AS-3 Cash Flow Statements

Cash-Flow Analysis

Prof. PUTTU GURU PRASAD

FACULTY
INC GUNTUR
pgp4149@gmail.com
1
 ◆ Introduction
Applicability
Index
◆
◆ Definitions
◆ Cash and Cash equivalents
◆ Features of Cash Flow Statement
◆ Operating Activities
◆ Investing Activities
◆ Financing Activities

• Interest
• Dividend
• Foreign Currency transactions
• Extraordinary items
• Treatment of Tax
• Investments in subsidiaries, associates and joint ventures
• Acquisitions and disposals of subsidiaries and other business units
• Non-cash transactions
• Disclosures of cash and cash equivalents

2
 WHY PREPARE A CASH FLOW
STATEMENT?
 Balance sheets, an income statement and
statement of changes in equity are based on
accrual accounting and provide only
piecemeal information about flows of funds
and cash
◆ Cash flow statement identifies cash inflows
and outflows from activities over the period
◆ Statement helps answer questions such as:
Why is the company in a liquidity crisis when
it has been profitable over the past few
years?
3
WHY A CASH FLOW STATEMENT?
◆ Profit and liquidity for a normal firm preparing its
accounts on the accrual basis does not mean the
same thing. A firm may be highly profitable but
may find itself with hardly any cash or working
capital to continue the operating cycles, a heavy
loss making firm may find itself flush with funds.
Only in case of a firm that prepares its accounts
on the cash basis will find its profits and cash
flow to be the same.
◆ Hence is the reason for preparing the cash flow
statements to understand the actual
requirements of cash and cash equivalents
4
 CFS help investors
◆ Asses the company’s ability to generate cash
flows from operations in the future
◆ Assess the company’s ability to meet its
obligations, any requirement of external financing
and to pay the shareholder’s dividends.
◆ Analyze the reasons for the difference between
the net profit and cash flows
◆ Analyze the effects on the organization's financial
position of its cash and non-cash investing and
financing activities

5
 Introduction
◆ Most developed counties, as early as in 1988, stated their
preference to cash flow reporting rather than funds flow
reporting
◆ The difference basically lies in the fact that while funds flow
refers to the entire working capital, cash flow only takes
cash and cash equivalents into consideration.
◆ Thus, whereas funds flow is based on accrual
basis and funds from operation is nothing but net
profit plus all non –cash expenses and
amortizations, cash flow is based purely based
upon the movements of cash and its equivalents.
◆ This makes cash flow reporting much more attractive

6
 Introduction
◆ Cash flow statement is additional information to
user of financial statement
◆ This statement exhibits the flow of incoming and
outgoing cash
◆ This statement assesses the ability of the
enterprise to generate cash and cash equivalents
◆ It also assesses the needs of the enterprise to
utilize the cash and cash equivalents generated
◆ It also assesses the liquidity and solvency of the
enterprise.

7
 Applicability
◆ This standard applies to the enterprises:
◆ Having turnover more than Rs. 50
Crores in a financial year;
◆ Listed companies;
◆ Cashflow statement of listed
companies shall be presented only
under the indirect method as
prescribed in AS 3

8
 Definitions
◆ Cash comprises cash on hand and demand
deposits with banks.
◆ Cash equivalents are short term, highly liquid
investments that are readily convertible into
known amounts of cash and which are
subject to an insignificant risk of changes in
value.
◆ Cash flows are inflows and outflows of cash
and cash equivalents.

9
 Definitions
◆ Operating activities are the principal revenue-
producing activities of the enterprise and
other activities that are not investing or
financing activities.
◆ Investing activities are the acquisition and
disposal of long-term assets and other
investments not included in cash
equivalents.
◆ Financing activities are activities that result in
changes in the size and composition of the
owners’ capital (including preference share
capital in the case of a company) and
borrowings of the enterprise.
10
 Cash and Cash Equivalents
◆ Cash Equivalents
◆ Held for meeting short term commitments
◆ It is readily convertible into known amounts of
cash
◆ It has a very insignificant risk
◆ Short maturity (say 3 months maximum)
◆ Cash flows exclude
◆ Movements between cash and cash
equivalents
◆ Cash management includes the investment of
excess cash in cash equivalents
11
 Features of Cash Flow Statement
◆ The cash flow statement should report cash
flows during the period classified by
◆ Operating,

◆ Investing and
◆ Financing activities.
◆ Sum of these three types of cash flow reflect net
increase or decrease of cash and cash
equivalents.

12
 Operating Activities
◆ These are principal revenue producing activities
of the enterprise.
◆ Examples:
◆ Cash receipts from sale of goods / rendering
services;
◆ Cash receipts from royalties, fees,
commissions and other revenue;
◆ Cash payments to suppliers of goods and
service;
◆ Cash payments to and on behalf of employees.

13
 Investment Activities
◆ The activities of acquisition and
disposal of long term assets and other
investments not included in cash
equivalent are investing activities.
◆ It includes making and collecting loans,
acquiring and disposal of debt and
equity instruments, property and fixed
assets etc.
◆ Examples of cash flows arising from
investing activities are as follows:
14
 Investment Activities
◆ Examples of investing activities are
as follows:
◆ Cash payments to acquire fixed assets
◆ Cash receipts from disposal of fixed assets
◆ Cash payments to acquire shares,
warrants or debt instruments of other
enterprises and interest in joint ventures
◆ Cash receipt from disposal of above
investments

15
 Financing Activities
◆ Those activities that result in changes in size and
composition of owners capital and borrowing of the
organization.
◆ It includes receipts from issuing shares, debentures,
bonds, borrowing and payment of borrowed amount, loan
etc.
◆ Sale of share
◆ Buy back of shares
◆ Redemption of preference shares
◆ Issue / redemption of debentures
◆ Long term loan / payment thereof
◆ Dividend / interest paid

16
 Cash flow from operating activities
◆ It can be derived either from direct method or
indirect method
◆ Direct method:
◆ In this method, gross receipts and gross
payments of cash are disclosed
◆ Indirect method:
◆ In this method, profit and loss account is
adjusted for the effects of transaction of
non-cash nature.

17
 Interest
◆ Interest Received
◆ Received from investment – it is in investment activities
◆ Received from short term investment classified, as cash
equivalents should be considered as cash inflows from
operating activities.
◆ Received on trade advances and operating receivables
should be in operating activities
◆ Interest Paid
◆ On loans / debts are in financing activities
◆ On working capital loan and any other loan taken to
finance operating activities are in operating activities
◆ Cash flow from interest should be separately disclosed.

18
Dividend
◆ Dividend Received
◆ For financial enterprises – in operating
activities
◆ For other than financial enterprises – in
investing activities
◆ Dividend Paid
◆ Always classified as financing activities
◆ Cash flow from dividend should be separately
disclosed

19
 Foreign currency transaction
◆ The effect of change in exchange rate in
cash and cash equivalents held in foreign
currency should be reported as separate
part of the reconciliation of cash and cash
equivalents.

◆ Unrealized gain and losses arising from

changes in foreign exchanges rates are
not cash flows.
20
 Extraordinary items
◆ The cash flows associated with
extraordinary items should be classified
as arising from:
◆ Operating

◆ Investing or
◆ Financing activities
as appropriate and separately disclosed.

21
 Treatment of tax
◆ Cash flow for tax payments / refund
should be classified as cash flow from
operating activities.

◆ If cash flow can be specifically identified

as cash flow from investment / financing
activities, appropriate classification
should be made.

22
 Investments in subsidiaries,
associates and joint ventures
◆ Only the cash flow between itself and
the investee is required to be
reported
◆ Example:
◆ Cash flow relating to dividends
and advances

23
 Acquisitions and disposals of
subsidiaries and other business
units
◆ Cash flow on acquisition and disposal of subsidiaries and other
business units should be :
◆ Presented separately
◆ Classified as investing activities
◆ Total purchase and disposal should be disclosed
separately
◆ The position of the purchase / disposal consideration
discharged by means of cash and cash equivalents
should be disclosed

24
 Non-cash transactions
◆ These should be excluded from the cash flow statement
◆ These transactions should be disclosed in the financial
statements.
◆ Examples
◆ Acquisition of assets by assuming directly
related liabilities
◆ Acquisition of an enterprise by means of issue
of equity sshares
◆ Conversion of debt to equity

25
 Disclosures of cash and cash
equivalents
◆ The components of cash and cash equivalents
should be disclosed

◆ Reconciliation of the amount in the cash flow

statement with the equivalent items reported in
the balance sheet

◆ The amount of cash and cash equivalent balance

held by the enterprises that are not available for
use (with explanation by management)
26
 ANALYSING THE CASH FLOW
◆ Statements of cash flows help users:
◆ To evaluate a company’s ability to
generate positive cash flows
◆ meet its obligations to shareholders,
creditors and governments
◆ assess a company’s solvency and need for
external financing
◆ explain variances between reported
accrual profit and cash flows from
operating activities
◆ Single statements are of limited use, a useful analysis requires
statements covering five or more years.

27
 Statement of Cash Flows:

◆ The connection between two successive

balance sheets & the statement of cash
flows can be shown :
a. Assets = Liabilities + Owners’ equity
b. Cash + Noncash assets = Liabilities + Owners’ equi

Cash = Liabilities − Noncash assets + Owners’ equi

. ∆Cash = ∆Liab − ∆Noncash assets + ∆Owners’ equit

28
II. Statement of Cash
Flows:

∆ Cash = ∆ Liab ∆ Noncash assets + ∆ Owners’ equity

 The cash flow statement simultaneously

provides an explanation of why a firm’s cash
position has changed between successive
balance sheet dates and explains changes that
have taken place in the firm’s noncash asset,
liability, and stockholders’ equity accounts over
the same time period.
29
 II. Statement of Cash Flows:

◆ The change in a firm’s cash

position between successive
balance sheet dates will not equal
the reported earnings for that
period.

30
 Flow of Funds Statement

A summary of a firm’s changes in

financial position from one period to
another; it is also called a sources and
uses of funds statement or a statement
of changes in financial position.
Has been replaced by the cash flow
statement (1989) in U.S. audited
annual reports.
31
 Flow of Funds Statement

What are “funds”?

funds

All of the firm’s investments and

claims against those investments.
Extends beyond just transactions
involving cash.
cash

32
 Sources and
Uses Statement
The letters labeling
the boxes stand for
Uses,
ses Sources,
ources A L
Assets,
ssets and
Liabilities (broadly
defined). The pluses
(minuses) indicate
S - +
increases
(decreases) in
assets or liabilities.
U + -
33
 BW’s Determination
of Sources and Uses
Assets 2007 2006 +/- S/U
Cash and C.E. $ 90 $ 100 - S
Acct. Rec. 394 410 - S
Inventories 696 616 + U
Prepaid Exp 5 5 --
Accum Tax Prepay 10 9 + U
$ 1,140 N/A
Current Assets $ 1,195 930 N/A
Fixed Assets (@Cost) 1030 (299) N/A
Less: Acc. Depr. (329) $ 631 + U
Net Fix. Assets $ 701 50 --
Investment, LT 50 223 --
34 Other Assets, LT 223 $ 2,044
 BW’s Determination
of Sources and Uses
Assets 2007 2006 +/- S/U
Cash and C.E. $ 90 $ 100 $10 S
Acct. Rec. 394 410 16 S
Inventories 696 616 80 U
Prepaid Exp 5 5 --
Accum Tax Prepay 10 9 1 U
$ 1,140 N/A
Current Assets $ 1,195 930 N/A
Fixed Assets (@Cost) 1030 (299) N/A
Less: Acc. Depr. (329) $ 631 70 U
Net Fix. Assets $ 701 50 --
Investment, LT 50 223 --
35 Other Assets, LT 223 $ 2,044
 BW’s Determination
of Sources and Uses
Liabilities and Equity 2007 2006 +/- S/U
Notes Payable $ 290 $ 295 - U
Acct. Payable 94 94 --
Accrued Taxes 16 16 --
Other Accrued Liab. 100 100 --
$ 505 N/A
Current Liab. $ 500 453 + S
Long-Term Debt 530
Shareholders’ Equity 200 --
Com. Stock ($1 par) 200 729 --
Add Pd in Capital 729 157 + S
Retained Earnings 210 $ 1086 N/A
36 Total Equity $ 1,139 $ 2,044
 BW’s Determination
of Sources and Uses
Liabilities and Equity 2007 2006 +/- S/U
Notes Payable $ 290 $ 295 $ 5 U
Acct. Payable 94 94 --
Accrued Taxes 16 16 --
Other Accrued Liab. 100 100 --
$ 505 N/A
Current Liab. $ 500 453 77 S
Long-Term Debt 530
Shareholders’ Equity 200 --
Com. Stock ($1 par) 200 729 --
Add Pd in Capital 729 157 53 S
Retained Earnings 210 $ 1086 N/A
37 Total Equity $ 1,139 $ 2,044
 “Basic” Sources
and Uses Statement
SOURCES
Increase, Retained Earnings $ 53
Decrease, Accounts Receivable 16
Increase, Long-Term Debt 77
Decrease, Cash + Cash Equivalents 10
USES $156
Increase, Inventories $80
Increase, Accum Tax Prepay 1
Decrease, Notes Payable 5
Increase, Net Fixed Assets 70
38
$156
 Adjusting the “Basic”
Sources and Uses Statement

The following three slides are

Basket Wonders’ Balance Sheet
and Income Statement that was
discussed in Chapter 6.
This information will be needed
to adjust the “basic” Sources
and Uses Statement.
39
 Basket Wonders’ Balance
Sheet (Asset Side)
Basket Wonders Balance Sheet (thousands) Dec. 31, 2007a
Cash and C.E. $ 90 a. How the firm stands on
Acct. Rec.c 394 a specific date.
Inventories 696 b. What BW owned.
Prepaid Exp d 5 c. Amounts owed by
Accum Tax Prepay 10 customers.
d. Future expense items
Current Assetse $1,195 already paid.
Fixed Assets (@Cost)f 1030 e. Cash/likely convertible
Less: Acc. Depr. g (329) to cash within 1 year.
Net Fix. Assets $ 701 f. Original amount paid.
Investment, LT 50 g. Acc. deductions for
40 Other Assets, LT 223 wear and tear.
b
 Basket Wonders’ Balance
Sheet (Liability Side)
Basket Wonders Balance Sheet (thousands) Dec. 31, 2007
Notes Payable $ 290 a. Note, Assets =
Acct. Payablec 94 Liabilities + Equity.
Accrued Taxes d 16 b. What BW owed and
Other Accrued Liab. d 100 ownership position.
Current Liab. e $ c. Owed to suppliers for
500 Long-Term Debt f goods and services.
530 Shareholders’ d. Unpaid wages,
Equity Com. Stock ($1 salaries, etc.
par) g 200 Add Pd in Capital g e. Debts payable < 1 year.
729 Retained f. Debts payable > 1 year.
Earnings h
210 Total g. Original investment.
41 Equity $1,139 h. Earnings reinvested.
 Basket Wonders’
Income Statement
Basket Wonders Statement of Earnings (in thousands)
for Year Ending December 31, 2007a
Net Sales $ 2,211 a. Measures profitability
Cost of Goods Sold b 1,599 over a time period.
Gross Profit $ 612 b. Received, or receivable,
SG&A Expenses c 402 from customers.
EBITd $ c. Sales comm., adv.,
210 Interest Expensee officer’s salaries, etc.
59 EBT f $ d. Operating income.
151 Income Taxes e. Cost of borrowed funds.
60 EATg $ 91 f. Taxable income.
Cash Dividends 38 g. Amount earned for
42
Increase in RE $ 53 shareholders.
 Adjusting the “Basic”
Sources and Uses Statement
Recognize Profits and Dividends
Change in retained earnings is composed
of profits and dividends.
Source: Net Profit $91
Less Use: Cash Dividends 38
(Net) Source: Incr., R.E. $53
43
 Adjusting the “Basic”
Sources and Uses Statement
Recognize Depreciation and Gross
Changes in Fixed Assets
Change in net fixed assets is composed
of depreciation and fixed assets.
Source: Depreciation $ 30
Less Use: Add. to F.A. 100
(Net) Use: Incr., Net F.A. $ 70
44
 Sources and Uses
Statement (Sources Side)
SOURCES
Funds provided by operations
Net Profit $ 91
Depreciation 30

Decrease, Accounts Receivable 16

Increase, Long-Term Debt 77
Decrease, Cash + Cash Equivalents 10
$224

45
 Sources and Uses
Statement (Uses Side)
USES

Dividends $ 38
Additions to fixed assets 100

Increase, Inventories 80
Increase, Accum. Tax Prepay 1
Decrease, Notes Payable 5
$224

46
 Analyzing the Sources
and Uses Statement

Sources Uses
Primarily Primarily through
through net an increase in
profit from inventories and
operations and expenditures on
long-term debt capital assets.
increases.
47
 Statement of Cash Flows
A summary of a firm’s payments
during a period of time.
This statement reports cash inflows
and outflows based on the firm’s
operating activities,
activities
investing activities,
activities and
48
financing activities.
activities
 Statement of Cash Flows
Cash Flow from Operating Activities

Shows impact of transactions not

defined as investing or financing
activities.
◆ These cash flows are generally the cash
effects of transactions that enter into the
determination of net income.

49
 Cash Flow From
Operating Activities
Cash Inflows
From sales of goods or services
From interest and dividend income
Cash Outflows
To pay suppliers for inventory
To pay employees for services
To pay lenders (interest)
To pay government for taxes
To pay other suppliers for other
operating expenses
50
 Cash Flow From
Operating Activities
It would seem more logical to classify
interest and dividend income as an
“investing” inflow, while interest paid
certainly looks like a “financing”
outflow.
But, the U.S. Financial Accounting Standards
Board -- by a slim 4 to 3 vote -- classified these
items as “operating” flows.

51
 Statement of Cash Flows
Cash Flow from Investing Activities
Shows impact of buying and selling
fixed assets and debt or equity
securities of other entities.
Cash Flow from Financing Activities
Shows impact of all cash transactions
with shareholders and the borrowing
and repaying transactions with lenders.
52
 Cash Flow From
Investing Activities
Cash Inflows
From sale of fixed assets (property, plant,
equipment)
From sale of debt or equity securities (other
than common equity) of other entities
Cash Outflows
To acquire fixed assets (property, plant,
equipment)
To purchase debt or equity securities (other
than common equity) of other entities
53
 Cash Flow From
Financing Activities
Cash Inflows
From borrowing
From the sale of the firm’s own equity
securities
Cash Outflows
To repay amounts borrowed
To repurchase the firm’s own equity
securities
To pay shareholders dividends

54
 Indirect Method --
Statement of Cash Flows
Cash Flow from Operating Activities

Net Income $ 91
Depreciation 30
Decrease, accounts receivable 16
Increase, inventories ( 80)
Increase, accum. tax prepay ( 1)

Net cash provided (used) by

operating activities $ 56

55
 Indirect Method --
Statement of Cash Flows

Cash Flow from Investing Activities

Additions to Fixed Assets $(100)

Net cash provided (used) by

investing activities $(100)

56
 Indirect Method --
Statement of Cash Flows

Cash Flow from Financing Activities

Increase, notes payable $ ( 5)

Increase, long-term debt 77
Dividends paid ( 38)

Net cash provided (used) by

financing activities $ 34

57
 Indirect Method --
Statement of Cash Flows

Increase (decrease) in cash

and cash equivalents $ ( 10)
Cash and cash equivalents, 2006 100
Cash and cash equivalents, 2007 $ 90

Supplemental cash flow disclosures

Interest paid $ 59
Taxes paid 60

58