PREPARE CASH FLOW STATEMENT IN THREE(3) STEPS
Before going to brief discussion on cash flow statement, let us know about profit and loss account if you give a trial balance to ten different people and ask them to arrive profits then you will get ten different answers because of different assumptions, but in case of cash flow the ten answers will be same as we considering with only cash items unless non-cash items as in profit and loss account.
Profit is an accounting concept. Profit is derived on accrual assumption. Profit and cash flow from operating activities are not the same. Cash flow statement is an important tool for making several management decisions such as declaration of dividend and investments.
Cash and Cash equivalent
Cash means cash n hand and balance of foreign currency. Cash equivalents implies bank balance and other risk free short term investments, and advances which are encashable, it includes short term highly liquid investments that are readily convertible into cash. Equity investments are not considered as cash equivalent because of high market risk. Investments in call money, money market mutual funds are usually classified as cash equivalent.
Types of cash flow
Cash flow statement explains cash movements under three different heads, such as:
Cash flow from operating activities
Cash flow from investing activities
Cash flow from financing activities
Sum of these three activities of cash flow reflects net increase or decrease of cash and cash equivalents.
Operating activities are the principal revenue producing activities of the enterprise and other activities that are not investing and financing.
Elements of operating cash flow
Cash receipts from sale of goods and services
Cash receipts from royalty, fees, commissions and other revenue.
Cash payment to suppliers of goods and services
Cash payment to employees
Cash payment and refunds of income taxes
Depending on type of business the elements will changes
Insurance companies: Cash receipts and cash payment by way of premiums and claims, annuities and other policy benefits
Banking companies: Cash receipt and cash payment by way of interest earned, commission earned , interest paid etc
Investing activities are the purchase and sale of long term assets and other investments not included in cash equivalents.
Elements of investing cash flow
Cash payments for acquisition of fixed assets
Cash receipts from sale of fixed assets
Cash payments to acquire shares, debt instruments of other companies(excluding items covered under cash equivalents)
Cash receipts from sale of shares, debt instruments of other companies(excluding items covered under cash equivalents)
Financing activities are the activities that result in changes in the size and composition of the owners capital including preference shares capital.
Elements of financing cash flows
Cash proceeds from issuing of shares or other equity instruments.
Cash payments to owners to acquire shares ( Buy back of shares)
Cash proceeds from issuing debentures ,loans, notes, bonds etc.
Cash repayment of amount borrowed.
Ass per accounting standard 3 there two methods for preparing cash flow statement
- Direct method
- Indirect method
Here we are going to prepare cash flow statement under indirect method which is very popular.
Acquire all relevant data required to prepare cash low such as balance sheet and statement of profit and loss.
Classify the items into three groups such as operating, Investing, Finance
Current assets and current liabilities are classified as operating activity
Non- current assets such as fixed assets and investment are classified as investing activity(Exclude unamortized expense)
Share holder funds such as share capital and preference capital are classified as Financing activity
In case of Profit and loss
After classification of items in operating, Investing, and Finance substitute values in cash flow statement ,the changes in current assets(I.e increase or decrease compared with previous year) shall be done with care.
Following is the cash flow statement under indirect method