Cash Flow Statement

Cash Flow Statement

The balance sheet and income statement reflect the accrual based accounting to match the revenues and associated the expenses. These statement gives detail about the profit based this but does not gives information about the firm's liquidity and other information that can help investors in forecasting the change in assets/liabilities, break-even etc.

The cash flow statement reconcile accrual based accounting (i.e. balance sheet & income statement) with the inflows & outflows of the cash to and from an organization due to various transactions in a given accounting period. It helps in assessing the ability of a company to generate cash & cash equivalents and to utilize the same. It helps to assessing the liquidity and solvency of the entity.

Basic elements of Cash Flow Statement

Cash flow statement has three basic elements:

1. Cash flows from Operating Activities (CFO) - It focuses on principal revenue producing activities of the company

2. Cash flows from Investing Activities (CFI) – It focuses on acquisition and disposal of long term assets and investments (other than those considered in cash equivalents). It also includes investments made by business entities in other company’s shares and debentures.

3. Cash flow from Financing Activities (CFF) – It focuses on activities that result in change in size and composition of owners’ equity and borrowings of the company

Methods of generating Cash Flow Statement

There are two methods of calculating the Cash Flow Statement

1. Direct method – In the direct method all the cash inflows and outflows are collated to compute the net cash increase or decrease in the company’s account. With this method all the cash major classes of gross cash receipts and gross cash payments are disclosed and changes that cash transactions cause in revenue & expense accounts are analysed.

2. Indirect method - The Income Statement is adjusted for the effects of transactions of non-cash and non-operating nature. It is also referred as “Reconciliation to Net Income”

Indirect method 

  a. Start with PBT from Income Statement

  b. Add non-cash expenses i.e. depreciations, amortization, provisions for liabilities

  c. Adjust for non-operating activities i.e.

     » Add non-operating expenses - Interest costs and other non-operating expenses
     » Deduct non-operating income
     » Deduct non-recurring income
     » Deduct actual cash tax paid

  d. Working capital adjustments i.e. changes in current assets and current liabilities (other than cash and cash equivalents)

  e. Cash flow from operating activities (d + e)

  f. Cash flow from investing activities

  g. Cash flow from financing activities

  h. Net cash flow (e + f + g)

 Refer following image for calculations using indirect method.

 Things to remember:

1. US GAAP start with net income whereas Indian GAAP start with PBT

2. Interest on loan comes under CFO in US GAAP whereas in Indian GAAP it comes under CFF