Cash Flow Statement Notes | Management Accounting

[Cash Flow Statement Notes, Cash Flow Statement Format, Management Accounting Notes, Notes for B.Com, BBA and MBA]

Cash Flow Statement Notes
Management Accounting Notes
Notes For B.Com, BBA and MBA Students

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In the post I have given a brief explanation of Cash Flow Statement. These notes are useful for the students of B.Com, BBA and MBA of various universities. For more notes visit our website regularly.

Table of Contents

1. Meaning of Cash Flow Statement

2. Objectives of Cash Flow Statement

3. Importance of Cash Flow Statement

4. Limitations of Cash Flow Statement

5. Procedure of Cash Flow Statement

6. Various Activities under cash flow statement

7. Format of Cash Flow Statement as per AS-3

a) Operating Activities

b) Investing Activities

c) Financing Activities

8. Distinguish between:

(a) Funds flow statement and Balance sheet

(b) Funds flow statement and cash flow statement

(c) Funds flow statement and Income statement

(d) Cash Flow Statement and Cash Budget

(e) Cash flow statement and cash book

Cash Flow Statement:

A Cash Flow Statement is similar to the Funds Flow Statement, but while preparing funds flow statement all the current assets and current liabilities are taken into consideration. But in a cash flow statement only sources and applications of cash are taken into consideration, even liquid asset like Debtors and Bills Receivables are ignored.

A Cash Flow Statement is a statement, which summarises the resources of cash available to finance the activities of a business enterprise and the uses for which such resources have been used during a particular period of time. Any transaction, which increases the amount of cash, is a source of cash and any transaction, which decreases the amount of cash, is an application of cash.

Simply, Cash Flow is a statement which analyses the reasons for changes in balance of cash in hand and at bank between two accounting period. It shows the inflows and outflows of cash.

Objectives of Cash Flow Statement

The Cash Flow Statement is prepared because of number of merits, which are offered by it. Such merits are also termed as its objectives. The important objectives are as follows:

1)      To Help the Management in Making Future Financial Policies: Cash Flow statement is very helpful to the management. The management can make its future financial policies and is in a position to know about surplus or deficit of cash.

2)      Helpful in Declaring Dividends etc.: Cash Flow Statement is very helpful in declaring dividends etc. This statement can supply necessary information to understand the liquidity.

3)      Cash Flow Statement is Different than Cash Budget: Cash budget is prepared with the help of inflow and outflow of cash. If there is any variation, the same can be corrected.

4)      Helpful in devising the cash requirement:  Cash flow statement is helpful in devising the cash requirement for repayment of liabilities and replacement of fixed assets.

5)      Helpful in finding reasons for the difference:  Cash Flow Statement is also helpful in finding reasons for the difference between profits/losses earned during the period and the availability of cash whether cash is in surplus or deficit.

6)      Helpful in predicting sickness of the business:  Cash flow is helpful in predicting sickness of the business. A sound cash position is a true indicator of sound financial position.

7)      Supply Necessary Information to the Users: A Cash Flow Statement supplies various information relating to inflows and outflows of cash to the users of accounting information in the following ways:

(i) To assess the ability of a firm to pay its obligations as soon as it becomes due;

(ii) To analyze and interpret the various transactions for future courses of action;

(iii) To see the cash generation ability of a firm;

(iv) To ascertain the cash and cash equivalent at the end of the period.

8)      Helps the Management to Ascertain Cash Planning: No doubt a cash flow statement helps the management to prepare its cash planning for the future and thereby avoid any unnecessary trouble.

Importance of Cash Flow statement:

Cash flow statement is very useful to the management for short-term planning due to the following reasons:

(i) Show the relationship of net income to changes in the business cash: Generally there is direct relation between net income and cash. High net income leads to increase in cash and vice versa. But there may be a situation where a company’s net income is high but decrease in cash balance and increase in cash balance when net income is low. Every user is interested to know the reasons or difference between the net income and net cash provided by operations.

(ii) Helpful in preparing Cash Budget: A Cash Budget is an estimate of cash receipts and disbursement for a future period of time. Cash Flow Statement provides help to the management to prepare Cash Budget. A comparison of cash budget and cash flow statement reveals the extent to which the sources of the business were generated and used as per the plans of the business.

(iii) Measurement of Liquidity:  Liquidity means ability of a business enterprise to pay off its liabilities when due. Cash Flow Statement helps to know about the sources where from the cash will be available to pay off the liabilities.

(iv) Dividend Decisions: The Capacity of the firm to pay dividends to shareholders depends on the generation of cash flows. Cash flow statement helps the management to know about the sources of cash to pay off dividend.

(v) Prediction of sickness:  With the help of preparing cash from operation a business enterprise may come to know about cash losses in operation. It helps to predict this type of sickness.

(vi) Future Guide: Most of the users are interested to assess the ability of the firm in generating future cash flows, its timing and certainty. These questions can be answered by analyzing the cash flow statement.

(vii) The use of cash in investing and financing Transaction: Information in cash flow statement would be useful to find out as to how cash has been obtained from investing and financing activities and how cash has been used to invest and repay borrowings etc. The statement would be useful to users to ascertain the following:

a)      The change in the net assets of the business.

b)      The change in the financial structure.

c)       The financing of expansion.

d)      The utilization of finance obtained by the enterprise.

e)      The impact of investing and financing activities on the cash balance of the enterprise.

(viii) Enhances the Comparability of report: It enhances the comparability of the reporting of operating performance by different enterprises, because it eliminates the effect of using different accounting treatments for the same transactions and events.

Limitations of Cash Flow Statement

Though the Cash Flow Statement is a very useful tool of financial analysis, it has its limitations which must be kept in mind at the time of its use. These limitations are:

1)      Non-cash Transactions are ignored: The Cash Flow Statement shows only inflows and outflows of cash. It does not show non-cash transactions like the purchase of buildings by the issue of shares or debentures to the vendors or issue of bonus shares.

2)      Not a substitute for an Income Statement:  An income statement shows both cash and non-cash items. The income statement shows the net income of the firm whereas the Cash Flow Statement shows only the net cash inflows or outflows which do not represent the net profits or losses of the enterprise.

3)      Historical in Nature:  It rearranges the existing information available in the income statement and the balance sheet. It will become more useful if it is accompanied by the projected Cash Flow Statement.

4)      Ignorance:  It ignores basic accounting concept, i.e., accrual concept.

5)      What is Cash: It is difficult to precisely define the term ‘cash’. There are controversies over a number of items like cheques, stamps, postal orders, etc. to be included in cash.

6)      Does not reveal true liquidity position: A Cash flow statement reveals the inflow and outflow of cash but the exclusion of near cash items from cash obscures the true reporting of the firm’s liquidity position.

7)      Working Capital ignored: Working Capital being a wider concept of funds, a funds flow statement presents a more complete picture than cash flow statement.

8)      Not a substitute of funds flow statement: It cannot replace funds flow statement as it cannot show the financial position of the concern in totality.

Preparation of Cash flow statement/Various activities under cash flow statement (AS-3)

Cash flow statement is a statement which shows the movement of cash and cash equivalents over a particular period of time. It comprised of three sections: Operating activities, investing activities and financing activities. There are two methods of preparing cash flow statement: the direct method preferred by FASB and indirect method preferred by most businesses because of its simplicity. The difference between the two methods lies in the operating section only. Investing and financing activities calculation are same under both the methods.

A) Section one: Cash flow from operating activities: Operating activities are the principal revenue generating activities of the business. These are cash flows from regular course of operations such as manufacturing, trading etc. All activities that are not investing or financing activities are included under operating activities.

Examples of Operating Activities:

Ø  Cash receipts from the sale of goods and rendering of services. (Source)

Ø  Cash payments to suppliers of goods and services. (application)

Ø  Cash receipts from royalties, fees, commission and other revenue. (Source)

Ø  Cash payments to and on behalf of employees for wages, etc. (application)

Ø  Cash payments and refunds of income taxes. (application)

Under indirect method cash flow from operating activities is calculated with the help of net profit before tax and extraordinary items. Non-cash and non-operating expenses and losses are added and non-cash and non-operating incomes are deducted from net profit before tax and extraordinary items to find net cash flow from operating activities before working capital change. After this changes in working capital is adjusted and payment of taxes during the year is deducted to find cash flow from operating activities.

B) Section two: Cash from investing activities: The investing activities of a business include all cash flow arises due to acquisition and disposal of long term assets (whether tangible and intangible) and investments. Acquisition or disposal of companies also comes under investing activities. These are separately discloses in cash flow statement.

Examples of Investing Activities:

Ø  Cash payments to acquire long term fixed assets (tangible and intangible) and investments. (application)

Ø  Cash receipts from the disposal of long term fixed assets (including intangibles) and investments. (Source)

Ø  Cash payments for purchase or of shares, warrants, or debt instruments of other enterprises and interest in joint ventures. (application)

Ø  Cash receipts from sale of shares, warrants, debt instruments of other enterprises and interest in joint ventures. (source)

Ø  Cash receipts from repayments of advances and loans made to third parties. (source)

All the sources of cash from investing activities are added and all the applications of cash in investing activities are deducted to find net cash flow from investing activities.

C) Section three: Cash flows from financing activities: Financing activities are the activities which results in changes in the size and composition of the owner’s capital and borrowings of the enterprises from other sources. The financing activities of a firm include issuing or redemption of share capital, issue and redemption of debentures, raising and repayment of long term loans etc. Dividends and Interest paid are also come under financing activities. 2

Examples of Financing Activities: (Sources and applications of cash flow)

Ø  Cash proceeds from the issue of shares or other similar instruments. (source)

Ø  Cash proceeds from the issue of debentures, loans, bonds and other short term borrowings. (source)

Ø  Buy-back of equity shares. (application)

Ø  Cash repayments of the amounts borrowed including redemption of debentures. (application)

Ø  Payments of dividends and interest on borrowings. (application)

All the sources of cash from financing activities are added and all the applications of cash in financing activities are deducted to find net cash flow from financing activities.

Last section – Bottom line: All the cash flows from three sections are added to find net cash flow during the year. Thereafter opening balance of cash and cash equivalent s are added with this amount and the resulting amount will be the closing balance of cash and cash equivalents. Here cash and cash equivalents means:

Cash: Cash comprises cash on hand and demand deposits with banks.

Cash Equivalents: Cash Equivalents are short-term, highly liquid investments that are readily convertible cash. Examples of cash equivalents are: (a) treasury bills, (b) commercial paper, (c) money market funds and (d) Investments in preference shares and redeemable within three months.            (2018)

Format of Cash Flow Statement under Indirect Method

Particulars

Amount

A.      Cash Flow from operating activities:

Net Surplus before tax and extraordinary items

Add: Non operating/non-cash expenses

Less: Non operating/non-cash income

 

++++++++

++++++++

------------

Net cash flow from operating activities before change in W.C

Effect of change in working capital:

Increase in current assets

Decrease in current assets

Increase in Current Liabilities 

Decrease in current liabilities

++++++++

 

-----------

+++++++

+++++++

----------

 

Less: Payment of taxes net of tax refund

+++++++

-----------

1. Cash Flow from operating activities

B.      Cash Flow from Investing activities:

Sources of cash                                        

Applications of cash                                

+++/---

 

++++++

---------

2. Cash flow from investing activities

C.      Cash Flow from Financing activities:

Sources of cash                                       

Applications of cash                            

+++/----

 

++++++

---------

3. Cash flow from Financing activities

+++/---

D.      Cash Flow during the year (1 + 2 + 3)

Add: Opening balance of cash & cash equivalent

++++/----

+++++++

Closing balance of cash & cash equivalent

+++++++

Distinguish between:

(a) Funds flow statement and Balance sheet

(b) Funds flow statement and cash flow statement

(c) Funds flow statement and Income statement

(d) Cash Flow Statement and Cash Budget

(e) Cash flow statement and cash book

(a) Difference between Funds flow statement and Balance sheet:

(i) Balance sheet is a statement showing the financial position of the concern on a particular date. It shows all assets and liabilities whether current or fixed, tangible or intangible etc., while Funds Flow Statement shows the changes in current assets an current liabilities during a particular period of time.

(ii) Balance Sheet shows the total financial position on a particular date and its utility is very limited for the management. On the other hand, Funds Flow Statement is a comparative statement of assets and liabilities and depicts the changes in working capital during the period of two Balance sheets.

(iii) Funds Flow Statement is an analysis and control device for the management. It is a modern technique of knowing the inflows and outflows of funds during a particular period. Balance Sheet represents the balance of various assets and liabilities and does not present analysis of any kind.

(iv) There are two views of the financial position of the firm-long term and short-term. Short-term financial position means the solvency of the firm in the near future while on the other hand, long-term financial position means future financial structure of the firm. Both are inter-relate but there is a differences in their analysis. The short-term view of the financial position of the firm cannot be had from the Balance Sheet.

(b) Difference between Funds Flow Statement and Cash Flow Statement

Basis of Difference

Funds Flow Statement

Cash Flow Statement

Basis of Analysis

Funds flow statement is based on broader concept i.e. working capital.

Cash flow statement is based on narrow concept i.e. cash, which is only one of the elements of working capital.

Objective

The object funds flow statement is to disclose the magnitude, direction and causes of changes in working capital.

The object of cash flow is to disclose the magnitude, direction and causes of changes in cash and cash equivalents.

Source

Funds flow statement tells about the various sources from where the funds generated with various uses to which they are put.

Cash flow statement starts with the opening balance of cash and reaches to the closing balance of cash by proceeding through sources and uses.

Usefulness

Funds flow statement is more useful in assessing the long-term financial position.

Cash flow statement is more useful in assessing the short-term financial position of the business.

Schedule of Changes in Working Capital

In funds flow statement changes in current assets and current liabilities are shown through the schedule of changes in working capital.

In cash flow statement changes in current assets and current liabilities are shown in the cash flow statement.

Causes

Funds flow statement shows the causes of changes in net working capital.

Cash flow statement shows the causes of changes in cash.

Principal of Accounting

Funds flow statement is based on the accrual basis of accounting.

In cash flow statement, data are obtained on accrual basis which are converted into cash basis.

Compulsion

There is no prescribed form for preparation of Funds flow statement.

Cash flow statement is compulsory to be prepared in prescribed proforma as given in AS – 3.

Relationship

Funds flow statement can be prepared from the cash flow statement under indirect method.

But a cash flow statement cannot be prepared from funds flow statement.

Financial Health

Sound fund position does not necessarily mean sound cash position.

But sound cash position is always followed by sound fund position.

(c) Difference between Income Statement and Funds Flow Statement

Basis

Income Statement

Funds Flow Statement

Meaning

Income statement is a summary of total income and total expenses and losses of a particular period.

Funds flow statement is the statement of changes in financial position.

Objectives

Income statement is prepared to ascertain the profit earn or loss suffered by a firm.

Funds Flow Statement is prepared to identify how the profit has been utilized.

Preparation

Income statement is prepared on the basis of nominal accounts.

Funds flow statement is prepared on the basis of balance sheet.

Measurement

Income statement is helpful in measuring the profitability of a firm.

Funds flow statement is helpful in determining the net changes in working capital.

Period

It is usually prepared after six months or a year.

It is usually prepared every month.

Matching

This matches the cost of goods sold with the revenue in order to know the profit or loss.

This statement matches the funds raised with funds applied without making any distinction between capital and revenue items.

Scope

It presents the result of all financial transactions of the business during a specified period.

It presents information only relating to working capital and thus its scope is limited.

Reliability

It is not very reliable as items shown in profit or loss account can be easily manipulated by the management.

It is more reliable as items shown in this statement cannot be easily manipulated by the management.

(d) Difference between Cash flow statement and Cash Budget:

Basis

Cash Flow Statement

Cash Budget

Objective

It is prepared to explain to management the sources of cash and its uses during a particular period of time.

It is prepared to show the probable cash position at a planned operation.

Coverage

It summarizes effect of specific cash transactions into three categories operating, investing and financing activities of an enterprise during a period in prescribed format.

It can also be coordinated in relation to total working capital, sales, investments and debts.

Meaning

It means inflows and outflows of cash and cash equivalents.

It is estimated receipts and payments of cash over a period of time.

Technique of analysis

It is a technique of past analysis.

It is a technique of future financial forecasting.

Period

It covers a period of one year.

It is broken into monthly, weekly segments.

Emphasis of source

It does not emphasize on a particular source and use.

It emphasizes on the financial pattern to meet seasonal or temporary cash needs.

Management Accounting

Chapter Wise Notes

Chapter Wise MCQs

1. Introduction to Management Accounting

2. Funds Flow Statement

3. Cash Flow Statement

4. Marginal Costing

5. Budget and Budgetary Control

Also Read:

6. Standard Costing and Variance analysis

7. Ratio Analysis

Management Accounting MCQs

Marginal and Absorption Costing

Budget and Budgetary Control

Standard Costing

Ratio Analysis

Cash Flow Statement

Funds Flow Statement

Financial Statement and Financial Statements Analysis

Management Accounting Important Questions for Upcoming Exams (Dibrugarh University)

Management Accounting Solved Papers: 2013  2014 2015  2016 2017 2018 2019

Management Accounting Question Papers: 2013 2014 2015 2016 2017 2018 2019

(e) Difference between Cash flow statement and Cash Book:

Basis

Cash Flow Statement

Cash Budget

Meaning

It means inflows and outflows of cash and cash equivalents.

It is a book of prime or original entry where every transaction is recorded first.

Objective

It is prepared to explain to management the sources of cash and its uses during a particular period of time.

It is prepared to record the receipts and payments for the accounting year.

Coverage

It summarises effect of specific cash transactions into three categories operating, investing and financing activities of an enterprise during a period in prescribed format.

Each and every transaction is recorded in cash book in chronological order.

Technique of analysis

It is a technique of past analysis.

It is a technique of future financial forecasting.

Period

It is prepared at the end of the accounting year.

It is prepared during the accounting year.

Nature

It is a statement.

It is a journal.

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