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Module 1: Cash Flow Statement

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Namaste. In last two sessions we have been discussing one of the very important statementsthat is in the form of Cash Flow Statement. We already revised it last time but I willjust give a brief revision, so cash flow statement had three categories, operating, investingand financing. Now, what do you mean by operating do you remember? So, these were principalrevenue generating activities; now the challenge in operating activities was it can be by directmethod.So, have a look at this format or it can be also calculated by indirect method that isstarting from P and L, we have to list out certain activities which are non-operatingor non-cash.And then we also list out working capital items to get cash flow from operating activities.Then we discussed the second head which is investing activity, any moment because offixed assets or investments either buying or selling which was all categorized as investingactivities.We have also discussed financing activity.So, these are the examples of financing activities, now these are the movements in equity or inborrowings. Any issue of shares, or purchase of shares, or any issue of debentures, orpurchase of debentures, or taking of loan, or repayment of loan paying installment ofloan is all considered as financing.There are two unique items in it which were also discussed that is interest, by defaultI think you all know that any interest received will be generally considered as an investingflow. Because, you make investment you get interest, but there are exceptions which areequally important. So, keep in mind three exceptions if the investment is of cash equivalentnature, or the interest is received on trade advances, or operating receivables the interestwill be an operating inflow. And, if all the interest received is for a finance enterpriselike a bank then it is a operating flow.Then interest paid normally it is a financing activity, but interest on a working capitalloan will be a operating activity, and for a finance enterprise we will categorize thisas a operating flow.As far as the dividend is concerned mostly dividend received is an investing flow, butfor a finance company it is a operating flow. And for dividend paid it is very simple forany type of enterprise without exception we will categorize it as a financing is it clearare there any queries. As I have told earlier also I remind you about two things all yourqueries and questions please discuss them on the discussion forum. So, ask to TA’s,ask to me or ask to all other colleagues who are also studying with you.Second important thing is download your annual report and read the statement which we arediscussing for your own company. So, for last two sessions we have discussed cash flow,I hope you have seen you have start reading the cash flow of your own company. If youobserve any special things, you can of course discuss in the discussion forum are you clear,we will look at some more peculiar items now that is foreign currency transactions.Now, all the transactions may not be in the domestic currency, if it is a foreign currencyitem then it needs that is also shown in the same cash flow, but it is reported as a separatepart of reconciliation of cash and cash equivalent. Because, suppose we are an Indian companywe hold some balances in dollars, the value of rupee to dollar will change in the beginningas well as in the end though changes in the value are not as such any cash flow. So, theywould be shown as a reconciliation in the cash and cash equivalent.Now, suppose there are any unrealized gains in the foreign due to foreign exchange ratechanges like, we are holding dollars the value of dollar increases, but we are not yet soldthose dollars then it is a unrealized gain. So, these are not known as cash flows theywould be reconciled in cash and cash equivalent. Now there is, so this is about foreign currencyitems the second is above the next one is about extraordinary items, I hope you rememberthe extraordinary items which we had discussed.Now, if the cash flows are associated with extraordinary items they should be shown underthe respective heads, but to be separately disclose. So, for example, if there is a lossby fire you know extraordinary means some major loss it is a mega loss by fire. Thenunder what head will you categorize as a operating or as investing or as finance. What do youfeel? Now here we have to look at what we have lost,suppose stock is lost by fire, then that loss will you show it in cash flow and if yes underwhich head. First of all this being a non cash item it will not flow in coming cashflow, but if you receive insurance claim for loss of stock where will you show? That insuranceclaim will be treated since, it is a loss of stock which is a operating item, insuranceclaim received because of loss of stock or because of loss of profit policy it will beconsidered as a operating item. Will it go as investing item anytime? In somecases suppose, it is a claim for loss of machinery because of fire stock and machinery both mightbe lost. Whatever is a portion related to loss of machinery that will be consideredas a cash inflow due to investing activity that is what is known by as whatever is aassociated item it will be late ok, so are you getting now I am showing it on screen.So, whatever is a relevant item normally it is either operating or investing.Now, next is about treatment of taxes, normally taxes are an operating item; so whatever isa tax paid we will show it as a operating expense.If there are some specific taxes on investing or financing related items we will show itunder the respective head. So, example is dividend tax whenever we pay dividend we haveto pay tax on that dividend, so taxes on dividend will be categorized as a financing flow. Ihope you remember that dividend first of all is financing, so tax there on is also financing.Now, next one is about cash flow related to subsidiaries.Now, for subsidiary companies or associate companies since this is a cash flow statementonly the cash flow related to enterprise and the investee would be reported, so cash flowrelated to dividend and advances will be shown.Now, the next one is a case about acquisition and disposal of various businesses. Now, supposewe acquire another company and make payment there off then it is considered as an investingactivity. But, within investing activity it will be separately shown as a investing activityand total amount which is purchased or dispose will be separately shown under the respectiveactivity. Now, if the payment is made by means of cash and cash equivalent, that should beseparately shown ok.Now, the next is about non-cash transactions, there are certain transactions which are tobe excluded from cash flow and they should not be shown because, it is non-cash in nature.Can you think of any examples of such items that there is a transaction, but it is noncash in nature, so should not come in cash flow. Do you think of any such examples? Ithink some of you are guessing it correctly.Suppose, you purchase new assets normally we purchase fixed asset and pay for it, soit will come as a investing outflow. But, suppose new assets are purchased, but we donot pay cash instead of paying cash we are assuming liability against the asset, so weare taking over asset and also taking over liability in exchange. So, no cash paymentor receipt is involved, so it will not be shown in the cash flow.Similarly, sometimes we purchase another company, but do not pay cash make the payment in theform of shares; so we get that business of the enterprise in lieu of that we issue ourshares. So, our assets increase, liabilities increase and our share capital increases,no movement of cash then again it is a non cash transaction, another example is conversionof debt into equity. Now, there are certain types of debentureswhich are known as convertible debentures. So, those debentures are debt they are convertedinto equity shares no cash payment or there is a loan taken from bank and we are unableto make repayment. So, bank emphasizes or forces us to convert it into equity, againno cash is involved, so it is also an example of non cash transaction. So, keep in mindthat in most cases any movement or asset of liability will lead to cash flow, but we alsohave to be careful in the nodes to see whether there are any non cash flow items then theyshould not be considered in the cash flow.Now, in the end you are required to make disclosure of cash and cash equivalent, so you shouldshow the total cash, cash equivalent in the beginning and in the end and a reconciliation.Because, in the cash flow statement you have listed all inflows and outflows, the net totalof that should match with the movement of cash and cash equivalent and it should matchwith your balance sheet ok. There are also some more disclosures which are mandated bythe accounting standards, one is that enterprise has cash and cash equivalent, but that muchof balance is not available for use, then it needs to be separately disclosed.Now when such case will arise can you think of any such item, suppose we are having abranch in Afghanistan we have some cash there, but lot of terrorist activities are on, sowe are unable to use it, we will have to separately disclose it. So, any such cash or bank balancesnot available for business will be separately disclosed, there are also some undrawn borrowingfacilities I hope you know about bank overdraft. So, by bank overdraft bank has sanctionedus loan anytime we can withdraw it, it is almost equivalent to cash for us, but rightnow we have not withdrawn it, then such these are like balances available. So, they shouldalso be shown by way of note, but if there are any restrictions on use of them they shouldalso be discussed. Are you getting this? Now, after this we will move to we will havea look at certain formats and then we will move to the actual cases of calculation forcash flow. First let us look at certain formats, now whenever we discuss the operating, investing,and financing items we have looked at examples, but let us look at the actual format how itwill be disclose in the cash flow item.So, this is a format for cash generated from operations I think you have already seen it,but this is more detail. So, have a look at it, it starts with retained earnings, adddividend you get net profit after tax; keep in mind normally in P and L account your incomesminus expenses the last item is profit. Here we start with profit and go to cash from operations,add the tax expenses for the year you get net profit before tax then add non-cash items.So, depreciation or amortization like goodwill written off, then adjust for non operatingitems. So, loss on sale of assets or interest expenses are added interest dividend incomeor profit is reduced that is why you can see it is in bracket.You get fund from operations then adjust for working capital items, so any decrease incurrent asset or increase in current liabilities added and reverse that is increase in currentassets. See cash is also a current assets, so it is in competition with other currentasset, if other current assets goes up the cash false; that is why increase in currentasset is reduced, if there is a decrease in current liability then the cash falls.So, cash and current liabilities go together any increase in current liability you cansee here is leading to increase in cash decrease in current liability reduces our cash. Now,these items will be adjusted and you get cash generated from operations of course, you willhave to now reduce the income tax. So, you get cash flow from operating activities thisis the end of the first part of cash flow statement then.The second and third are very simple, now cash from investing activity you have to justlist the items.Next is cash from financing activity.I think you know the examples, so though there is no direct or indirect directly those itemsyou can add in the cash flow statement.So, at this stage you have got first second and third type of activities, so you get netincrease or decrease of cash which is a total of 1 plus 2 plus 3. Then you add cash andcash equivalents at the beginning, so you get cash and cash equivalent at the end ok.Now, here it should match the total increase plus beginning should be what is there inthe end.Now, apart from this you have to also show reconciliation of the balances, so in thebalance sheet you will have the value or the balances of cash and cash equivalent theyare restated in the cash flow statement both at the beginning and the end. So, the closingcash flow statement will show balances in the beginning as well as end of cash, bank,and short term investments which you are treating as cash equivalent are you getting.So, with this we have discussed the format, now we will go into actual case the caseswill be available to you on the Google link, but right now I am showing them here I wouldrequest you to read it carefully and we will also try to solve those that is the solutionof them.So, have a look at the case we are given a profit and loss account.So, sales and interests are given that is a total income of 215000, then various expensesare given like purchases, wages, interest, depreciation, office expense, goodwill, tax,dividend, so you get net profit.Then opening and closing balance sheet is given ok, so, liability side is given to you,then the asset side is given to you.So, you have got P and L at the end of year, then opening balance sheet and closing balancesheet with this much information we have been asked to prepare cash flow statement. Now,how will you proceed, now as per as the operating cash flow is concerned, I am just going backthis P and L statement is what is going to give you operating cash flow.So, we will start with net profit make adjustments here add and less they will give you operatingcash flow, balance sheet items are mostly related to investing or financing. So, anychange in the balance sheet item you should note carefully that is going into investingand financing; of course, there will be few items in the balance sheet which will haveimpact on operating also, so be careful about them ok.So, let us start with balance sheet one by one look at the change and take a notebookand note whether that particular change is investing or financing. Once you have donethat rest of the job is very simple it just clerical work you have to note it in the formatas a cash flow statement are you getting me. So, please try to solve with me, now the firstitem share capital, there is a increase from 160000 to 190000.You do not have to write the full balance sheet, but just write ac or something in shortform and note whether what type of item it is, so is it operating item or investing itemor financing item. So, I recommend that you just write ac write o or i or f whatever youfeel it is, so can you guess what type of flow it is? See there is a movement from 160it has increased to 190. So, it is some type of cash flow, is it anoperating? I think answer is no, because share capital has nothing to do with day to daybusiness, is it investing? Again the answer is no, because we are not making investmentshere. Some of the shareholders have made investment in our company and we have issued them shares,that is why our share capital balance has increased. So, it is not o not i it is a ftype of item that is financing item, please note it as f, so share capital in front ofthis you write f, is it an inflow or outflow? Better we write as inflow or outflow whatit is see the share capital balance has increased. So, we have received money and we have giventhem shares it is a cash flow statement, so cash has coming or has gone out, cash as actuallycome in. So, for the sake of working note write it as f inflow; that means, financeinflow, like that we will categorize each item I think the rest of the work is verysimple. The next is general reserve, which type of item it is actually there is no change,so there is nothing has happened just take it or say dash or something like that, nextis P and L account. Now, this is not profit and loss account this is a balance of P andL account which as increase from 9000 to 2200. So, it is which type of item, actually ifyou do 22 minus 9 there is a increase of 13000 you can see here net profit, actually thisis not even net profit this is a profit which is transferred to balance sheet ok. So, 13000is added to the balance of P and L in the balance sheet, so it is what type of item?This is increases because of the profit generated, so it is a o type of item. So, right now youjust mark it as o we will when we solve our operating we will take it into account, butright now let us mark it as o. Next is debentures, debenture balance hasreduced from 80000 to 51000, now you will categorize it as which type of item; see somemovement has happened there is a decrease in the balance. So, we must have redeem thedebentures; that means, we have paid money and cancelled part of the debentures of howmuch amount, 29000 which is a difference. So, it is which type of item is it o or ior f, it is not o its not day to day item it is neither I it is not our investment itis f item we had raised money by way of debentures now we are repaying it. So, mark it as f isit inflow or outflow it is basically an outflow we are making payment, so mark it as f outflow.Next one is creditors from 20 they have increased to 40, so it is what type of item? If youremember it is required for a calculating our operating flows this is a working capitalitem. So, mark it as o if want you can also say its working capital w cap or somethingcan write, but basically it is a o item, it is not a direct inflow or outflow. Next isproposed dividend, now this is a tricky item it has increased from 2 to 3 it is what typeof item? Is it o? No, is it i? No, it is f, I think you remember we have discussed thatpayment of dividend is always f, how much amount? 2000 or 3000 or 1000.Mostly the difference is the cash flow, but here it is not difference the whole of lastyear’s amount would have been paid just have a look at P and L also, in profit andloss you can see dividend 3000. So, what has happened is at the end of the current yearwe have made a proposed dividend of 3 it is this amount, and last year’s 2000 last yearmeans on 31st march 2019 200 would have been provided they would have already paid it,and for this year new 3000 has been provided. So, the entire amount of 2000 this is a specialitem please mark it carefully, so this 2000 is f outflow, it is a financing item it isa outflow, 3000 is not outflow it is basically a P and L item. So, you can write it as ao see dividend is a very special item it is going to come two times this is f outflowand 3000 is o we will consider it when we look at P and L account.Now, let us I hope you have understood the liability items we are going to see the answeralso, but better you note it and we will solve it together. Now, we will go to assets inassets the first item is land, land there is no change so dash, fixed assets there isa fall in fixed asset from 140 to 190 1. So, what is happened there could be sale, butit can be wrong also because please look there is a depreciation ok.So, depreciation of 9000 it matches here, so there is a reduction in the value of fixedasset no purchase or no sale, so probably it is dash. We will look at it once again,investment 59000 increasing to 1 1 1. So, what type of item it is, there is a increasinginvestment we have made payment and investment has increased, so it is a investing type offlow first time investing flow is coming, so mark it as I outflow are you getting.Next is sundry debtors, 12 to 17 what type of item? It is a working capital item or oitem, so mark it as o and we will adjust it in the operating flow. Next is bank, whattype of item it is? Actually it is a tricky item is not an item it is a cash equivalent.So, write its c, c for cash; goodwill, goodwill you can see it has fallen from 30 to 19 normallygoodwill falls because of amortization. So, we will have to look in P and L account,you can see here goodwill written off 11000, so 30 to 19 the difference is because of goodwillreturn of right now you can mark it as a o item, so I hope you have understood all themarkings of balance sheet. Now, as far as the P and L account is concerned I am onceagain taking you to P and L start with net profit and go back adjusting these items asper our format they can be plus or minus for few items which are non operating or non profit.So, we will now go to the solution only the first part is be tricky, now here we are startingwith operating flows. So, please have a look at P and L we are go in the reverse orderwe start with profit add dividend, add tax, add goodwill, like that we go on adding theitems which are these two are added because their financing item this is a financing itemtax is the tax which is provided goodwill is written off depreciation is written offthey are non operate non-cash items I will just show you the solution.So, retained earnings plus dividend give you profit as per P and L account which is 16000,add depreciation, add goodwill, add interest expense, add income tax, add and reduce interestincome. See here in P and L we had a interest income of 15000 which was added for P andL now we will reduce it; I know it is bit complicated, but just keep in mind as performat we are going these gives us funds from operations.Now, in funds from operations we are going to adjust to working capital items, so addincreasing debtors and less sorry add increase in creditors and less increase in debtorsthis gives me cash generated from operations, now income tax will come twice because hereincome tax provided was added.Now, this one this amount 37000 same amount of tax is also paid that is why I will payout the income tax income, tax paid I get net cash flow from operating activities areyou getting operating is only bit complicated investing is very simple I think you alreadynoted two items, one is purchase of investment, so it is less and interest income is our income,so you add it getting it. So, 37000 negative is a investing activitythe next is financing activity say very simple again four items issue of share is a receipt,dividend, redemption and interest is a payment. So, financing activities negative 15000, nowthe total of three all the three items, so we had taken 50000 as a operating activitiesand minus 37 as a flow from investing and minus 15 as a flow from financing. If youadd these 3 there is a net reduction of 2000, so net decrease in cash. Then go to balancesheet balance sheet has a opening bank balance of 5000 and closing bank balance of 3000.So, if you take minus 2 plus 5 you will get 3000, so here the cash flow statement tallies.We will also make a reconciliation in the beginning and end there is only one item,so beginning is 5000 end is 3000. So, we already knew that there is a fall of 2000 from balancesheet in the bank balance, now we have explained it through cash flow statement. I hope youhave understood it, once again have a look at both the problem and the solution thisis a starting and a simple problem and it will give you proper insights into cash flowstatement ok. So with this we will stop Namaste.