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Financial Accounting

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Financial Accounting (Mgt-101)
VU
Lesson-41
CASH FLOW STATEMENT
Cash flow statement shows, how cash was generated and how it was used during the period. These days, it is
required by law to include this statement in financial statements, especially in case of financial statements of
limited companies.
NEED FOR CASH FLOW STATEMENT
For any business, it is important to ensure that:
 Sufficient profits are made to compensate owners for the investment made, efforts put in and the
risk taken for the business,
 Sufficient funds are available to meet the obligations of the business as and when required.
The information as to profitability is provided by the Profit and Loss Account. The information as to
availability of funds or financial health is provided by the balance sheet. But the balance sheet is prepared on
a specific date and can provide information of financial position as on that date only. Cash flow, on the
other hand provides more detailed information about the movement of funds during the period. With the
help of cash flow, we can determine the amount of cash generated form different sources and the areas on
which it is utilized.
DIFFERENCE BETWEEN PROFITABILITY AND LIQUIDITY
Liquidity
It is the ability of a business to pay its debts in time. By having good liquidity, we mean that a business has
sufficient liquid funds (cash and cash equivalents) so that it can repay liabilities.
Cash
Cash includes cash in hand and demand deposits.
Cash Equivalents
Cash equivalents are those short term investments that can be converted into a known amount of cash at any
time. Usually, investments up to three months maturity are included in cash equivalents.
People generally mix up profitability with liquidity. One might think that if a business has earned, say, One
Million Rupees of profit than it should have approximately the same amount of cash in it.
But mostly this is not the case. Consider the following example:
 A person starts a small business with Rs. 10,000.
 He purchases goods worth Rs. 20,000. Rs. 10,000 is paid in cash and remaining is payable at the end
of the month.
 The same day, all the goods are sold on credit of two months for Rs. 30,000.
 Now if we draw a profit and loss account at the end of the month, the business has earned a profit
of Rs. 10,000, considering no expenses.
 But at the same time, it is time to pay to the Creditors, whereas payment from debtor is not due yet.
 This means that although the business earned a profit of Rs. 10,000 but it has no cash to pay to its
creditors.
 This simple example helps us to understand that liquidity is different from profitability
 But it is as important as profitability.
COMPONENTS OF CASH FLOW STATEMENT
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Financial Accounting (Mgt-101)
VU
Cash flow statement is divided into three components
 Cash Flow from Operating Activities
 Cash Flow from Investing Activities
 Cash Flow from Financing Activities
CASH FLOW FROM OPERATING ACTIVITIES
Cash flow from operating activities is generally derived from the principal revenue producing activities of the
business.
Cash Flow from Operating Activities is the indicator of success or failure of a business's operations. If the
cash flow from operations is continuously negative, this means that the business revenue is not enough to
recover the costs that are incurred to earn it. Therefore, in the long run Cash flow from operations must be
positive.
Examples of cash flows from operating activities are:
 Cash receipt from sale of goods and rendering of services.
 Cash receipts from fees, commission and other revenues.
 Cash payments to suppliers for goods and services.
 Cash payments to and on behalf of the employees.
 Cash payments or refunds of income taxes.
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Financial Accounting (Mgt-101)
VU
EXAMPLE
Net Profit before Tax
16,514
Add: Adjustment for Non-Cash Items
Depreciation for the Year
5,500
Provision for Doubtful Debts
810
Exchange Gain / Loss
-
Gain / Loss on Disposal of Assets
-
Return on Investments
4,000
Mark-up on Loans
3,500
Operating Profit Before Working Capital Changes
30,324
Working Capital Changes
Add: Decrease in Current Assets
40,000
Less: Increase in Current Assets
(50,000)
Add: Increase in Current Liabilities
-
Less: Decrease in Current Liabilities
-
Cash Generated From Operations
20,324
Less: Markup paid on loans
(3,000)
Less: Taxes Paid
(5,000)
Net Cash Flow from Operating Activities
12,324
CASH FLOW FROM INVESTING ACTIVITIES
Cash flow from investing activities includes cash receipts and payments that arise from Fixed and Long
Term assets of the organization.
Cash Flows from Investing Activities shows the investment trend of the business. If it is negative (Outflow)
this means that the company is investing in long term assets and is expanding. On the other hand if it is
positive (Inflow) over the years, this means that the company is selling its long term investments.
Examples of cash flows from investing activities are:
 Cash payments to acquire property plant and equipment. These also include payments made for self-
constructed assets.
 Cash receipts from sale of property plant and equipment.
 Cash payments and receipts from acquisition and disposal of other than long term assets e.g.
Shares, debentures, TFC, long term loans given etc.
If assets are held for trading purposes or in normal course of business e.g. car / property dealers and loans
given by banks, then cash flow from these are included in Operating Cash Flow.
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Financial Accounting (Mgt-101)
VU
EXAMPLE
Cash Flow from Investing Activities
Add: Disposal of Fixed Asset and Long Term Investments
100,000
Less: Acquisition of Fixed Assets and Long Term Investments
(80,000)
Add: Dividend Received / Returns on Investment Received
-
Net Cash Flow from Investing Activities
20,000
CASH FLOW FROM FINANCING ACTIVITIES
Cash flow from financing activities includes cash receipts and payments that arise from Owners of the
business and other long term liabilities of the organization.
Cash Flows from Financing Activities shows the behavior of investors (both equity capital and debt capital).
A positive figure (inflow) shows that funds are being invested in the company and vice versa.
Examples of cash flows from financing activities are:
 Cash received from owners i.e. share issue in case of company and capital invested by sole
proprietor or partners.
 Cash payments to owners i.e. dividend, drawings etc.
 Cash receipts and payments for other long term loans and borrowings.
EXAMPLE
Cash Flow from Financing Activities
Add: Shares Issued / Capital Invested
1,000,000
Less: Dividend Paid / Drawings
(400,000)
Add: Increase in Long Term Borrowings
150,000
Net Cash Flow from Financing Activities
750,000
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Financial Accounting (Mgt-101)
VU
PROCEDURE OF PREPARING CASH FLOW
Cash Flow Statement is prepared as follows:
 We start from the Profit / Loss for the period before taxation.
 Adjustments are made for non-cash items that are included in the profit and loss account such as
Depreciation, Provisions and other items that relate to investing and financing activities.
 This gives us Operating Profit before Working Capital Changes.
 Then Working Capital Changes, i.e. increase or decrease in items of current assets and liabilities, are
added / subtracted (Cash and Cash Equivalents are not included here)
 This gives the Cash Flow from Operations.
 To this figure, we add / subtract cash flows from investing and financing activities.
 This gives us Net Increase / Decrease in Cash and Cash Equivalents.
 To this figure we add Opening Balance of Cash and Cash Equivalents (that we excluded from
current assets)
 This gives us the Closing Balance of Cash and Cash Equivalents.
Increase or Decrease is generally taken as difference in opening and closing balances of accounts reported in
balance sheets.
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Financial Accounting (Mgt-101)
VU
FORM OF CASH FLOW STATEMENT
Name of the Entity
Cash Flow Statement for the Period Ending -----
Net Profit before Tax
XYZ
Add: Adjustment for Non-Cash Items
Depreciation for the Year
XYZ
Provision for Doubtful Debts
XYZ
Exchange Gain / Loss
XYZ
Gain / Loss on Disposal of Assets
XYZ
Return on Investments
XYZ
Mark-up on Loans
XYZ
Operating Profit Before Working Capital Changes
XYZ
Working Capital Changes
Add: Decrease in Current Assets
XYZ
Less: Increase in Current Assets
(XYZ)
Add: Increase in Current Liabilities
XYZ
Less: Decrease in Current Liabilities
(XYZ)
Cash Generated From Operations
XYZ
Less: Markup paid on loans
(XYZ)
Less: Taxes Paid
(XYZ)
Net Cash Flow from Operating Activities
XYZ
Cash Flow from Investing Activities
Add: Disposal of Fixed Asset and Long Term Investments
XYZ
Less: Acquisition of Fixed Assets and Long Term Investments
(XYZ)
Add: Dividend Received / Returns on Investment Received
XYZ
Net Cash Flow from Investing Activities
XYZ
Cash Flow from Financing Activities
Add: Shares Issued / Capital Invested
XYZ
Less: Dividend Paid / Drawings
(XYZ)
Add: Increase in Long Term Borrowings
XYZ
Net Cash Flow from Financing Activities
XYZ
Net Increase / Decrease in Cash and Cash Equivalents
XYZ
Add: Opening Balance of Cash and Cash Equivalents
XYZ
Closing Balance of Cash and Cash Equivalents
XYZ
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Table of Contents:
  1. Introduction to Financial Accounting
  2. Basic Concepts of Business: capital, profit, budget
  3. Cash Accounting and Accrual Accounting
  4. Business entity, Single and double entry book-keeping, Debit and Credit
  5. Rules of Debit and Credit for Assets, Liabilities, Income and Expenses
  6. flow of transactions, books of accounts, General Ledger balance
  7. Cash book and bank book, Accounting Period, Trial Balance and its limitations
  8. Profit & Loss account from trial balance, Receipt & Payment, Income & Expenditure and Profit & Loss account
  9. Assets and Liabilities, Balance Sheet from trial balance
  10. Sample Transactions of a Company
  11. Sample Accounts of a Company
  12. THE ACCOUNTING EQUATION
  13. types of vouchers, Carrying forward the balance of an account
  14. ILLUSTRATIONS: Ccarrying Forward of Balances
  15. Opening Stock, Closing Stock
  16. COST OF GOODS SOLD STATEMENT
  17. DEPRECIATION
  18. GROUPINGS OF FIXED ASSETS
  19. CAPITAL WORK IN PROGRESS 1
  20. CAPITAL WORK IN PROGRESS 2
  21. REVALUATION OF FIXED ASSETS
  22. Banking transactions, Bank reconciliation statements
  23. RECAP
  24. Accounting Examples with Solutions
  25. RECORDING OF PROVISION FOR BAD DEBTS
  26. SUBSIDIARY BOOKS
  27. A PERSON IS BOTH DEBTOR AND CREDITOR
  28. RECTIFICATION OF ERROR
  29. STANDARD FORMAT OF PROFIT & LOSS ACCOUNT
  30. STANDARD FORMAT OF BALANCE SHEET
  31. DIFFERENT BUSINESS ENTITIES: Commercial, Non-commercial organizations
  32. SOLE PROPRIETORSHIP
  33. Financial Statements Of Manufacturing Concern
  34. Financial Statements of Partnership firms
  35. INTEREST ON CAPITAL AND DRAWINGS
  36. DISADVANTAGES OF A PARTNERSHIP FIRM
  37. SHARE CAPITAL
  38. STATEMENT OF CHANGES IN EQUITY
  39. Financial Statements of Limited Companies
  40. Financial Statements of Limited Companies
  41. CASH FLOW STATEMENT 1
  42. CASH FLOW STATEMENT 2
  43. FINANCIAL STATEMENTS OF LISTED, QUOTED COMPANIES
  44. FINANCIAL STATEMENTS OF LISTED COMPANIES
  45. FINANCIAL STATEMENTS OF LISTED COMPANIES