Statement of

Cash Flows
Learning outcomes
• Introduction
• Cash And Cash Equivalents
• Purpose of Statement of Cash Flow
• Classification of Cash Flow Activities
• Relationship of Cash Flow Activities
• Cash Flow Statement
• Reporting Cash Flows
• Usefulness of Cash Flow Statement
• Comparison with IAS 7 and Ind AS 7
• Free Cash Flow
Introduction
Introduction (contd…)
• The balance sheet is a snapshot of entity’s financial resources and obligations at
a particular point of time and the statement of profit and loss reflects the
financial performance for the period
• These two components of financial statements are based on accrual basis of
accounting
• The statement of cash flows includes only inflows and outflows of cash and cash
equivalents; it excludes transactions that do not affect cash receipts and
payments
• The information on cash flows are useful in assessing sources of generating and
deploying cash and cash equivalents during the reporting period
• Ind AS 7, Statement of Cash Flows, prescribes principles and guidance on
preparation and presentation of cash flows of an entity from operating activities,
investing activities and financing activities for a reporting period
Cash And Cash Equivalents
• Cash Flow Statement provides an analysis of changes in cash and cash
equivalents:
➢Cash comprises of cash in hand, cash balances with banks that are
repayable on demand and demand deposits with banks
➢Cash equivalents are short-term, highly liquid investments that are
readily convertible into known amount of cash and which are subject
to an insignificant risk of change in value
➢Bank overdrafts
➢Investment in equity shares or equity mutual fund though highly
liquid is not considered as cash equivalents since there is significant
risk of change in value in short-term
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Purpose of Statement of Cash Flow
• The statement of cash flows is required to report cash flows classified by
operating, investing and financing activities along with the components of
cash and cash equivalents at the beginning and end of the reporting period
i.e. to explain the reasons for increase or decrease in the cash and cash
equivalents between two balance sheet dates
• Aids the management as a tool of cash planning and control
• Analyses the difference between the figures of big profits and shortage of
cash
• Helps in formulating a proper dividend policy of the concern
• Ensures a prospective investor that his investments get regular returns in
future
Classification of Cash Flow Activities
• For a better understanding of the sources and uses of cash, they are
classified into three headings as follows:

• https://youtu.be/EA-3bAHrMxE
Classification of Cash Flow Activities (contd…)
Classification of Cash inflows and Cash Outflows Activities
Relationship of Cash Flow Activities

Beginning Cash Balance

Plus: Cash Flow from Operating Activities
Plus: Cash Flow from Investing Activities
Plus: Cash Flow from Financing Activities
Equals: Ending Cash Balance
Cash Flow From Operating Activities
• Sources and uses of cash from the main revenue generating activities of the
business
• Operating activities create revenues, expenses, gains, and losses. It is the
principal revenue-producing activities of the enterprise
• Any cash flow that is not occurring on account of investing activities or
financing activities will be shown under this head
• There are two methods cash flow entries in Operating Activities:
✓Direct Method

✓Indirect Method

• The two methods have no effect on investing or financing activities

Cash Flow From Operating Activities (contd…)
Cash Flow From Operating Activities (contd…)
• The direct method provides information which may be useful in estimating
future cash flows and which is not available under the indirect method and is,
therefore, considered more appropriate than the indirect method
• However, indirect method of determining the cash from operating activities is
more popular in actual practice
• It is worth noting that both direct and indirect methods adjust current assets
and current liabilities related to operating activities to determine cash from
operating activities
• But direct method adjust individual items of profit and loss account and
indirect method adjusts overall net profit (or loss) to determine cash from
operation
• Therefore, indirect method fails to provide break-up of cash from operations
Reporting Cash Flows from Operating Activities
• As per IAS 7, an entity shall report cash flows from operating activities
using either:
(a) the direct method, whereby major classes of gross cash receipts
and gross cash payments are disclosed; or
(b) the indirect method, whereby profit or loss is adjusted for the
effects of transactions of a non-cash nature, any deferrals or accruals
of past or future operating cash receipts or payments, and items of
income or expense associated with investing or financing cash flows
• Entities are encouraged to report cash flows from operating activities
using the direct method. The direct method provides information which
may be useful in estimating future cash flows and which is not available
under the indirect method
Cash Flow From Operating Activities – Direct
Method
Cash Flow From Operating Activities – Indirect
Method
Cash Flow From Investing Activities
• Investing activities are the acquisition and disposal of long term assets
and other investments not included in cash equivalents
• Investing activities involve purchases and sales of property, plant and
equipment and investments
• Receipts from disposal of property, plant and equipment include directly
related proceeds of insurance settlements
• Cash receipts and cash payments from investing activities are computed
by analyzing changes in the balance sheet amounts for property, plant
and equipment and investments and considering the cash effects of the
related transactions that took place during the period
• Interest and dividends received are also part of cash inflows from
investing activities
Cash Flow From Financing Activities
• Financing activities are the activities that result in the change in size and
composition of owner’s capital (including preference share capital in
case of company) and borrowings of the enterprise
• These involve raising and repayment of capital and loans
• Cash inflows and cash outflows from financing activities are calculated
by analyzing changes in the balance sheet amounts for equity and
financial liabilities and considering the cash effects of transactions
during the period
• Interest and dividends paid are part of cash outflows from financing
activities
Cash Flow Statement
Form of Cash Flow Statement
Form of Cash Flow Statement (contd…)
Form of Cash Flow Statement (contd…)
Form of Cash Flow Statement (contd…)
Reporting Cash Flows
• Cash flows arising from the following operating, investing or financing
activities may be reported on a net basis:
✓ (a) cash receipts and payments on behalf of customers when the cash flows
reflect the activities of the customer rather than those of the entity; and
✓ (b) cash receipts and payments for items in which the turnover is quick,
the amounts are large, and the maturities are short
• Cash flows arising from transactions in a foreign currency shall be recorded
in an entity’s functional currency by applying to the foreign currency amount
the exchange rate between the functional currency and the foreign currency at
the date of the cash flow
• The cash flows of a foreign subsidiary shall be translated at the exchange
rates between the functional currency and the foreign currency at the dates of
the cash flows
Reporting Cash Flows (contd…)
• Unrealised gains and losses arising from changes in foreign currency
exchange rates are not cash flows
• The effect of exchange rate changes on cash and cash equivalents held or
due in a foreign currency is reported in the statement of cash flows in order to
reconcile cash and cash equivalents at the beginning and the end of the period
• This amount is presented separately from cash flows from operating, investing
and financing activities and includes the differences, if any, had those cash
flows been reported at end of period exchange rates
• Suppose the money is received on account of exports on 15th January, 2020 in
US $. The company prepares the accounts in rupees. In such case the exchange
rate between USD and Rupee as on 15th January 2020 need to be applied for
conversion
Reporting Cash Flows (Contd…)
• Cash flows from interest and dividends received and paid shall each be
disclosed separately. Cash flows arising from interest paid and interest and
dividends received in the case of a financial institution should be classified as cash
flows arising from operating activities
• In the case of other entities, cash flows arising from interest paid should be
classified as cash flows from financing activities while interest and dividends
received should be classified as cash flows from investing activities. Dividends
paid should be classified as cash flows from financing activities
• Cash flows arising from taxes on income shall be separately disclosed and shall
be classified as cash flows from operating activities unless they can be specifically
identified with financing and investing activities
• The aggregate cash flows arising from obtaining or losing control of
subsidiaries or other businesses shall be presented separately and classified
as investing activities
Reporting Cash Flows (Contd…)
• 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 in the Cash Flows
Statement to enable users to understand their nature and effect on the
present and future cash flows of the enterprise
• Investing and financing transactions that do not require the use of cash or
cash equivalents shall be excluded from a statement of cash flows. Such
transactions shall be disclosed elsewhere in the financial statements in a
way that provides all the relevant information about these investing and
financing activities
• An entity shall disclose the components of cash and cash equivalents and
shall present a reconciliation of the amounts in its statement of cash flows
with the equivalent items reported in the balance sheet
Reporting Cash Flows (Contd…)
• An entity shall disclose, together with a commentary by
management, the amount of significant cash and cash equivalent
balances held by the entity that are not available for use by the
group
• Non-cash transactions: Many investing and financing activities do not
have a direct impact on current cash flows although they do affect the
capital and asset structure of an enterprise.
✓ Examples of non-cash transactions are:
(i) The acquisition of assets by assuming directly related activities.
(ii) The acquisition of an enterprise by means of issue of shares; and
(iii) The conversion of debt to equity
Reporting Cash Flows (Contd…)
• Investing and financing transactions that do not require the use of cash
or cash equivalents should be excluded from a Cash Flow Statement.
Such transactions should be disclosed elsewhere in the financial
statements in a way that provides all the relevant information about
these investing and financing activities
Usefulness of Cash Flow Statement
Cash flow statement provides the following benefits :
➢ A cash flow statement when used along with other financial statements
provides information that enables users to evaluate changes in net assets of
an enterprise, its financial structure (including its liquidity and solvency)
and its ability to affect the amounts and timings of cash flows in order to
adapt to changing circumstances and opportunities
➢ Cash flow information is useful in assessing the ability of the enterprise to
generate cash and cash equivalents and enables users to develop models to
assess and compare the present value of the future cash flows of different
enterprises
➢ It also enhances the comparability of the reporting of operating
performance by different enterprises because it eliminates the effects of
using different accounting treatments for the same transactions and events
Usefulness of Cash Flow Statement (contd…)
➢ It also helps in balancing its cash inflow and cash outflow, keeping in
response to changing condition. It is also helpful in checking the
accuracy of past assessments of future cash flows and in examining the
relationship between profitability and net cash flow and impact of
changing prices
Positive Cash Flow
➢ Positive cash flow indicates that a company has more money flowing
into the business than out of it over a specified period
➢ This is an ideal situation to be in because having an excess of cash allows
the company to reinvest in itself and its shareholders, settle debt
payments, and find new ways to grow the business
➢ Positive cash flow does not necessarily translate to profit. However your
business can be profitable without being cash flow-positive, and you can
have positive cash flow without actually making a profit
Negative Cash Flow
➢ Having negative cash flow means your cash outflow is higher than your
cash inflow during a period, but it doesn’t necessarily mean profit is lost
➢ Instead, negative cash flow may be caused by expenditure and income
mismatch, which should be addressed as soon as possible
➢ Negative cash flow may also be caused by a company’s decision to
expand the business and invest in future growth, so it’s important to
analyze changes in cash flow from one period to another, which can
indicate how a company is performing overall
Comparison with IAS 7 and Ind AS 7
➢ IndAS 7 differs from International Accounting Standard (IAS) 7, Statement
of Cash Flows, in the following major respects:
✓ In case of other than financial entities, IAS 7 gives an option to classify
the interest paid and interest and dividends received as item of operating
cash flows. Ind AS 7 does not provide such an option and requires these
item to be classified as item of financing activity and investing activity,
respectively
✓ IAS 7 gives an option to classify the dividend paid as an item of operating
activity. However, Ind AS 7 requires it to be classified as a part of
financing activity only
✓ Different terminology is used in Ind AS 7, e.g., the term ‘balance sheet’ is
used instead of ‘Statement of financial position’ and ‘Statement of profit
and loss’ is used instead of ‘Statement of comprehensive income’
Comparison with IAS 7 and Ind AS 7 (Contd…)
➢ Paragraph 2 of IAS 7 which states that IAS 7 supersedes the earlier
version IAS 7 is deleted in Ind AS 7 as this is not relevant in Ind AS 7.
However, paragraph number 2 is retained in Ind AS 7 to maintain
consistency with paragraph numbers of IAS 7
➢ The following paragraph numbers appear as ‘Deleted ‘in IAS 7. In order to
maintain consistency with paragraph numbers of IAS 7, the paragraph
numbers are retained in Ind AS 7:
(i) paragraph 29
(ii) paragraph 30
Illustration I
➢ TheC & Co. reported net profit for the year ended on March 31, 2021, at
INR 100,000. It recognized income tax expense at INR 20,000.
Depreciation for the year was recognized at INR 10,000. During the year
trade receivables increased by INR 2,000, inventories reduced by INR
3,000, prepaid rent decreased by 1,000, accounts payable increased by
INR 3000, and income tax payable decreased by INR 500.
Required:
Calculate cash flows from operating activities using the indirect method.
Solution
Illustration II
Solution
Free Cash Flow (FCF)
• Free Cash Flow (FCF) is the cash left over after a company pays for its operating expenses
and capital expenditures (CAPEX)
• Free cash flow is an important measurement since it shows how efficient a company is at
generating cash
• Investors use free cash flow to measure whether a company might have enough cash, after
funding operations and capital expenditures, to pay investors through dividends and share
buybacks
• Free cash flow is defined as follows:
FCF = Operating Cash Flow – Capital Expenditures
OR
FCF = NOPAT – Net investment in operating capital
OR
FCF = (NOPAT + Depreciation) – Gross investment in operating capital
where, NOPAT is the profit a company would generate if it had no debt and no excess
liquidity
Free Cash Flow (FCF)(contd…)
• FCF is an important measure because it allows a company to pursue opportunities
that enhance shareholder value. Excess cash can expand production, develop new
products, make acquisitions, pay dividends and reduce debt
• As FCF increases, balance sheet strength and health rises; however, it is
important to note that negative FCF is not a bad indicator
• If FCF is negative, it could be a sign a company is making significant investments.
If these investments earn high returns, the strategy has the potential to add value
in the long run
• Rapidly growing firms do have negative cash flows as they require external
infusion of funds to support growth
• To determine whether growth is profitable we examine the return on invested
capital (ROIC) and compare it with the weighted average cost of capital (WACC)
ROIC = NOPAT / Operating Capital
Free Cash Flow (FCF)(contd…)
• To calculate free cash flow another way,
✓ Locate the income statement and balance sheet
✓ Start with net income and add back charges for depreciation and
amortization
✓ Make an additional adjustment for changes in working capital, which is done
by subtracting current liabilities from current assets
✓ Then subtract capital expenditure (or spending on plants and equipment):
Net Income
+ Depreciation/Amortization
– Change in Working Capital
– Capital Expenditure
= Free Cash Flow
Free Cash Flow (FCF)(contd…)
• It's important to note that an exceedingly high FCF might be an indication
that a company is not investing in its business properly, such as updating its
plant and equipment
• Conversely, negative FCF might not necessarily mean a company is in
financial trouble, but rather, investing heavily in expanding its market
share, which would likely lead to future growth
• Value investors often look for companies with high or improving cash flows
but with undervalued share prices
• Rising cash flow is often seen as an indicator that future growth is likely
Net Operating Profit After Taxes (NOPAT)
• NOPAT is the profit a company would generate if it had no debt and no
excess liquidity
NOPAT = (PBT + Interest – Other Income) (1 – Tax Rate)
Operating Assets and Net Operating Capital
• Operating assets consist of assets necessary to operate the business
• Operating assets may be further divided into long-term operating assets (such as
plant and equipments) and operating current assets (such as inventories,
receivables and so on)
• The difference between operating current assets and operating current liabilities
is called net operating working capital
• Non-operating assets consist of assets such as surplus land, excess cash and
investment in subsidiaries
• By definition,
➢ Net Operating Capital = Long-term Operating Assets + Net Operating
Working Capital
➢ Net Operating Working Capital = Operating Currents Assets – Operating
Current Liabilities
Uses of Free Cash Flow (FCF)
• FCF can be used for,
➢Interest payment on debt

➢Repayment of debt

➢Dividend payment on equity

➢Share buyback

➢Purchase of marketable securities and other non-operating assets

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