What is a cash flow statement?
A cash flow statement is a report that shows the inflow (cash coming in) and outflow (cash going out) of cash during one accounting period. The rule book for it in India is AS 3 (revised). Listed companies and bigger companies must prepare it along with the balance sheet and the statement of profit and loss.
Why do we need it? Profit is not the same as cash. A company may sell on credit and show profit, but the cash may still be with customers. The cash flow statement tells the real cash story.
Uses
- Shows whether the business can pay its bills on time.
- Explains why cash went up or down even when profit was high or low.
- Helps plan future cash needs and dividends.
Limits
- It ignores non-cash deals, such as buying a machine by issuing shares.
- It is based on past data, so it is not a full plan for the future.
- It cannot replace the profit and loss statement.
Cash and cash equivalents
Cash = cash in hand + demand deposits with banks (current and savings accounts).
Cash equivalents are short-term, highly liquid investments that can be turned into a known amount of cash quickly and have very little risk of a change in value. A usual test: the investment matures within three months from the date it was bought. Examples: a 2-month fixed deposit, treasury bills, commercial paper with short maturity.
Not cash equivalents: equity shares (their price can change a lot), a 1-year fixed deposit. A bank overdraft that is repayable on demand is usually shown as a reduction of cash.
Moving money from cash to a cash equivalent (for example, depositing cash in a 60-day FD) is not a cash flow, because both are in the same pool.
Operating, investing and financing activities
Operating activities
The main revenue-earning work of the business. Inflows: cash sales, cash from debtors, commission or royalty received (for a normal company). Outflows: payments to suppliers, wages, rent, office expenses, income tax paid.
Investing activities
Buying and selling long-term assets and investments. Inflows: sale of machinery, land, long-term investments; interest and dividend received. Outflows: purchase of fixed assets, patents, long-term investments.
Financing activities
Changes in the size of owners' capital and borrowings. Inflows: issue of shares, debentures, long-term loans taken. Outflows: redemption of preference shares or debentures, repayment of loans, interest paid, dividend paid.
Special case: financial enterprises
For a bank or finance company, lending and investing is its main business, so interest and dividend received and interest paid are operating activities. Dividend paid is still financing.
Indirect method (AS 3 revised): step by step
- Net profit before tax and extraordinary items. Take net profit from the statement of profit and loss (difference in surplus) and add back: provision for tax made this year, proposed dividend of last year paid this year (if given as appropriation), transfers to reserves.
- Add non-cash and non-operating expenses: depreciation, amortisation of goodwill/patents, loss on sale of fixed assets, interest on debentures and loans (it is a financing outflow), preliminary expenses written off.
- Less non-operating incomes: profit on sale of fixed assets or investments, interest and dividend received.
- This gives operating profit before working capital changes.
- Working capital changes: increase in a current asset (debtors, stock, bills receivable, prepaid expense) — subtract; decrease — add. Increase in a current liability (creditors, bills payable, outstanding expenses) — add; decrease — subtract.
- This gives cash generated from operations. Subtract income tax actually paid.
- Result: net cash from operating activities.
Depreciation and sale of assets
Prepare a fixed asset account (and accumulated depreciation account if given). The missing figure is often depreciation or the book value of the asset sold. The cash received from the sale goes in investing; the profit or loss on sale is adjusted in operating.
Dividends
Proposed dividend is not a liability now (it is shown in notes), so the dividend of the previous year that is paid this year is a financing outflow. Interim dividend paid is also a financing outflow.
Tax
Tax paid = opening provision + provision made this year − closing provision. Add the provision made to profit, and subtract tax paid in operating activities.
Format of the cash flow statement
A. Cash flows from operating activities … (net)
B. Cash flows from investing activities … (net)
C. Cash flows from financing activities … (net)
Net increase / decrease in cash and cash equivalents (A + B + C)
Add: cash and cash equivalents at the beginning
Cash and cash equivalents at the end
The closing figure must equal the cash and cash equivalents in the closing balance sheet. That is your check.
Key formulas and definitions
- Net change in cash = Operating (A) + Investing (B) + Financing (C)
- Closing cash = Opening cash and cash equivalents + Net change
- Net profit before tax = Net profit (change in surplus) + Provision for tax + Transfers to reserves + Interim dividend
- Operating profit before WC changes = NPBT + Depreciation + Loss on sale + Interest paid − Profit on sale − Interest/dividend received
- Current asset ↑ → subtract; current asset ↓ → add; current liability ↑ → add; current liability ↓ → subtract
- Tax paid = Opening provision + Provision made this year − Closing provision
Worked examples
1. Classify: (a) cash sales ₹40,000, (b) purchase of a patent ₹25,000, (c) dividend paid ₹10,000, (d) interest received by a trading company ₹3,000.
(a) Operating inflow. (b) Investing outflow. (c) Financing outflow. (d) Investing inflow (for a non-financial company).
2. Cash in hand ₹15,000, bank current account ₹35,000, 45-day treasury bills ₹20,000, shares of another company ₹50,000. Find cash and cash equivalents.
15,000 + 35,000 + 20,000 = ₹70,000. Shares are not cash equivalents because their value can change a lot.
3. Net profit ₹70,000; provision for tax made ₹30,000; depreciation ₹20,000; loss on sale of machine ₹5,000. Find operating profit before working capital changes.
NPBT = 70,000 + 30,000 = 1,00,000. Add depreciation 20,000 and loss 5,000 → ₹1,25,000.
4. Continue: debtors increased ₹15,000, stock decreased ₹10,000, creditors increased ₹8,000, tax paid ₹25,000. Find cash from operating activities.
1,25,000 − 15,000 + 10,000 + 8,000 = 1,28,000 (cash generated from operations). Less tax paid 25,000 → ₹1,03,000.
5. Machinery: opening ₹2,00,000, closing ₹2,40,000. Depreciation charged ₹20,000. A machine with book value ₹20,000 was sold at a loss of ₹5,000. Find the cash from sale and the machinery bought.
Sale proceeds = 20,000 − 5,000 = ₹15,000 (investing inflow). Machinery A/c: 2,00,000 − 20,000 (dep.) − 20,000 (sold) + purchase = 2,40,000 → purchase = ₹80,000 (investing outflow).
6. Provision for tax: opening ₹20,000, closing ₹25,000; provision made this year ₹30,000. Find tax paid.
Tax paid = 20,000 + 30,000 − 25,000 = ₹25,000. Subtract it in operating activities.
7. Operating +₹1,03,000; investing: machine sold 15,000, machine bought 60,000; financing: shares issued 50,000, dividend paid 20,000, loan repaid 30,000. Opening cash ₹12,000. Find closing cash.
Investing = 15,000 − 60,000 = −45,000. Financing = 50,000 − 20,000 − 30,000 = 0. Net increase = 1,03,000 − 45,000 + 0 = 58,000. Closing cash = 12,000 + 58,000 = ₹70,000.
Common mistakes
- Starting from net profit after tax. Always go back to net profit before tax, then subtract tax actually paid.
- Putting the full sale price of a machine in operating. Only the profit or loss is adjusted there; the cash received goes to investing.
- Treating dividend paid or interest on debentures as operating for a normal company. Both are financing outflows (and interest is added back in operating).
- Reversing the working capital rule. Remember: current asset up → cash down (subtract); current liability up → cash up (add).