Preparation of cash flow statement is similar a to that of funds flow statement. Infect, the basic difference arises from the definition of funds. In funds flow statement, fund means ‘networking capita” while in cash flow statement it means ‘cash AS-3 has not prescribed any specific format of this statement but SEBI has approved the it to be prepared.
How to Calculate Cash Flow
There are two methods of how to calculate cash flow from operating activities:
(a) Direct method, and (b) indirect method.
Direct Method: Under this method, cash receipts from operating revenues and cash payments for operating expenses are calculated and shown in the cash flow statement. The difference between the total cash receipts and total cash payments as shown as the net cash flow from operating activities.
There are many items which appear in the Profit and Loss Account on accrual basis. Necessary adjustments are made to these items to convert them into cash based items.
[Note: Direct method of determining cash flows from operating activities has not been used in this book to solve practical problems. The indirect method is more popular in actual practice and has been used in practical problems.]
Indirect Method. Under the indirect method, the net cash from operating activities is determined by making necessary adjustments in the net profit (or loss) as disclosed by Profit and Loss Account. Adjustments in net profit or loss are for the effects of:
(a) non-cash items like depreciation;
(b) changes during the period in inventories and operating receivables and payable;
(c) all other items for which cash effects are investing and financing cash flows.
The indirect method is also known as ‘Reconciliation Method’ as it involves a reconciliation of the net profit with net cash flows horn operating activities.
Cash Flow Calculation from Investing Activities
Cash inflows and cash outflows from investing activities result from acquisition and disposal of long term assets, non-operating current assets and investments. The net effect of cash inflows and outflows is determined and shown as cash flows from investing activities in the cash flow statement.
Cash Flows Calculation from Financing Activities
These activities relate to issue of shares and debentures, redemption of preference shares and debentures, raising of loans and repayment of loans etc. The net effect of inflows and outflows of cash relating to these financing activities is determined and shown in the cash flow statement under this head of Cash Flows from Financing Activities.
1. Assesses cash flow from operating activities. Cash flow statement provides information about cash generated from operating activities. It provides explanation for the difference net profit and cash from operations. Cash provided by operating activities is very important to assess the cash
generated by internal sources.
2. Payment of dividends. Decisions to pay dividends cannot be based on net profit only. Availability of profit in the form of cash is also important for dividend disbursement. Thus cash provided by operating activities assumes importance for declaration of dividend.
3. Cash from investing and financing activities. Cash flow statement provides information not only about cash provided by operating activities but also by non-operating activities under two heads, namely investing activities and financing activities. This helps to explain the overall liquidity position of the enterprise and its ability to meet its cash commitments.
4. Explains reasons for surplus or shortage of cash. A business may have made profit and yet running short of cash. Similarly a business may have suffered a loss and still has sufficient cash at the bank. A cash flow statement discloses reasons for such increases or decreases of cash balance.