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Unit 11 Cash Flow Analysis
Structure:
11.1 Introduction
Objectives
11.2 Meaning
Self Assessment Questions 1
11.3 Objective
Self Assessment Questions 2
11.4 Uses
Self Assessment Questions 3
11.5 Steps in preparationSelf Assessment Questions 4
11.6 Difference between CFS and FFS
Self Assessment Questions 5
11.7 Computation
Self Assessment Questions 6
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.
Self Assessment Questions 1
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.
Self Assessment Questions 2
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.
Self Assessment Questions 3
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.
Self Assessment Questions 4
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.
Self Assessment Questions 5
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.
Self Assessment Questions 6
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:
Self Assessment Questions 1
1. Statement Accounting for variation in cash
2. Financial polices and procedures
Self Assessment Questions 2
1. show causes of changes.
2. Liquidity
3. short term.
Self Assessment Questions 3
1. reasons.
2. major
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3. financial, short term liquidity
Self Assessment Questions 4
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.
Self Assessment Questions 5
1. accrual, cash
2. FFS , CFS
3. opening and closing, recorded.
4. ledger, not
5. net effect, cash receipts.
6. flexible, rigid.
Self Assessment Questions 6
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
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