As per Accounting Standard (AS-3) issued by the Institute of Chartered Accountants of India, the term cash includes:
1. Cash in hand.
2. Demand deposits with banks.
3. Cash equivalents. These 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.
Meaning of Cash Flow
Cash flow means inflow and outflow of cash. An inflow i.e. source of cash increases the total cash available at the disposal of the firm while an outflow i.e. use of cash decreases it. The difference between cash inflows and cash outflows is known as net cash flow which can be either net cash inflow or net cash outflow.
It should be noted that cash flow statement deals with flow of cash fund but does not consider movement among cash, bank balance and cash equivalents. This is in line with funds flow statement which exclude movements between items that constitute working capital i.e. current assets and current liabilities.
Classification of Cash Flows
1. Operating Activities: Operating activities are the principal revenue activities of the enterprise. Cash flow these activities result from transactions and other events that enter into the determination of net profit or Loss. Examples of cash flow from operations are:
(i) Cash receipts from the sale of goods and the rendering of services usually forms a major share of cash inflow.
(ii) Cash receipts from royalties, fees, commission and other revenue.
(iii) Cash payment to suppliers for goods and services, such as payment of expenses like lighting and power, rent, insurance etc.
(iv) Cash payment of salaries and wages to workers.
2. Investing Activities: These are the acquisitions and disposal of long term assets (such as plant, machinery, furniture, land and building etc.) and other investments not included in cash equivalents. Examples of cash flow arising from investing activities are:
(i) Cash receipts from disposal of fixed assets.
(ii) Cash payments to acquire fixed assets.
(iii) Cash payments to acquire shares/debentures of other enterprises.
(iv) Cash receipts from disposal of shares, debentures of other enterprises.
(y) Cash advances and loans made to third parties.
(vi) Cash receipts from repayment of advances and loans made to third parties.
3. Financing Activities: These would be the activities that lead to changes in the composition and size of the owners capital and borrowings of the business. Examples of cash flows coming from financing activities are: (1) Cash receipts from issue of shares and debentures, etc.
(ii) Cash receipts horn loans raised
(iii) Cash payments for redemption of preference shares and debentures.
(iv) Buy back of equity shares.
Important Points for Students
1. Order followed for presenting the cash flow is to show operating activities, followed by investing activities, and then financing activities.
2. The net cash flow from an activity—operating, investing and financing can be positive or negative. Positive cash flow means net inflow i.e. receipts exceed payments. Negative cash flow means net outflow i.e. payments exceed receipts.
3. The sum of net inflows or outflows of all the activities represents an increase or decrease in cash flows, which is reconciled with opening and closing balance of cash.
Treatment of Other Items
1. Interest and Dividends:
(i) In case of a financing enterprise, cash flows from interest paid and interest and dividend received should be treated as cash flows from operating activities. Dividends paid should be classified as cash flows from financing activities.
(ii) In the case of other enterprises, cash flows arising from interest and dividend paid should be classified as cash flows from financing activities while interest and dividend received should be classified as cash flows from investing activities.
2. Income Tax: Cash flows arising horn income tax should be classified as flows from operating activities unless they can be specifically identified with financing and investing activities. For example, capital gain tax on sale of land can be identified with investing activity and therefore in the
cash flow statement, it should be shown as outflow from investing activities.
3. Extra ordinary items: The cash flows associated with extra ordinary items should be classified as arising horn operating, investing or financing activities as appropriate and separately disclosed. For example, legal claim, cost of winning a law suit or lottery, receipt of claim from an insurance
company etc. are extra ordinary items.
4. Non Cash Transactions: There are certain transactions which do not involve cash inflow or cash outflow. Although they do affect the capital and assets of an enterprise, they are excluded from cash flow statement for obvious reasons. Examples non-cash transactions are:
(i) Acquisition of assets by issue of shares/debentures.
(ii) Conversion of convertible debentures into shares.
(iii) Acquisition of a fixed asset, say machinery, on credit etc.