cash flow statement analysis

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Accounting and Financefor Managers LESSON

8CASH FLOW STATEMENT ANALYSIS

CONTENTS

8.0 Aims and Objectives

8.1 Introduction

8.2 Meaning & Motives of Cash Flow Statement

8.3 Utility of Cash Flow Statement

8.4 Steps in the Preparation of Cash Flow Statements

8.4.1 Preparation of Adjusted Profit and Loss Account

8.4.2 Comparison of Current Items to determine the Inflow of Cash or Outflow of Cash

8.4.3 Preparation of Cash Flow Statement

8.5 Let us Sum up

8.6 Lesson-end Activity

8.7 Keywords

8.8 Questions for Discussion

8.9 Suggested Readings

8.0 AIMS AND OBJECTIVES

In this lesson we shall discuss about cash flow statement analysis. After going throughthis lesson you will be able to:

(i) discuss meaning and motives of cash flow statement.

(ii) analyse utility of cash flow statement and steps in the preparation of cash flowstatements.

8.1 INTRODUCTION

Cash is considered one of the vital sources of the firm to meet day to day financialcommitments. The cash is considered to be as most important source of life blood of thebusiness. The day to day financial commitments are met out only out of the availableresources. The cash resources are availed through two different type of receipts viz.sales, dividends, interests known as regular receipts and sale of assets, investmentsknown as irregular receipts of the business enterprise. To have smooth flow of businessenterprise, it should have ample cash resources for its operations. The availability ofcash resources is mainly depending on the cash inflows of the enterprises. The smoothnessin operations of the enterprise is obtained through an appropriate matching of cash inflowsand cash outflows.

To have smoothness in the operations of the enterprise, the firm should have an appropriatevolume of cash resources at speedier rate as well as more than the financial commitmentsof the firm. This smoothness could be attained by way of an appropriate planning analysison the cash resources of the firm. The meaningful analysis is only possible through cashflow statement analysis which facilitates the firm to identify the possible sources of cashas well as the expenses and expenditures of the firm.

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Cash Flow Statement Analysis8.2 MEANING & MOTIVES OF CASH FLOW STATEMENT

The cash flow statement is being prepared on the basis of an extracted information ofhistorical records of the enterprise. Cash flow statements can be prepared for a year, forsix months , for quarterly and even for monthly. The cash includes not only means thatcash in hand but also cash at bank.

Motives of preparing the cash flow statement:

l To identify the causes for the cash balance changes in between two different timeperiods, with the help of corresponding two different balance sheets.

l To enlist the factors of influence on the reduction of cash balance as well as toindicate the reasons though the profit is earned during the year and vice versa.

8.3 UTILITY OF CASH FLOW STATEMENT

Utility of cash flow statements are as follows:

l To identify the reasons for the reduction or increase in the cash balances irrespectivelevel of the profits earned by the firm.

l It facilitates the management to maintain an appropriate level of cash resources.

l It guides the management to take futuristic decisions on the prospective demandsand supply of cash resources through projected cash flows.

v How much cash resources are required?

v How much cash requirements could be internally settled?

v How much cash resources are to be raised through external sources?

v Which type of instruments are going to be floated for raising the requiredresources?

l It helps the management to understand its capacity at the moment of borrowing forany further capital budgeting decisions.

l It paves way for scientific cash management for the firm through maintenance ofan appropriate cash levels i-e optimum level cash of resources.

l It avoids in holding excessive or inadequate cash resources through proper planningof cash resources.

l It moots control through identification of variations occurred in the cash expensesand expenditures.

Cash flow statement vs Fund flow statementCash flow statement Fund flow statement

Cash inflow and outflow are only considered Increase or decrease in the working capital is registered

Causes & changes of cash position Causes & changes of working capital position Considers only most liquid assets pertaining to cash resource ; which fosters only for very short span of planning

Considers in general i-e current assets ; the duration of the liquidity of the current assets are longer in gestation than the liquid assets ; which paves way for long span of planning

Opening and closing balances of cash resources are considered for the preparation

Increase or decrease of working capital is considered but not the opening and closing balance for preparation

The flow in the statement means real cash flow The flow in the statement need not be real cash flow

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Accounting and Financefor Managers 8.4 STEPS IN THE PREPARATION OF CASH FLOW

STATEMENTS

8.4.1 Preparation of Adjusted Profit and Loss Account

Adjusted Profit & Loss Account

Accounting Profit to be adjusted

To find out the cash Profit/Loss

Addition of Non cash & Non Operating Expenses

Deduction of Non cash & Non operating Incomes

Net profit method

Cash from operations or Cash lost in operations

Prepare Non – current accounts to identify the flow cash

Sale of Assets or Investments, Raising of financial resources

Purchase of Assets or Investments, Redemption of financial resources

Cash Inflows Cash out flows

Balancing Figure

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Cash Flow Statement Analysis

Alternate method:

Net Profit

( +)

(-)

8.4.2 Comparison of Current items to determine the inflow of cash or outflowof cash

8.4.3 Preparation of cash flow statement

The cash flow statement can be prepared either in statement form or in accountingformat.

Inflow cash Outflow cash Opening cash balance XXXX Redemption of preference shares XXXX Cash from in operations XXXX Redemption fo debentures XXXX Sale of assets XXXX Repayment of loans XXXX Issue of shares XXXX Payment of dividends XXXX Issue of debentures XXXX Payment of tax XXXX Raising of loans XXXX Cash lost in operations XXXX Collection from debentures XXXX Refund of tax XXXX XXXX XXXX

Sales Method

Cash Sales

Deduct Cash Purchases & Cash Operating Expenses

Cash from operations or Cash lost in operations

Decrease in current assets & Increase in current liabilities

Increase in current assets & Decrease in current liabilities

Increase in current assets Outflow of cash

Decrease in current assets

Decrease in current liabilities

Increase in current liabilities

Inflow of cash

Outflow of cash

Inflow of cash

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Accounting and Financefor Managers

December 31 Particulars 1992 Rs 1993 Rs

Debtors 1,00,000 94,000 Bills receivable 20,000 25,000 Creditors 40,000 50,000 Bills payable 16,000 12,000 Outstanding expenses 2,000 2,400 Prepaid expenses 1,600 1,400 Accrued Income 1,200 1,500 Income received in advance 600 500 Profit made during the year - 2,60,000

Decrease in current assets & Increase in current liabilities

Increase in current assets & Decrease in current liabilities

Check Your Progress

(1) Cash flow means

(a) Change in cash position

(b) Change in working capital position

(c) Change in current assets position

(d) Change in current liabilities position

(2) Adjusted profit and loss account is to determine

(a) Cash from operations

(b) Cash lost in operations

(c) Cash from operations or Cash lost in operations

(d) None of the above

(3) Comparison in between the current assets and current liabilities to determine

(a) Cash inflow

(b) Cash out flow

(c) Both (a) & (b)


(4) Non current accounts are prepared for the cash inflows and cash outflowson the basis of which of the following relationship

(a) Non current asset account and Cash

(b) Non current liability account and Cash

(c) Both (a) & (b) only


Illustration 1

From the following balances you are required to calculate cash from operations:

According to net profit method , the cash from operation has to be found out

Cash from operations

= Net profit (+) (-)

The next step is to quantify the decrease in current assets and increase in current liabilities,in order to add with the closing net profit of the given statements and then the addedvolume should be deducted from the increase in current assets and decrease in currentliabilities.

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Cash Flow Statement Analysis

Illustration 2

From the following profit and loss account you are required to compute cash fromoperations

Profit and loss account for the year ending 31st Dec, 1983

Cash from operations Rs Rs

Illustration 3

The comparative balance sheets of M/s Ram Brothers for the two years were as follows

Cash from operations Rs Rs Profit made during the year s Add Decrease in debtors 6,000 Increase in creditors 10,000 Outstanding expenses 400 Prepaid expenses 200 16,600 Less Increase in Bills receivable 5,000 Decrease in Bills payable 4,000 Increase in accrued income 300 Income received in advance 100 9,4000 Cash from operations 2,67,200

Rs Rs To salaries 10,000 By Gross profit 50,000 To Rent 2,000 By profit on sale of land 10,000 To Depreciation 4,000 By income tax refund 6,000 To loss on sale of plant 2,000 To Good will written off 8,000 To proposed dividend 10,000 To provision for taxation 10,000 To Net profit 20,000 66,000 66,000

Net profit made during the year 20,000 Add: Non cash expenses Depreciation 4,000 Loss on sale of plant 2,000 Good will return off 8,000 Non operating expenses Proposed dividend 10,000 Provision for taxation 10,000 34,000 Less Non cash income Profit on sale of land 10,000 Non operating income Income tax refund 6,000 16,000 38,000

Mar,31 Mar,31 Liabilities 1984 1985

Assets 1984 1985

Capital 3,00,000 3,50,000 Land &Building 2,20,000 3,00,000 Loan from Bank 3,20,000 2,00,000 Machinery 4,00,000 2,80,000 Creditors 1,80,000 2,00,000 Stock 1,00,000 90.000 Bills payable 1,00,000 80,000 Debtors 1,40,000 1,60,000 Loan from SBI 50,000 Cash 40,000 50,000 9,00,000 8,80,000 9,00,000 8,80,000

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Original cost of the Asset Rs.50,000 Accumulated Depreciation Rs.20,000 Rs.30,000 Sale price Rs.26,000 Loss on sale of the assets Rs.4,000

Rs Rs To Balance B/d (Opening) 5,00,000 By cash sale 26,000 By Profit and loss a/c Loss

Balancing Fig 4,000

By Depreciation Provision 20,000 By Balance c/d(Closing )

2,80,000+1,70,000 4,50,000

5,00,000 5,00,000

Additional Information

i. Net profit for the year 1985 amounted to Rs. 1,20,000

ii. During the year a machine costing Rs.50,000 ( accumulated depreciation Rs. 20,000)was sold for Rs. 26,000. The provision for depreciation against machinery as on 31Mar, 1984 was Rs.1,00,000 and 31st Mar, 1985 Rs.1,70,000

You are required to prepare a cash flow statement

First step is to prepare non current accounts

Non current account includes both non current liability and asset

First start with non current liability

Dr Capital A/c Cr

The next step is to find out the depreciation provided during the year, which affects noncurrent asset account of the firm is Machinery account.

Before discussing the accounting transactions, the journal entry for provision fordepreciation should be known.

Provision for depreciation Account

Dr Cr

Cash sale of the machinery amounted Rs.26,000

What happens during the cash sale of a machinery ?

Debit what comes in - Cash resources are coming in

Credit what goes out- Machinery is going out of the firm

While selling the machinery, it is most important to identify the worth of the sale transactionof the machinery ?

Once the loss of the transaction is found out, the amount of the loss should be appropriatelyrecorded

Machinery Account

Dr Cr

Rs Rs To Drawings. Balancing Fig. 70,000 By Balance B/d (Opening) 3,00,000 To Balance c/d(Closing ) 3,50,000 By Net profit 1,20,000

4,20,000 4,20,000

Rs Rs To Machinery 20,000 By Balance B/d 1,00,000 To Balance C/d 1,70,000 By Adjusted profit and loss

account ( Depreciation provided during the year)

90,000

1,90,000 1,90,000

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Cash Flow Statement AnalysisDr Land and Building Cr

The next step is to prepare adjusted profit and loss account

Dr Adjusted profit and loss account Cr

The next most important step is to compare the current assets

Increase in creditors -Rs.20,000 - cash inflow

Loan from SBI -Rs 50,000 -cash inflow

Decrease in stock -Rs.10,000 - cash inflow

Loan repaid -Rs.1,20,000 -cash outflow

Decrease in Bill payable -Rs.20,000 - cash outflow

Cash flow statement

Illustration 4

Data ltd, supplies you the following balance on 31st Mar 1995 and 1996

Additional information

i. Dividends amounting to Rs 7,000 were paid during the year 1996

ii. Land was purchased for Rs. 20,000

iii. Rs.10,000 were written off on good will during the year

iv. Bonds of Rs.12,000 were paid during the course of the year

v. You are required to prepare a cash flow statement

The first step is to prepare non current accounts

The first step is to prepare non current assets and liabilities account

As far as non current asset account - Land account has to be prepared

Dr Land Cr

Rs Rs To Balance B/d(Opening) 2,20,000 To Purchase 80,000 By Balance c/d(Closing ) 3,00,000

3,00,000 3,00,000

To Machinery A/c(Loss on sale ) Rs. 4,000

By Balance B/d Rs.

To Depreciation provided during the year

90,000 By cash from operations 2,14,000

To Balance c/d 1,20,000 2,14,000 2,14,000

Inflow Rs Out flow Rs Opening cash balance 40,000 Loan repaid 1,20,000 Creditors 20,000 Bills payable 20,000 Loan from SBI 50,000 Debtors 20,000 Stock 10,000 Land and buildings purchased 80,000 Machinery cash sale 26,000 Drawings 70,000 Cash from operations 2,14,000 Closing cash balance 50,000 3,60,000 3,60,000

Liabilities 1995 1996 Assets 1995 1996 Share capital 1,40,000 1,48,000 Bank balance 18,000 15,600 Bonds 24,000 12.000 Accounts

Receivable 29,800 35,400

Accounts payable 20,720 23,680 Inventories 98,400 85,400 Provision for debts 1,400 1,600 Land 40,000 60,000 Reserves and Surpluses

20,080 21,120 Good will 20,000 10,000

2,06,200 2,06,400 2,06,200 2,06,400

Rs Rs To Balance B/d(Opening) 40,000 To Purchase (Given) 20,000 By Balance c/d(Closing ) 60,000

60,000 60,000

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The non current liability account to be prepared

The first non current liability account got affected is Share capital account

Dr Share capital account Cr

The next non current liability account is that Bonds account

Dr Bond account Cr

The next step is to prepare the Adjusted profit and loss account

Dr Adjusted profit and loss account Cr

The next most important step is to compare the current assets during the two years

Increase in Accounts payable - Rs. 2,960 - Cash inflow

Decrease in Inventories -Rs. 7,000 - Cash inflow

Increase in Bank Balance - Rs. 2,400 -Cash outflow

Increase in accounts receivable -Rs. 5,600 - Cash outflow

The next step is to draft the Cash flow statement

Cash flow statement

Check Your Progress

(1) Cash flow statement analysis is an analysis of short span of analysis due to

(a) Current assets position is only considered

(b) Super quick assets position only considered

(c) Working capital position is considered


(2) How cash flows are denominated in terms of both current assets and currentliabilities?

(a) Increase in current assets & Decrease in current liabilities

(b) Decrease in current assets & Increase in current liabilities

(c) Increase in current assets & Increase in current liabilities

Rs Rs By Balance B/d(Opening ) 1,40,000 To Balance c/d (Closing ) 1,48,000 By cash Balancing figure 8,000

1,48,000 1,48,000

Rs Rs To cash redemption (Given) 12,000 By Balance B/d(Opening ) 24,000 To Balance c/d(Closing ) 12,000

24,000 24,000

To provision for doubtful debts

200 By Balance B/d 20,080

To Good will written off 10,000 By cash from operations 18,240 To dividends paid 7000 To Balance c/d 21,120

38,320 38,320

Inflow Rs Out flow Rs Opening cash balance 18,000 Increase in Bills receivable 5,600 Issue of shares 8,000 Purchases of land 20,000 Increase in Bills payable 2,960 Dividends paid 7,000 Decrease in stock 13,000 Bonds repaid 12,000 Cash from operations 18,240 Closing cash balance 15,600

60,200 60,200

Contd...

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Cash Flow Statement Analysis(d) Both (a) & (b)

(3) Cash position at the opening and closing comprises of

(a) Cash in hand

(b) Cash at bank

(c) Both cash in hand and at bank


(4) Cash flow analysis superior than the fund flow analysis due to

(a) Shorter span of cash resources are considered

(b) Real cash flows only taken into consideration

(c) Opening & closing cash balances are only considered

(d) (a), (b) & (c)

(5) Sale of the Plant & Machinery falls under the category of

(a) Non current asset sale- cash in flow

(b) Current asset sale - cash out flow

(c) Non current asset sale -cash out flow


8.5 LET US SUM UP

The cash resources are availed through two different type of receipts viz sales, dividends,interests known as regular receipts and sale of assets , investments known as irregularreceipts of the business enterprise. Cash flow statements can be prepared for a year, forsix months , for quarterly and even for monthly The cash includes not only means thatcash in hand but also cash at bank.

8.6 LESSON-END ACTIVITY

Parle Food Products experiences a considerable seasonal variation in its business. Thehigh point in the year’s activity comes in November, the low point in July. During whichmonth would you expect the company’s ratio to be higher? If the company was choosinga fiscal year for accounting purposes, what advice would you give?

8.7 KEYWORDS

Cash

Cash Flow Statement

Fund Flow Statement

8.8 QUESTIONS FOR DISCUSSION

1. Define cash flow.

2. Highlight the steps involved in the process of Cash flow statement analysis.

3. Draw the proforma of the Adjusted profit and loss account.

4. Illustrate the impact of the changes taken place on the current assets and currentliabilities to the tune of cash flows determination of the firm.

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5. Briefly explain the objectives of preparing the cash flow statement.

6. Explain the various utilities of the cash flow statement analysis.

7. Illustrate the various differences in between the cash flow and fund flow statementsanalysis.

8.9 SUGGESTED READINGS

R.L. Gupta and Radhaswamy, "Advanced Accountancy".

V.K. Goyal, "Financial Accounting", Excel Books, New Delhi.

Khan and Jain, "Management Accounting".

S.N. Maheswari, "Management Accounting".

S. Bhat, "Financial Management", Excel Books, New Delhi.

Prasanna Chandra, "Financial Management - Theory and Practice", Tata McGrawHill, New Delhi (1994).

I.M. Pandey, "Financial Management", Vikas Publishing, New Delhi.

Nitin Balwani, "Accounting & Finance for Managers", Excel Books, New Delhi.

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