LMT SCHOOL OF MANAGEMENT, THAPAR UNIVERSITYMasters of Business Administration

Course: Financial Reporting and AnalysisFaculty: Dr. Sonia Garg (Email: sonia.garg@thapar.edu)

Session 18, 19, 20: Cash Flow Statement

Duration: 180 minsSlides: 15

21/04/2023 Cash Flow Statement 2

Cash flow statement AS-3 weblink

• SEBI made CFS mandatory in 1995• It is a derived statement• It is a flow report of cash inflows and outflows

during the accounting period• It is prepared in accordance with AS-3• It is drawn vertically• Cash flows are classified into those from

operating, investing and financing activities• Cash comprises of cash and cash equivalents

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Important terms• Cash comprises cash on hand and demand deposits with banks.

• Cash equivalents are short term, highly liquid investments that are readily convertible into known amounts of cash and which are subject to an insignificant risk of changes in value.

• Operating activities are the principal revenue-producing activities of the enterprise and other activities that are not investing or financing activities.

• Investing activities are the acquisition and disposal of long-term assets and other investments not included in cash equivalents.

• Financing activities are activities that result in changes in the size and composition of the owners’ capital (including preference share capital in the case of a company) and borrowings of the enterprise.

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Examples of Operating Cash flows

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Examples of Investing Cash flows

• Interest received and dividend received are investing cash inflows for a non-financial enterprise but operating cash inflows for a financial enterprise

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Examples of Financing Cash flows

Dividends paid, Dividend tax and Interest paid are financing cash outflows for a non-financial enterprise but operating cash outflows for a financial enterprise

In case of installment paid on fixed asset including both interest and principal payment, first is financing activity and the other is an investing activity

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Other special considerations

• Hedging contracts: classify it same as the position hedged

• Foreign currency: classify it same as parent transaction• Extraordinary Items: disclose separately• Taxes on income: operating activity in general• Acquisition and disposal of subsidiaries: show

separately under investing activities• No consolidation is attempted for cash flow statement• Non-cash investing or financing activity: e.g. acquisition

of asset by assuming some liability show in footnotes

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Methods of reporting operating cash flows

Direct Method• Start with gross cash receipts

and gross cash payments• Adjust for changes in

inventories, a/c receivables and a/c payables

• Adjust for non-cash items like depreciation, provisions, deferred tax, unrealized gains

• Adjust for cash effects of investing and financing activities

Indirect Method• Start with net income from

P/L• Adjust for changes in

inventories, a/c receivables and a/c payables

• Adjust for non-cash items like depreciation, provisions, deferred tax, unrealized gains

• Adjust for cash effects of investing and financing activities

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Disclosure in F/S

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Preparation of Cash Flow Statement: Indirect Method

Cash flow from Operating activities– Start with net income before extra-ordinary income and tax– Adjust for interest, dividend income and gain/loss on sale of

fixed asset (investing activities); interest and dividend expense (financing activities); depreciation, deferred tax expense, miscellaneous expenses written off (non-cash expenses)

– Adjust for current assets (add on decrease in CA) and current liabilities (add on increase in CL) (CA: Inventory, A/c receivable, prepaid expense CL: A/c payable, wages/salaries payable, tax payable)

– Add corporate tax paid

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Investing and Financing Cash flows

Cash flow from investing activities are due to– Sale/purchase of fixed asset– Sale/purchase of investments– Interest and dividend income– Tax paid on interest income

Cash flow from financing activities are due to– Share capital raised or repaid– Secured loans raised or repaid– Interest and dividend expense– Corporate dividend tax paid

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XYZ Balance SheetAs of December 31, 2009 and 2010 (in thousand dollars)

2009 2010 Change

Assets 2876 3436 560

Cash and Cash equivalents 230 326 96

A/C Receivables 586 673 87 Operating

Inventory 610 657 47 Operating

Fixed Assets at cost 2000 2350 350 Investing

Acc. Depreciation (1000) (970) 30

Net Fixed Assets 1000 1380 380

Investments 450 400 (50) Investing

Liabilities and Owner’s Equity 2876 3436 560

Accounts Payable 332 388 56 Operating

Income tax payable 9 10 1 Operating

Short-term borrowings 147 126 (21) Financing

Long-term debt 500 835 335 Financing

Deferred taxes 65 70 5 Operating

Share Capital 50 60 10 Financing

Additional paid-in capital 133 167 34 Financing

Retained Earnings 1640 1780 140

XYZ Income StatementFor the year ended December 31, 2010 (in

thousand dollars)

Sales Revenue 3190

Cost of Sales 2290

Gross Profit 900

Expenses:

Depreciation 120

Other Expenses 497

Gain on disposal of asset 20

Income Taxes 103

Net Income 200

Dividends paid in cash 60

Surplus balance from P/L 140

Additional Information: • Purchased new fixed asset for

$500,000 • Sold old fixed asset with a GBV of

$150,000 and Acc. Dep. Of $150,000 for $20,000

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XYZ Cash Flow StatementFor the year ending 31 December, 2010 (in thousand dollars)

Cash flow from operating activities

Net Income 200

Add: Depreciation 120

Add: Deferred Taxes 5

Less: Increase in A/c receivables (87)

Less: Increase in inventories (47)

Add: Increase in a/c payables 56

Add: Increase in taxes payable 1

Less: Gain on sale of equipment (20)

Net Cash flow from operating activities 228

Cash flow from investing activities

Acquisition of plant and equipment (500)

Proceeds from sale of plant and equipment 20

Purchase/Proceeds from sales of investment securities 50

Net Cash flow from investing activities (430)

Cash flow from financing activities

Proceeds from/payments to short term debt (21)

Proceeds from/payments to long term debt 335

Proceeds from issuing stock 44

Dividends paid (60)

Net Cash flow from financing activities 298

Net increase (decrease) in cash and cash equivalents 96

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Manipulations in Cash Flow Statement

• Inflating Cash flow from Operations– Shifting financing cash inflows to operating cash inflows, e.g.

giving inventory to a bank on collateral and showing it as a sale of inventory

– Selling accounts receivables and shifting future period cash flows to current period

• Deflating cash flow from operations– Improperly capitalizing operating costs, recording operating

costs as an asset and not an expense thus decreasing operating cash flows

– Recording purchase of inventory as an investing outflow

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Be careful about

• Big margin expansion shortly after an inventory write-off

• Sudden swings in cash flow• Companies providing less disclosure than prior period• Rapidly growing fixed asset accounts may signal

aggressive capitalization• Unexpected increase in capital expenditure• Differences in accounting policies when comparing

peers• New or unusual assets cropping on the B/S