What is a Cash Flow Statement?

What is a Cash Flow Statement?

The movement of cash & cash equivalents or inflow and outflow of cash is known as Cash Flow. Cash inflows are the transactions that result in an increase in cash & cash equivalents; whereas, cash outflows are the transactions that result in a reduction in cash & cash equivalents. Hence, a statement showing flows of cash & cash equivalent during a specified time period is known as a Cash Flow Statement. Simply put, a cash flow statement is a summary of different sources and applications of cash during a specific time period and analyses the reasons behind changes in cash balance between the two balance sheet dates. (Here, ‘cash’ means cash & cash equivalent) Hence, one can prepare a cash flow statement if the two comparative balance sheets of a company are given. A cash flow statement includes only those items which affect cash. This is the reason why a cash flow statement is also known as Statement of Changes in Financial Position – Cash Basis, or a Funds Flow Statement – Cash Basis.

A cash flow statement can be prepared for the past or can project the future. The transactions of a cash flow statement are categorised into three activities; namely, Cash flow from Operating Activities, Cash flow from Investing Activities, and Cash flow from Financing Activities. The Institute of Chartered Accountants in India has issued Accounting Standard AS – 3 revised for the preparation of cash flow statements. Besides, with the introduction of the Companies Act 2013, the preparation of a Cash Flow Statement is now mandatory for every type of company except OPC (One Person Company) [Section 2(40)].

Terminology used in Cash Flow Statement:

At present times, a cash flow statement is prepared as per the requirements of the Accounting Standard (AS-3) issued by the Institute of Chartered Accountants of India (ICAI). According to the As-3 (Revised), a cash flow statement summarizes the cash inflows and outflows of an organisation resulting from Operating Activities, Investing Activities, and Financing Activities during a specified time period. 

Some basic terms used while preparing a cash flow statement are as follows:

1. Cash:

Cash under a cash flow statement consists of cash in hand and demand deposits with banks.

2. Cash Equivalents:

Cash Equivalents are short-term highly liquid investments that can be easily converted into a known amount of cash with insignificant risk. Cash and Cash Equivalents also consist of investments that have a maturity period of three months or less from the date of acquisition. For Example, Treasury Bills, Commercial Papers, etc. Besides these, a company’s preference shares purchased shortly before their date of redemption are also treated as Cash and Cash Equivalents, only if there is no risk in the failure of their payment by the company. In simple terms, Cash and Cash Equivalents consist of Short-term Deposits/Short-term Investments, Marketable Securities/Treasury Bills, and Current Investments.

Note: The Current Investments of a company are considered Marketable Securities, until and unless specified otherwise.

3. Cash Flow:

Cash Flow refers to the inflow and outflow of cash and cash equivalents. According to As-3 (Revised), an organisation should prepare its cash flow statement in a manner that reveals the inflows and outflows of cash and cash equivalents classified into three parts; viz., Cash Flow from Operating Activities, Cash Flow from Investing Activities, and Cash Flow from Financing Activities. One should also keep in mind that any movement in the components of cash and cash equivalents is the part of cash management of an organisation instead of its operating, investing, and financing activities. 

Some examples of Movement of Cash and Cash Equivalents are as follows:

• Cash Deposited into Bank
• Cash Withdrawn from the bank for business purposes
• Purchase and sale of marketable securities 

The users of a cash flow statement of a company can evaluate the impact of the activities mentioned above on its cash and cash equivalents. 

Cash Flow from Three Different Activities:

1. Cash Flow from Operating Activities:

The principal revenue-producing activities of a company are categorised under Operating Activities. Simply put, it includes those activities which help an organisation in ascertaining the net profit or net loss of an enterprise. The basic information required for the calculation of cash flow from operating activities is taken from the comparative balance sheets, and profit & loss account of the current accounting period. There are some non-cash transactions in the profit & and loss account that do not result in either inflow or outflow of cash, these items are eliminated from the net profit as per the profit & loss account. According to AS-3, there are two methods that can be used to determine cash flow from operating activities; viz., direct method and indirect method. Some of the cash flows arising from operating activities are as follows:

• Cash receipts from the sale of goods and rendering services.
• Cash receipts from fees, royalties, commissions, and other revenue.
• Cash payments to and on behalf of employees.
• Cash payments to suppliers for goods and services.
• Cash payments or refunds on income taxes unless they can be identified specifically with financing and investing activities.
• Cash receipts and cash payments of an insurance enterprise for premiums and claims, annuities, and other policy benefits. 
• Cash receipt and payments that relates to future contracts, option contracts, forward contracts, and swap contracts when the contracts are held for dealing or trading purposes. 

2. Cash Flow from Investing Activities:

The sale and purchase of investments and fixed assets, which are not held by a company for resale purposes are covered under Investing Activities. Cash flow from investing activities also discloses the expenditures incurred for the resources intended to generate future income and cash flows of the company. Some examples of cash flows arising from investing activities are as follows:

• Cash receipts from the sale of fixed assets (including intangibles).
• Cash payments for acquiring fixed assets (including intangibles).
• Cash receipts from the sale of shares, warrants, or debt instruments of other organisations (other than receipts for those instruments that are considered to be cash & cash equivalents).
• Cash payments for acquiring shares, warrants, or debt instruments of other organisations (other than payments for those instruments that are considered to be cash & cash equivalents).
• Cash receipts of insurance claims for the property involved in an accident.
• Cash advances and loans made to third parties. However, in the case of financial organisations, cash advances and loans will be treated as cash flows from operating activities. 
• Cash receipts from the repayment of advances and loans made to third parties. However, in the case of financial organisations, cash receipts and repayments of advances and loans will be treated as cash flows from operating activities. 
• Cash receipts of interest and dividend. However, in the case of financial organisations, cash receipts of interest and dividend will be treated as cash flows from operating activities. 

3. Cash Flow from Financing Activities:

The activities that bring a change in the capital and borrowings of a company are covered under Financing Activities. Cash Flow from Financing Activities helps the lenders of funds in estimating their claims on cash flows in the future. It is calculated by analysing the change in Equity and Preference Share Capital, Debentures, and other short-term and long-term borrowings. The activities under financing activities include:

• Cash receipts from issue of shares; i.e., equity shares, preference shares, or both.
• Cash receipts from issue of debentures, loans, bonds, and other short-term borrowings. Example, Cash Credit and Bank Overdraft.
• Cash repayment of loans including bonds, current maturity of debentures, etc.
• Buy-back of equity shares, redemption of preference shares.
• Cash payment of interest on short-term or long-term loans and debenture, and cash payment of dividend, interim dividend, and dividend tax on shares.

Note:

Financing Activities will not include Issue of Bonus Shares, Conversion of Debentures into Shares, and Issue of Share Capital, or Debenture against the purchase of fixed assets, as they do not involve cash.

Treatment of Special Items as per AS-3:

1. Interest and Dividend Received:

The interest and dividend received by a company are treated as cash inflow from investing activities.

2. Interest, Dividend, and Interim Dividend Paid:

Interest, Dividend, and Interim Dividend Paid by a company are treated as cash outflow from financing activities.

3. Tax Paid:

The tax paid by a company is treated as cash outflow from operating activities as it is paid on the company’s operating income.

4. Dividend Tax:

The tax paid on the dividend is treated as a finance activity along with the dividend paid. 

5. Capital Gain Tax:

If the company has paid capital gain tax on the profit from sale of fixed assets, it is treated as an investing activity.

6. Extra-ordinary Income:

Insurance Claim received by a company for the loss of stock is an operating activity. Whereas, Insurance Claim received for the destruction of fixed assets is an investing activity.