International financial and management accounting lesson 07

International Financial and Management Accounting LESSON 7 CASH FLOW STATEMENT ANALYSIS CONTENTS 7.6 Steps in Preparation of Cash Flow Statements 7.0 AIMS AND OBJECTIVES After studying t

International Financial and

Management Accounting LESSON

7 CASH FLOW STATEMENT ANALYSIS

CONTENTS

7.6 Steps in Preparation of Cash Flow Statements

7.0 AIMS AND OBJECTIVES

After studying this lesson you will be able to:

 Plan for any financing, investment and dividend proposals, the cash of the two different time horizons should be relatively considered

 Know the influence of cash from operations

 Study the various sources of cash inflows and cash outflows

 Determine the amount of cash inflows and cash outflows of the organisation

7.1 INTRODUCTION

Cash is considered one of the vital sources of the firm to meet day-to-day financial commitments The cash is considered to be as most important source of lifeblood of the business The day-to-day financial commitments are met out only out of the available resources The cash resources are availed through two different types of receipts viz sales, dividends, interests known as regular receipts and sale of assets, investments known as irregular receipts of the business enterprise To have smooth flow of business enterprise, it should have ample cash resources for its operations The availability of cash resources is mainly depending on the cash inflows of the enterprises The smoothness

129 Cash Flow Statement Analysis

in operations of the enterprise is obtained through an appropriate matching of cash inflows

and cash outflows

To have smoothness in the operations of the enterprise, the firm should have an appropriate

volume of cash resources at speedier rate as well as more than the financial commitments

of the firm This smoothness could be attained by way of an appropriate planning analysis

on the cash resources of the firm The meaningful analysis is only possible through cash

flow statement analysis, which facilitates the firm to identify the possible sources of

cash as well as the expenses and expenditures of the firm

7.2 MEANING OF CASH FLOW STATEMENT

The cash flow statement is being prepared on the basis of an extracted information of

historical records of the enterprise Cash flow statements can be prepared for a year, for

six months, for quarterly and even for monthly The cash includes not only means that

cash in hand but also cash at bank

7.3 MOTIVES OF CASH FLOW STATEMENT

Motives of preparing the cash flow statement:

 To identify the causes for the cash balance changes in between two different

time periods, with the help of corresponding two different balance sheets

 To enlist the factors of influence on the reduction of cash balance as well as to

indicate the reasons though the profit is earned during the year and vice versa

7.4 UTILITY OF CASH FLOW STATEMENTS

 To identify the reasons for the reduction or increase in the cash balances

irrespective level of the profits earned by the firm

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

 It guides the management to take futuristic decisions on the prospective

demands and supply of cash resources through projected cash flows

 How much cash resources are required?

 How much cash requirements could be internally settled?

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

 Which type of instruments are going to be floated for raising the required

resources?

 It helps the management to understand its capacity at the moment of borrowing

for any further capital budgeting decisions

 It paves way for scientific cash management for the firm through maintenance

of an appropriate cash levels i.e optimum level cash of resources

 It avoids in holding excessive or inadequate cash resources through proper

planning of cash resources

 It moots control through identification of variations occurred in the cash

expenses and expenditures

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7.5 CASH FLOW VS 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

7.6 STEPS IN PREPARATION OF CASH FLOW STATEMENTS

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

Balancing Figure

Figure 7.1: Preparing Non-Current Accounts

Preparation of Adjusted Profit and Loss Account:

Adjusted Profit & Loss Account

Accounting profit to be adjusted Net profit method

Contd

131 Cash Flow Statement Analysis

To find out the cash Profit/Loss

Addition of Non Cash & Non Operating Expenses

Deduction of Non cash & Non operating Incomes

Cash from operations or Cash lost in operations

Figure 7.2: Adjusted Profit and Loss Account

Alternate method:

Net Profit

(+)

(-)

Sales Method

Cash Sales

Deduct Cash Purchases & Cash Operating Expenses

Cash from operations or Cash lost in operations

Increase in current assets &

Decrease in current liabilities

Decrease in current assets &

Increase in current liabilities

Figure 7.3: Alternate Method for Cash-flow Statement

Comparison of Current items to determine the inflow of cash or outflow of cash

Decrease in current assets

Decrease in current liabilities

Increase in current liabilities

Inflow of cash

Outflow of cash

Inflow of cash

Figure 7.4: Comparison of Items to Determine Cash Flow

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7.7 PREPARATION OF CASH FLOW STATEMENT

The cash flow statement can be prepared either in statement form or in accounting format

Opening cash balance XXXX Redemption of preference shares XXXX

Collection from debentures XXXX

Check Your Progress 1

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:

c) Both (a) & (b) d) None of the above

4 Non-current accounts are prepared for the cash inflows and cash outflows on the basis of following relationship:

a) Non current asset account and a) Cash

b) Non current liability account and Cash

c) Both (a) & (b) only d) None of the above

Illustration 1

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

December 31 Particulars

1992 Rs 1993 Rs

133 Cash Flow Statement Analysis

Solution:

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

Cash from operations

= Net profit (+)

(-) Decrease in current assets

&

Increase in current liabilities

Increase in current assets

&

Decrease in current liabilities

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 added

volume should be deducted from the increase in current assets and decrease in current

liabilities

Add

Less

Illustration 2

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

operations

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

Rs Rs

To loss on sale of plant 2,000

To Goodwill written off 8,000

To proposed dividend 10,000

To provision for taxation 10,000

Solution:

Add:

Non-cash expenses

Depreciation 4,000

Non-operating expenses

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Less

Non-cash income

Non-operating income

38,000

Illustration 3

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

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

Bills payable 1,00,000 80,000 Debtors 1,40,000 1,60,000

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 31 Mar, 1984 was Rs.1,00,000 and 31st Mar, 1985 Rs.1,70,000 You are required to prepare a cash flow statement

Solution:

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

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

The next step is to find out the depreciation provided during the year, which affects non-current asset account of the firm is Machinery account Before discussing the accounting transactions, the journal entry for provision for depreciation should be known

Dr Provision for depreciation Account Cr

To Balance C/d 1,70,000 By Adjusted profit and loss

account ( Depreciation provided during the year)

90,000

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

135 Cash Flow Statement Analysis

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

of the machinery?

Original cost of the Asset Rs.50,000

Accumulated Depreciation Rs.20,000

Rs.30,000

Loss on sale of the assets Rs.4,000

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

recorded

Machinery Account

Rs Rs

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

The next step is to prepare adjusted profit and loss account

Dr Adjusted profit and loss account Cr

To Machinery A/c (Loss on

sale)

Rs.4,000 By Balance B/d

-

To Depreciation provided

during the year

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

To Balance c/d 1,20,000

The next most important step is to compare the current assets

Increase in creditors -Rs.20,000 - 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

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Cash flow statement

purchased

80,000

Cash from operations 2,14,000 Closing cash balance 50,000

Illustration 4

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

Share capital 1,40,000 1,48,000 Bank balance 18,000 15,600

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

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

Solution:

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

To Balance B/d (O pening) 40,000

To Purchase (Given) 20,000 By Balance c/d (Closing ) 60,000

The non-current liability account to be prepared The first non current liability account got affected is Share capital account

Rs Rs

By Balance B/d(Opening ) 1,40,000

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

137 Cash Flow Statement Analysis The next non-current liability account is that Bonds account

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

To Balance c/d(Closing ) 12,000

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

To provision for doubtful

debts

To Good will written off 10,000 By cash from operations 18,240

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

Increase in Accounts payable - Rs.2,960 - 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

Check Your Progress 2

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

d) None of the above

2 How cash flows are denominated in terms of both current assets and current

liabilities ?

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

d) Both (a) & (b)

3 Cash position at the opening and closing comprises of

c) Both cash in hand and at bank d) None of the above

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 inflow b) Current asset sale – cash outflow

c) Non current asset sale – cash outflow d) None of the above

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7.8 AS-3 REVISED CASH FLOW STATEMENTS

 Cash flow statement provides information about the cash receipts and payments

of an enterprises for a given period It provides important information that supplements the profit and loss account and balance sheet

 The statement of cashflows is required to be reported by Accounting

Standard-3 (Revised ) issued by the Institute of Chartered Accountants of India in March

1997 Which replaces the 'Changes in Financial Position' as per AS-3

 There are certain changes in the preparation of cashflow statement from the previous methods as a result of the introduction of AS-3 (Revised)

 AS-3 (Revised) is mandatory in nature in respect of accounting periods commencing on or after 1-4-2001 for the following:

(i) Enterprises whose equity or debt securities are listed on a recognised stock exchange in India, and enterprises that are in the process of issuing equity or debt securities that will be listed on a recognised stock exchange

in India as evidenced by the board of directors' resolution in this regard (ii) All other commercial, industrial and business reporting enterprises, whose turnover for the accounting period exceeds Rs 50 crores

Cash flow Statement (Indirect Method) (Accounting Standard-3 (Revised) (Rs.) Cash flow from Operating activities

Net profit before tax and extraordinary items xxx

Adjustments for:

-Gain or loss on sale of fixed assets (xxx)

Adjustment for:

-trade and other receivables xxx

Cash before Extraordinary Items xxx

Cashflow from Investing activities

Purchase of fixed assets (xxx)

Cashflow from Financing activities

Proceeds from issue of share capital xxx Proceeds from long-term borrowings xxx Repayment to finance/lease liabilities (xxx)

Net Increase (decrease) in cash and cash equivalents during the period

(a+b+c) xxx

Cash and cash equivalents at the beginning of the year xxx Cash and cash equivalents at the end of the year xxx