Financial and Management Accounting Notes 11

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Financial and Management Accounting Unit 11

Sikkim Manipal University 229

Unit 11 Cash Flow Analysis

Structure:

11.1 Introduction

Objectives

11.2 Meaning

Self Assessment Questions 1

11.3 Objective


11.4 Uses


11.5 Steps in preparationSelf Assessment Questions 4

11.6 Difference between CFS and FFS


11.7 Computation


Terminal Questions

Answer to SAQs and TQs

11.1 Introduction

The funds flow analysis deal with the flow of funds within and outside the organization. The main

focus of funds flow statement is to explain the changes which have taken place in net working

capital during the period under consideration. Funds flow statement normally fails to explain the

changes in cash balance. The movement of cash is of vital importance to the management. The

organization may become directionless if the cash inflows are not sufficient to meet the cash

outflows. Many a time, a management is posed with the paradox of huge profits and yet

impossible to pay dividends or even taxes. This is due to the ground realities that cash is either

not received or the cash received is drained out in other items. Hence, it has become anecessity to have a cash flow analysis on a day to day basis. The statement shows the items

resulting in cash inflows and cash outflows.


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Learning Objectives:

After studying this unit, you should be able to understand the following

1. Understand the meaning of cash flow statement.

2. Appreciate the uses of cash flow statement.3. Acquaint with steps in preparation of CFS.

4. Distinguish between FFS and CFS.

5. Compute the CFS.

11.2 Meaning of Cash Flow Statement

Cash flow statement, also known as Statement Accounting for variations in cash shows the

movement of cash and their causes during the period under consideration. The statement is

mainly prepared to show the impact of financial policies and procedures on the cash position. It

takes into account all the transactions that have a direct impact upon cash.


1. CFS is also known as __________________.

2. CFS is prepared to Know ______________.

11.3 Objectives

The main objective of cash flow analysis is to show the causes of changes in cash balances

during the period under consideration. The necessary information required to keep the

management of the real cash position, this statement is comes handy. It bring in the liquidityposition of the firm. It is of particular importance in short range planning. It enables a

management to take a strong short term financial decision relating to liquidity and ways and

means to achieve it.


1. Main objective of CFS is _______________-.

2. CFS brings in ___________________ position.

3. CFS is ________________ of importance in ________ planning.

11.4 Uses of Cash Flow Statement

The cash flow statement, being one of the important financial documents a firm has to possess ,

reveals the effective uses. First of all, it explains in depth the reasons for the low cash balance

available at a particular time. Based on this, it is possible to find the reasons for such a situation.


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It also shows the major sources and uses of cash. By effectively maintaining the cash and

controlling the outflow of cash, it is possible to set in motion the smooth functioning of the

organization. It helps the financial decisions more effectively with regard to short term liquidity

position of an organization. Projections of cash inflows and outflows can be regulated based onthe records available in the past. Proper projections can be made once the reasons are

analyzed. Based on this, it is possible to liquidate the short term obligations without much fun-

fare. Short term obligations need to be serviced so that the credit worthiness of an organization

can be carried on unabated.


1. CFS explain _______________ low cash balance.

2. CFS shows _________ flows.

3. CFS helps ________decision ______________ position.

11.5 Steps In Preparation Of Cash Flow Statement

The Cash Flow Statement (CFS) is prepared with the help of Balance Sheet. , income statement.

The measurement of cash flow is primarily based on income statement. Under the CFS, the cash

basis technique is adopted. The measurement of cash flow is not measurement of net income.

The CFS depends primarily on determining cash receipts and disbursements over a given period.

The CFS is concerned with cash inflows sources of cash_ and cash outflows (application of

cash).The sources and application of cash are computed separately.

The various sources for cash inflows are :

Cash Sales : When a concern is doing its business on cash basis, the cash flows in out of sales

effected. When the cash sales are in vogue, it is quite natural that the business also effects its

purchases on cash basis. In addition, the operating expenses should be payable in cash.

Therefore the cash inflow should be as follows :

Cash inflow from cash sales = Cash sales cash purchases operating expenses.

In addition, if the business is conducted both on cash and credit basis, then from the total sales

effected, deduct the credit sales. Therefore the cash sales is :

Total sales credit salesOR

Total sales increase in debtors and Bills receivable.

So also, the cash purchases are also dealt with in the same manner as discussed with cash

sales.


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Net Profit method : Cash from operations can be determined with the net profits figure also.

This method is handy when the amount of sales is not known In this case, non cash and non

trading expenses and losses are added back to net profit. From this, the income from

investments, increase in Accounts Receivable, increase in prepaid expenses, decrease inoutstanding expenses are deducted.

In addition to the above, operating profits are also considered as cash from operations, such as

increase in share capital, debentures, loans, other receipts such as dividends, interest on

investment, and reduction in or sale in assets.

Cash outflows : These refers to uses or application of cash. These arises due to operating loss,

redemption or repayment of redeemable preference shares or debentures, repayment of loans,

purchase of assets, other revenue payments such as dividend, income tax , interest,

compensation.


1. CFS is prepared with the help of ____________.

2. CFS is based on _________ technique.

3. CFS is ____________________.

4. Cash sales refers_________________.

5. Cash flow _______________________.

6. For credit transaction the equation is cash flow = total sales______________.

7. Cash outflow = total purchase ____________________.

8. Net profit method is used when __________ not known.

9. ______ and ______ added back to net profit.

10. Cash outflow refers to________________.

11.6 Difference Between Cash Flow And Funds Flow Statement

The major differences between the two are :

1. FFS is related with accrual basis whereas CFS is on cash basis. For this the, it is

necessary to convert the accrual to cash basis.

2. In FFS, a Schedule of changes in working capital de-linking the current assets and currentliabilities are made. But in FFS, no schedule is prepared.

3. FFS shows the causes of the changes in net working capital. CFS shows the causes for

the change in cash

4. In FFS, no opening or closing balances are recorded. But in CFS both are incorporated


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5. FFS is not based on the Ledger mode. But CFS is prepared on the basis of Ledger

principles.

6. In FFS, To and By are indicated. In CFS, these are indicated.

7. In FFS, net effect of receipts and disbursements are recorded. In CFS only cash receiptsand payments are recorded.

8. FFS is concerned with the total provision of funds. CFS is concerned with only cash.

9. FFS is flexible but CFS is rigid

10. FFS is more relevant for long range financial strategy. CFS concentrates on short term

aspects mostly affecting the liquidity of the business.


1. FFS is __________ basis CFS is __________.

2. Statement of working capital is the _____________. And not the ______________.

3. In FFS __________ balance not recorded but CFS _____________.

4. CFS is ____________ mode but FFS_______

5. FFS ________ receipts are recorded in CFS________

6. FFS is _________ CFS ___________.

11.7 Computation Of Cash From Operations

The Cash Flow Statement should be prepared as per the revised Accounting Standard issued by

the ICAI . Accounting Standards 3 specifies : The cash flow statement should report cash flowsduring the period classified by operating, investing and financing activities. As per the revised

standard, there are two methods of preparing cash flow statement namely Direct method and

Indirect method. In this Study material, indirect method is adopted throughout.

Format

CASH FLOW STATEMENT AS PER AS - 3

For the year ended ..

A Cash flow from operating activities :

Net profit before taxes and extraordinary items

ADJUSTMENTS FOR

1, Depreciation

2. Miscellaneous expenses written off

3. Loss on sale of fixed assets


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4. interest expenses

5. Dividend income

Operating profit before working capital changes

ADD : Decrease in current assetsIncrease in current liabilities

Deduct : Increase in current assets

Decrease in current liabilities

Cash Generated from operating activities

B. CASH FLOWS FROM INVESTING ACTIVITIES

Purchase of fixed assets

Sale of fixed assets

Purchase of long term investment

Sale of long term investment

Interest received

Dividend received

Capital gain tax on income from sale of long term investment

Net cash from investing activities

C. CASH FLOWOS FROM FINANCING ACTIVITIES

Proceeds from issue of share capitalProceeds from long term borrowing

Repayment of long term borrowings

Interest paid

Dividend paid

Tax on distributed profit

Net cash from Financing Activities

Total of A + B +C

Net Increase or Decrease in cash and cash equivalents

Add : Cash and cash equivalents opening balance

Cash and cash equivalents : closing balance

Classification of cash flows :


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Cash flow statement has been divided into three parts namely:

1. Cash flows from Operating Activities

2. Cash flows from Investing Activities

3. Cash flows from Financing Activities

CASH FLOWS FROM OPEPRATING ACTIVITIES

Meaning : Operating activities are the principal revenue producing activities of the enterprise

and other activities that are not investing or financing activities.,. Therefore, they generally result

from the transactions and other events that enter into the determination of net profit or loss.

Object : The amount of cash flows arising from operating activities is a key indicator of the

extent to which the operations of the enterprise have generated sufficient cash flows to maintain

the operating capability of the enterprise, pay dividends, repay loans and make new investments

without recourse to external source of financing. Information about the specific components of

future operating cash flows is useful in conjunction with other information in forecasting future

operating cash flows.


1. CFS is prepared as a per _________.

2. CFS deals with ____, __________, _____________activities .

3. CFS is based on 2 methods _____________ and _______________.

4. Operating Activity is based on __________.


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Problem 1: Compute the cash flow from operating activities

Profit and Loss Account

To By

Cost of goods sold 4,00,000 Sales including cash sales 5,00,000

1,00,000

Office expenses 12,000 Profit on sale of land 30,000

Selling expenses 8,000 Interest on investment 20,000

Depreciation 6,000

Loss on sale of plant 4,000

Goodwill written off 3,000

Income tax 7,000

Net Profit 1,10,000

__________ _________

5,50,000 5,50,000

Position of current assets and current liabilities are as follows :

MARCH 31

2006 2007

Stock 30,000 28,000

Debtors 15,000 12,000

Bills Receivable 6,000 8,000

Creditors 10,000 12,000

Bills Payable 8,000 5,000

Outstanding expenses 4,000 5,000

Solution

Statement showing cash flows from operating activities

Net Profit before tax and extraordinary items 1,10,000

ADD : income tax 7,000Adjustments for Depreciation 6,000

Goodwill written off 3,000

:Loss on sale of plant 4,000


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Prepaid expenses 600 500

Accrued income 300 450

Operating profit before working capital changes Rs.3,80,000

Solution

Statement showing cash flow from operating activities

Operating profit before working capital changes 3,80,000

ADD : Decrease in current assets

Debtors 20,000

Prepaid expenses 100

Increase in current liabilities

Creditors 10,000

Outstanding expenses 2,000

32,100

4,12,100

Less : Increase in current assets

Bills receivable 5,000

Accrued income 150

Decrease in current liabilities

Bills payable 8,000

Income receivable in advance 200

(13,350)

Net cash from operating activities 3,98,750

Problem 3: The following is the position of current assets and current liabilities

March 31

2006 2007

Short term loan 15,000 18,000Creditors 30,000 8,000

Provision for Doubtful debts 1,200 -

Bills Payable 18,000 20,000

Stock in trade 15,000 13,000


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Bills Receivable 10,000 22,000

Prepaid expenses 800 600

Outstanding expenses 300 500

Current year net loss is Rs.38,000. Calculate the cash flows

Solution

Statement showing cash flows from operating activities

Net Loss ( 38,000 )

ADD: Decrease in Current Assets

Provision for doubtful debts 1,200

Stock 2,000

Prepaid expenses 200

Increase in current liabilities

Outstanding expenses 200

Bills payable 2,000

+ 5,600

__________

32,400 )

DEDUCT Increase in current assets

Short term loan 3,000

Bills receivable 10,000Creditors 22,000

+ 35,000

Net cash loan in operating activities ( 67,400 )

Problem 4:

Following extracts are in respect of a company.

MARCH

2006 2007

Debtors 30,000 10,000

Stock 25,000 28,000

B.R. 40,000 8,000

Short term loan 10,000 11,000

Prepaid expenses 8,000 8,100


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Bills receivable 50,000 48,000

Stock 60,000 42,000

Short term loan - 10,000

Goodwill 20,000 8,000Prepaid expenses 5,000 4,000

Creditors 26,000 38,000

Bills payable 30,000 26,000

5. Cash transactions in respect of DR Ltd are as follows :

Balance of cash on hand 70,000 Payment to creditors 25,00,000

Receipts from Debtors 30,00,000 Purchase of fixed assets 2,50,000

Issue of shares 8,00,000 Payment for overheads 1,50,000

Sale of fixed assets 2,00,000 Salaries 70,000

Income tax 1,00,000

Dividend paid 80,000

Repayment of loan 1,50,000

Closing balance of cash 7,70,000

40,70,000 40,70,000

Prepare a cash flow statement

Answer Self Assessment Questions:


1. Statement Accounting for variation in cash

2. Financial polices and procedures


1. show causes of changes.

2. Liquidity

3. short term.


1. reasons.

2. major


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3. financial, short term liquidity


1. B.S. income statement.

2. cash basis

3. measurement of net income

4. sale through case only

5. cash sales cash purchase operating expenses.

6. credit sales

7. minus credit purchases

8. sales

9. cash and non- trading expenses and losses.

10. application of cash.


1. accrual, cash

2. FFS , CFS

3. opening and closing, recorded.

4. ledger, not

5. net effect, cash receipts.

6. flexible, rigid.


1. AS 3

2. operating, investing and financing.

3. Direct, Indirect.

4. profit and loss account

Answer for Terminal Questions

1. Refer to unit 11.2 and 11.3

2. Refer to unit 11.5

3. Refer to unit 11.6

4. Net cash from operating activities Rs 13,000

5. Net cash from operating activities Rs 1,80,000

Cash flows from investing activities Rs 50,000

Cash flows from financing activities Rs 5,70,000

Financial and Management Accounting Notes 11

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