivalent either reduces or increases wewill call it as a cash flow and we will be shown in the cash flow statement this muchis what we had discuss and how will hope it is clear to you, but you can just glands tothe slides once again.So, this is a index we are slowly going to next items today.IndAS 7 is a new set of standard which we are following for this calculation.This is the definition of cash and cash equivalent, the meaning of cash, then the types of cashflows.Now, particularly we were discussing what is operating cash flow.So, operating as this name suggest means day to day activities or principal revenue generatingactivities of the enterprise.So, any item which is related to either generation of cash or expenditure of cash on day to daybusiness, which is considered as operating activity.Any activity which cannot fall in financing or investing, but there is a cash movementis also included because it is a residuary head known as operating activity.We have seen a few examples in the last session, but today going by the nature of businesscan you tell what will be the operating activity?For example suppose you are a web developer, you develop websites for various companieswhat will be the operating activity for you?What are the incomes for you?Probably are charging some fees to your clients for generating new web content, you may becharging fees for hosting their websites; all these would be incomes for you which willgo in P and L, they would also be cash generated for you.Whenever the customer pays you, you are generating cash and that cash is from operating activity.So, it falls in the first example, that is cash received from sale of goods or renderingservices.If you are Tata motors; in the last session we had taken example of Tata motors.For Tata motors what is a principal revenue generating activity, I think most of you knowthe company they sale cars.So, selling cars, trucks, vehicles is there business.So, money with they generate in cash by sale of car or by sale of a truck will be thereprincipal revenue generating activity.And what are the expenses?I think their common company rent, taxes, salaries, travelling expenses all of themare considered as for running of business.So, there your operating activity related outflows ok.Suppose you are a web developer company you purchase a car, will it be an operating activityoutflow?Answer is no because car is a fixed asset for you, it is not your day to day activityI do not think you will buy car and sell cars everyday who will buy and sell cars regularly?For a car dealer car is a stock item.So, purchase and sale of cars is a day to day activity it will be a operating activity,but for most other enterprises car is a part of fixed asset.So, for them purchase of car will fall in will go in fixed assets in the balance sheet;in cash flow statement where will it go?It will go in investing activity not in the operating activity; are you getting me?Some more examples are already listed here I think we have seen it in the last session.Now, there are two methods of preparing cash flow of which the first method is very simpleit is known as direct method.So, please have a look at the format I think it does not need any much of explanation itis very similar to P and L actual.In P and L you start with sales reduce all the expenses you get profit.Same way only exception is there we show actual payments plus outstanding expenses here youare only concentrating on actual receipts and payments.So, receipts from customers plus cash sales, that is your cash receipt minus payments toemployees, payments of rent, payments of payments to creditors not a purchases keep in mindP and L account we show purchases whether you pay or not it is considered as a expense,here only that much amount which you have paid to creditors.In case of cash purchase the amount will be same, but for credit purchase your purchasingnow paying later whenever you are paying it will go in cash flow statement ok.So, but this is relatively simple only one thing you have to keep in mind is almost likea P and L, but it should be on cash basis are you getting me.So, you are listing all cash receipts minus all cash payments from operating activities,they would be net cash from operating activities.Now, the second method is slightly complex because here we are going from P and L tocalculating cash from operating activities.So, in P and L account we get profit or loss for the period.We start from back or we start from transfer to reserve sometimes then we add back of fewitems to begin with we assume that profit is very close to cash from operations onlythose items which require adjustment.Suppose there are 40 items in P and L all of them will not need adjustment, few of themwhich are of two types they would need adjustments, only those two types of items we will eitheradd or reduced.So, what are these two types of items?One is if it is non-cash I will just show you the format.So, we are starting with retained earnings plus dividend plus taxes, that is net profitbefore tax then we add noncash items; best example of it is depreciation because we arealready discuss depreciation earlier, that it is not a cash expense it is charged toP and L, but does not involve cash so, be added back.Similarly if there are any non operating items.So, what are the non operating items?Keep in mind most of the items in P and L are operating, but a few items like sale ofmachinery and there is some loss on sale of that machinery that loss, but we will be shownin P and L. But, we do not want to have it here in cashflow that is why we add it back.So, add loss on sale of some something like a machinery.Similarly, if there is a profit on sale of land that is already shown in P and L so,we reduce it from there because its not operating item, we make a adjustment for it and afteradjusting these items we get funds from operations.After this also there is a third adjustment that is related to your current assets andcurrent liabilities.So, what happens is, from your current assets if there is a increasing current asset, itleads to less cash in the hands of company.So, suppose there are receivables.So, you have sent sold a goods, but you do not get cash your data.So, receivables are increasing your cash is falling.So, any increasing current asset there is a fall in cash keep in mind there is a competitionbetween current assets and cash; cash is also one of the current asset.So, other than cash if any other current asset is increasing, it leads to decrease in cash.You can have a look here there is a less increase of current asset similarly if current assetdecreases like you have credit you have debtors, debtors pay more cash to you their balancewill go down and you have more cash that is my add decrease in current assets.So, from the balance sheet we will get balances of current assets and liabilities, we wouldhave a look at increase and decrease make the adjustments in the funds from operationsthat will give you cash generated from operations are you getting me?So, fund is a amount of profit generated, but it is not cash.So, we are making adjustment and calculating cash generated from operation, we will haveto deduct the income taxes which are paid that gives you cash flow from operating activitiesis it clear?This much we are discuss last time, but since it is little more complex we have just revisedit again we are now going to next two heads, the next head is investing activities.These also bit of we have discuss last time so, all those activities which are relatedto long term assets like fixed assets or investments, they would be included here in investmentinvesting activities.So, what are the examples?Either purchase or sale of fixed asset; so, purchase of land sale of land, purchase ofmachinery, sale of machinery these are all investing activities or related to investmentslike keeping FD or withdrawing FD with bank, purchasing some shares or selling some sharesall this is included as investing activities.So, these are few of the examples just have a look at them.If you put FD in bank you will receive interest there on, that interest is also and investingrelated flow.If you purchase shares you will received dividend there on, that dividend is received becauseof your investment that is why it is considered as a investing activity that is also an exampleof investing activity are you getting?So, in operating activities there were two methods what were the two methods?Direct and indirect; luckily there are no two methods in investing activity you haveto directly show whatever is you have received or paid that is why calculation of investingactivities very simple there is nothing to be afraid, whatever is a amount which is paideither on fixed assets or investments or received because of them that will be directly show.Keep in mind we are not talking of profit or loss on sale of machinery that is for Pand L. In fact, now we are only concerned with the total amount which is either receivedor paid for fixed assets getting it.Now, the third type of activity is known as financing activity.Now here in the first session if you remember we had seen that business needs resources,those resources are assets now these assets are financed by somebody.So, somebody makes you payment you get some money from that money you have purchased theassets.Now from where you have raised the money or from where you have generated those financesthey are categorized as financing activities.There are two important types in it one is known as equity, the other is known as borrowings.Do you remember, when we discuss balance sheet we had discussed is I would request you togo back and have a look at balance sheet format.So, what does it fall what does falls under equity?These are the owners funds these are the moneys of the shareholders like share capital orpreference share capital that will be shown and what are the borrowings?Borrowings are various types of loans taken by you.So, either loan taken or loan prepaid or interest paid on that loan they are all falling underfinancing activities.So, here some examples are given like issue of shares or debentures borrowings and so,on what do you mean by debenture do you remember?So, debenture is also like a loan company obtains a loan and gives a certificate tothe lender in the form of debenture certificate, that is called as a debenture.But, it is just like a loan for the company so, that is also a financing activity.So, here there are some specific examples when you issue shares exactly reverse of itis called as buyback of shares; that means, company takes back the shares from shareholderand gives them money that is called as buyback of shares so, that also a financing.Same way issue or redemption of preference shares or debentures; in issue what happens?Company receives money gives preference shares.Buyback or redemption is exactly opposite company takes back shares give them cash boththe cases the cash is involved and it is related to financing of the business.So, it will fall in the financing category of cash flows are you getting?Now, whenever you raise funds, you have to compensate your investors in the form of interestor dividend.If you take loan you will pay interest that is also financing activity if you raise moneyby way of shares you will pay them dividend that is also a financing activity; are yougetting all the examples?Now, let us consider some specific items in the cash flow of which the first one is interest.We have just discussed it already, but this will be reinforcing in your mind interestcan be received or paid.Now, to begin with how do you account for interest received?We have already discussed this that you receive interest mainly because you are made investment.So, if you are made investment in bank like FD or if you are maid investment in debentureof some other company, you will receive interest from them that will be categorized as investingflow, but there are some exceptions to it which have noted please keep in keep themin mind.Suppose the investment is in cash equivalent for example, investment is in ultra shortterm deposit which you have categorized as cash equivalent, then it is not an investment.As far as cash flow is concerned it is not an investment that is why interest receivedon cash equivalent type of investment will be considered not as an investing activity,we will categorize is an operating activity because it is a day to day item similarlysometimes we receive interest from trade advances getting me?So, suppose we have put some money as an advance to our suppliers and they give us intereston that amount it is rare it does not happen every now and then, but suppose it is therewe have received some interest from it or suppose there is a bill receivable and onbill receivable we have received interest then it is not related to any investment itis not a long term activity.Because typically it is for one month two months three months four months like lessthan one year, that is why those investments and interest there on would be categorizedas operating activities.And the third example which is for specific type of undertakings or company is known asfinance enterprises.What are the examples of finance enterprises?For example, of bank a non banking finance companies for them finance is there business.So, giving loan is their business.So, they are bound to receive interest from their customers, that is there day to daybusiness activity or principal revenue generating activity.So, we will categorize it as operating flows for all finance related companies are yougetting.So, this is about interest received.Now, about interest paid.Now interest paid as you all know by default we will treated as a financing activity, butthere are a few exceptions.Suppose the loan is obtained as a working capital loan, I hope you know what is workingcapital.Working capital means current assets minus current liabilities this is a capital whichis used for day to day activities or if you remember our session 1 and 2 we had seen abusiness cycle.Now whatever is money blocked up in business cycle you can get some loan from bank forspecifically for working capital.Now, if you pay interest on a working capital loan, it should be categorized as an operatingflow not as a financing flow.And the third example or a second exception you can say is for a finance enterprise.Now, naturally for a finance enterprise paying of interest is a part of their day to dayactivity they receive interest they pay interest so, far them interest paid is categorizedas a operating flow are you getting.So, this was about interest; now based on these can you imagine what will happen fordividend?Because dividend also you get both the categories like dividend interest and dividend receivedand dividend paid.Now, if it is dividend paid what will happen?Whom do you pay dividend?We raise money by way of shares.So, share holders pay us as a company their money to compensate them we give them partof share of our profit that is known as dividend.So, it should fall in which category?Is it operating is it investing or is it financing?I think most of you are guessing it correct this is related to raising of funds.So, it is a financing activity, we have raised funds by way of shares we give dividend toshareholders.So, it will be considered as a financing outflow are there any exceptions like for interest?Now this is a peculiar item there are no exceptions even if it is a finance company, even if itis a operating item or whatever you will never consider it has operating or investing dividendpaid is always considered as a financing item.What about dividend received?Where will dividend received go?Dividend received is very similar to interest received actually by default it will be consideredas an investing flow.You will just go to that slide.So, dividend received what happens is for a non financial enterprises, we will alwayscategorize it as a investing flow because we have made investment in shares we get dividend.But for a finance company or for a bank we will categorize it as a operating flow becausefor them it is a day to day activity and dividend paid we have already discuss is always categoriesas a financing.So, you are getting me.So, we have discuss now today few peculiar items, first we discuss the investing operating,then investing, financing and two peculiar item that is interest and dividend.In the next session we will take a few more items and then we will start looking at the problems, Namaste.