Statement of Cash Flow

• Accounting & Bookkeeping
• ||
• October 2, 2020

The Statement of Cash Flow is an only exception to the concept of accrual. It gives the entity the power to know the precise source of cash generation. Many investors explore the statement of cash flows right after looking to profit figures, because they often feel that the profit might be manipulated by some non-cash transactions, like various provisions, fair value adjustments, etc.

However, all prefer cash whether it’s the corporate itself or investors because it shows not only what proportion Cash the corporate goes to get over the year, but also from where the cash was generated.

• By operating activities? or;
• By investing activities? or;
• By financing activities?

This information is provided within the cash flow statements which classify cash flows during the period from operating activities, investing activities and financing activities.

What comprises cash and cash equivalents?
Cash comprises cash in hand (e.g. petty cash balance) and demand deposits (e.g. saving or current bank accounts).

Cash equivalents are short-term and highly liquid investments that are easily convertible into cash and which are subject to an insignificant risk of changes in value. The investment which is of nature of short term maturity (from 1 to 3 months) would qualify for cash equivalent – for example, state Treasury note, short term govt. bond. However, most shares and other equity instruments are excluded from cash equivalents. 

Note that the movements between cash and cash equivalents are a very important part of cash management and this is why these are not shown in the operating, financing or investing part of the cash flow statement. So if the company buys an investment asset with a short maturity date, then this movement is not shown at all it always appears in such a manner that the cash and cash equivalents have not moved at all.

Presentation of Cash flow statement
Ind AS 7 states that the statement of cash flows shall always report cash flows during the period classified by operating, investing and financing activities and,

The statement of cash flows should also contain the final reconciliation in which it summarizes the overall movement in cash and cash equivalents (corresponding with the balance sheet) as shown in the below table.

In the notes to the financial statements, an entity shall disclose the components of cash and cash equivalents.

Operating activities
Operating activities are the principal revenue-generating activities of the entity which are performed in the ordinary course of business and other activities which are neither investing nor financing activities.

It is the most important because it shows the ability of the entity to generate cash by its own activities in the ordinary course of business, rather than by external financing or making investments.

Cash flows from operating activities result from the primary revenue-generating activities of each entity and therefore, there might be differences between different entities. 

For example, the manufacturing company would report the receipt of interest income from the acquired company as a financing activity, but the bank or Investment Company would report similar interest income as an operating activity based on its specific purpose.

However, cash flow from operating activities generally result from those activities which are of the nature of profit-making and the examples are of the operating activities are:

• Cash received from the sale of goods and the rendering of services in the ordinary course of business;
• Cash received of the nature royalties income, fees or commissions and other revenue ;
• Cash payments made to suppliers for goods and services received in the ordinary course of business;
• Cash payments to and on behalf of employees in the ordinary course of business;
• Cash received and cash payments made by an insurance entity for premiums and claims, annuities and other policy benefits in the ordinary course of business;
  

Methods of Preparing Cash flow Statement from Operating Activities.
A company has two options to prepare the cash flow statement from operating activities:

Direct method: In this case, the company is required to show major classes of gross cash receipts and gross cash payments; or

Indirect method: In this case, The Company start with the profit or loss before tax and then the adjustment for the following is needed:

• Changes in working capital over the period (inventories, operating receivables, payables);
• Items which are Non – cash nature (Depreciation or amortization expenses of fixed assets, revaluation gains of fixed assets, etc.)
• Items which are in relation with investing or financing activities.

The direct method can provide us more understandable information that is not disclosed under the indirect method. However, in reality, the indirect method is far more preferred in comparison to the direct method because it’s easy to get the information based on the accounting records.

Investing activities
Investing activities are those activities in which the long term assets are acquired and disposed of and other investments that don’t come in definition of cash equivalents.

Examples of cash flows which are classified into investing activities are:

• Cash payments made to acquire tangible and long term assets (including capitalized development costs and self-constructed PPE);
• Cash received from the sales of tangible, intangibles and other long-term assets;
• Cash payments made to acquire and cash received from the sales of financial instrument which are of the nature of equity or debt of other entities and interests in joint ventures (but that is not for trading or dealing purposes);
• Cash advances and loans given to other parties, and cash received from their repayment (other than advances and loans made by a financial institution – these would go to operating activities);
• Cash payments for and cash received from various derivative contracts except when the contracts are held for dealing or trading purposes or the payments are classified as financing activities.

Financing activities
Financing activities are those activities that result in changes in the composition and size of the contributed equity capital and borrowed capital of the entity.

Examples of cash flows which are arising from financing activities are:

• Cash received from issuing shares or other equity instruments;
• Cash payments made to owners to acquire or redeem the entity’s shares;
• Cash received from issuing debentures, loans, notes, bonds, mortgages and other short-term or long-term borrowings;
• Cash repayments of amounts borrowed from other entities; and
• Cash payments made by a lessee for the purpose of reduction of the outstanding liability relating to a finance lease.

Reporting cash flows from investing and financing activities
Only Gross cash flows are reported in the investing and financing activities, therefore no netting off is done.

It means that it is not possible to present the cash paid to acquire some tangible assets and cash received from the sale of some other fixed tangible assets in one line – instead it must be shown in cash flows, separately in 2 lines.

However, Ind AS 7 gives two exceptions where it can be present net:

• Cash receipts and payments on behalf of customers when the cash flows show off the activities of the customer rather than those of the entity. For example, some real estate companies can collect rents from tenants of the property and pay them over to the real property owners.
• Cash receipts and payments for those items in which the turnover is very quick, the amounts are very large, and the maturities are very short. For example, changes in principal amounts relating to credit card customers.

Also, financial institutions can also report certain transactions on a net basis, For example:

• cash receipts and payments for the acceptance and repayment of deposits with a fixed maturity date;
• the placement of deposits with and withdrawal of deposits from other financial institutions; and
• Cash advances and loans made to customers and the repayment of those advances and loans.

At AJSH, we assist our clients in preparation of financial statements, dealing with various corporate matters (Company incorporations, statutory audits, ROC Compliances, Company winding up), ITR Filings, TDS Compliance, and related services by providing them adequate support and guidance from our end. If you have any questions or wish to know more about Statement of cash flows, kindly contact us.