SYBMS Chpt: CASH FLOW ANALYSIS SEMESTER – III

Introduction:
A Balance Sheet of any entity is a status of assets and liabilities as on a particular date and hence
referred to as a ‘snapshot’ view of the status of the entity’s funds at one instant of time. Asset
side of the balance sheet shows the uses of those funds which would be invested in land and
building, plant and machinery, inventories etc. Income statement or a profitability statement can
also be termed as a flow statement since it explains changes that occurred in the profit and loss
account during the given period. However, this income statement does not provide information
about cash flows associated with the operations of the company. Hence, a separate statement is
prepared called ‘cash flow statement’, for the benefit of the readers/users of the financial
statements. In this statement the ‘Cash and cash equivalent ‘is considered to be a ‘Fund’.
Financial Statement Analysis:
Financial Statement Analysis is the process of identifying the financial strength and weaknesses
of a firm, from the available accounting data and financial statements. The analysis is done by
properly establishing the relationship between the items of balance sheet and profit and loss
account. Thus, the financial analysis is the process of selecting, relating and evaluation of the
accounting data or information.
Purpose of Financial Statement Analysis:
The following are the purposes of financial statement analysis –
1. Prospective investors who are desirous to know the actual and forecasted yield data.
2. The government is interested to know the comparative energy consumption of various types
of companies.
3. A bank may be keen to know the possible debt coverage out of profit at the time of lending
4. Customers also want to know the business viability before entering into a long-term contract.
5. The purpose of financial statement analysis is to aid decision making by the users of financial
statements.
Procedure of Financial Statement Analysis:
The following are the steps to be taken for making financial statement analysis:
1. Identification of the user’s purpose.
2. Identification of data source from the financial statement.
3. Selecting the techniques to be used for such analysis.
Types of Financial Statement Analysis:
The main objective of financial analysis is to determine the financial health of a business
enterprise. Thus, the following are the different types of financial statement analysis:
1. External Analysis: The analysis performed by outside parties is known as external Analysis
For example, creditors, investors, suppliers of long term debt etc.

2. Internal Analysis: The analysis performed by corporate finance and accounting departments
is known as internal analysis. It is more in detail as compared to external analysis. For example,
Financial Analysis by Financial Manager, management Account, Recovery Department, etc.
3. Horizontal Analysis: When analysis is made comparing financial statements of previous
years along with current year, it is known as horizontal analysis.
4. Vertical Analysis: This is an analysis of financial statement which converts each element of
the information into a percentage of the total amount of statement so as to establish relationship
with other components of the same statement.
5. Trend Analysis: It is an analysis which compares ratios of different components of the
financial statement, related to different period to those of a base year.
6. Ratio Analysis: Ratio Analysis is the establishment of numerical or quantitative relationship
between two items of financial statement.
7. Funds Flow Statements: This analysis provides a comprehensive idea about the movement
of finance in a business unit during a particular period.
Tools of Financial Statement Analysis:
Financial management includes financing investment and dividend policy decisions. In the area
of financing, there are various methods to procure funds. The finance manager has to use various
techniques and methods of capital budgeting. Thus, there are variety of methods and techniques
of financial analysis which are known as tools of financial statement analysis. The following are
the important tools of financial statement analysis.
1. Ratio Analysis
2. Cash Flow Analysis.
3. Comparative Financial Statement.
4. Common size Financial Statement.
5. Trend Analysis etc.
Meaning of Cash Flow Statement
Cash Flow Statement summarises the changes in the amount of cash for a particulars period. It
indicates the sources from which cash was obtained and the uses to which cash was put. It
concentrates only on the movement of cash, the inflows and outflows of cash. It shows the
receipts of cash from various sources and the payment of cash for various purposes during a
particular period.
AS 3: Accounting Standard 3, Cash Flow Statements issued by the Institute of Chartered
Accountants of India deals with various aspects of cash flow. ICAI has recommended that AS3
should be used by listed companies and other large concerns. Securities and Exchange Board of
India has made it compulsory for listed companies to attach the Cash Flow Statement to their
annul accounts. The Institute of Cost and Works Accountant of India has defined cash flow
statement as
“ A statement setting out the flow of cash under distinct heads of sources of funds and their
utilisation to determining the requirements of cash during the given period and to prepare
for its adequate provision”.
Objectives of Cash Flow Statement:
The following are the objectives of preparing cash flow statement.
1. To plan for optimum utilisation of funds and avoid the situations leading to idle cash or
shortage of cash.
2. To ensure timely payment of dividend and tax and other major cash transactions.
3. To exhibit in right perspective the company’s ability to meet demand of trade creditors and
bank loan etc.
4. To disclose the reasons that lead to movement of cash balances
Difference between Cash Flow and Funds Flow Statement
The following are the points of difference between a Cash Flow Statement and a Fund Flow
Analysis.
1. A cash flow statement is concerned only with the change in cash position while a funds flow
statement is concerned with change in working capital position between two balance sheet dates.
2. A cash flow statement is merely a record of cash receipt and disbursements.
3. Cash Flow Analysis is more useful to the management as a tool of financial analysis in short
period as compared to funds flow statement.
4. Inflow of cash results in inflow of funds but inflow of funds may not necessarily result in
inflow of cash.
Classification of Cash Flow
AS 3 Prescribes that cash flow should be classified into those arising out of
1. An operating activity 2. Investing activity or 3. Financing activity.
1. Cash Flow from Operating Activities
(1) Meaning: AS 3 defines operating Activities as the principal revenue –producing activities of
the enterprise. These activities determine the net profit or loss of a concern. Operating Activities
refer to the operations of business of purchase, sale etc. Sales generate cash; and purchases and
expenses use up the Cash. Net Profits lead to net increase in cash. Net increase in Cash from
operating activities is the main source of cash inflow.
(2) Inflows: Cash inflow from operating activities should be shown in the Cash Flow Statement
under the following heads:
(i) Cash receipt from sale of goods;
(ii) Cash receipts from rendering of services;
(iii) Cash receipts from royalties, fees, commissions etc;
(iv) Refund of income –tax.
(3) Outflow: Cash outflow from operating activities should be shown in the Cash Flow
Statement under the following heads:
(i) Cash payments to suppliers for goods and services (i.e. purchases and expenses);
(ii) Cash payments to employees;
(iii)Cash payments of income –taxes (except taxes arising out of investing or financing
activities).
2. Cash Flow from Investing Activities
(1) Meaning: AS 3 defines Investing Activities as the acquisition and disposal of long term
assets and investments. Acquiring and selling of a subsidiary or other concern should be shown
as Investing Activity. Investing Activities of acquisition of fixed assets, long term investments
reduce the cash and indicate cash outflow. Investing activities of disposal (sale) of fixed assets
etc. increase the cash inflow.
(2) Inflows: Cash inflows from investing activities should be shown in the CFS under the
following heads:
(i) Cash receipts from sale of fixed assets or intangible assets;
(ii) Cash receipts from sale of investments;
(iii) Cash received from repayments of advances or loans made to outsiders.
(3) Outflows: Cash outflows from investing activities should be shown in the CFS under the
following heads:
(i) Cash payments to purchase fixed assets (building, machinery etc)
(ii) Cash payments to acquire intangible assets (goodwill, patents etc)
(iii)Cash advances and loans made to outsiders;
(iv) Cash payments for purchase of investments.
3. Cash Flow from Financing Activities
(1) Meaning: AS 3 defines Financing Activities as the activities resulting in changes in the size
and composition of the owner’s capital and borrowings of the enterprise. Owner’s capital
includes Preference capital in case of a company. Financing Activities such as issue of shares,
taking a loan from Bank, sale of fixed assets etc. increase the amount of cash available and form
the source of cash inflow. Financing Activities such as repayment of preference capital or
repayment of loan reduce the amount of cash and indicate cash outflow.
(2) Inflows: Cash inflows from financing activities should be shown in the CFS under the
following heads:
(i) Cash received from issue of shares etc;
(ii) Cash received from issue of debentures, loans, bonds and other long term borrowings.
(3) Outflows: Cash outflows from financing activities should be shown in the CFS under the
following heads:
(i) Repayment of amounts borrowed;
(ii)Redemption of preference shares etc.
Distinguish between Operating, Investing & Financing
Operating Investing Financing
Types of Cash related to the day to Cash relating to Cash receipts and
Transactions day activities of running buying & selling disbursements related
the business revenue and assets that the firm to loans (principal
expense transactions. plans to use for longeronly) cash
than one year contributions from and
distributions to
owners.
Inflows Cash collection from Cash from sale of land Cash from issue of
customers. & buildings. Shares/ Debentures.
Outflows Cash paid to suppliers for Cash paid for purchase Cash dividend paid to
purchases. of land & buildings. the shareholders.
Cash flows Current assets and current Long –term assets. Long-term liabilities
related to liabilities and shareholder’s
equity.
Benefits of Cash flow Statement:
Cash flow statement is an important technique for short –term financial planning and analysis. It
has the following benefits:
1. Efficient Cash Management: The most important function of management is to manage the
cash resources in such a way that adequate cash is available for meeting the expenses. It helps to
plan and co-ordinate the financial operations of the business.
2. Internal Financial Management: It provides a clear picture of cash flows from operations.
Therefore, it is very useful for internal financial management.
3. Knowledge of changes in cash position: It enables the management to know about the
causes of changes in cash position. The finance manager can explain the relationship between
profit and cash balance.
4. Success or failure of Cash Planning: Comparison of actual and budgeted cash flow
statement helps the management to know the success or failure in cash management.
5. Projected Cash Flow: Projected Cash Flow statement helps to know the projected cash
inflows and cash outflows.
6. Supplemental to Fund Flow Statement: Cash Flow analysis supplements the fund flow
analysis as cash is a part of fund.
7. Tool of Analysis: Cash Flow analysis is certainly a better tool of analysis than the fund flow
analysis for short-term decisions.
Limitations of Cash Flow Analysis:
Cash Flow statement suffers from the following limitations:
1. Misleading Inter- Industry Comparison: Cash flow statement does not measure the
economic efficiency of one company in relation to another company. Hence, interindustry
comparison of cash flows may be misleading.

2. Misleading Inter- Firm Comparison: The terms and conditions of purchases and sales of
different firms may not be the same. Hence, inter-firm comparison becomes misleading.

3. Influence of Management Policies: Management Policies influence the cash easily by

making certain payments in advance or by postponing certain payments.

4. Cannot be equated with Income Statement: Cash flow statement cannot be equated with
income statement. Hence, net cash flow does not mean income of the business.

5. Not a substitute to other statements: Cash flow statement cannot be a substitute to other
statements viz. Fund Flow Statement and Balance Sheet.

Other Items
1. Interest and Dividends:
(1) Separate Disclosure: Cash flows from interest and dividends paid or received should be
shown separately in the Cash Flow Statement.
(2) Interest Paid: Interest paid should be shown as cash outflow from financing activity. Total
interest paid including interest treated as expense or capitalized as fixed assets as per AS10,
should be shown as cash outflow from financing activity.
(3) Interest/ Dividend Received: Interest and Dividend Received should be shown as cash
inflow from investing activities.
(4) Dividend Paid: Dividend Paid should be shown as cash outflow from financing activities.
This is because dividends paid indicate the cost of obtaining funds.
2. Income Tax:
(1) Separate Disclosure: Cash flows arising from taxes on income should be shown separately
in the Cash Flow Statement.
(2) From Operating Activities: Such cash flows should be normally classified as cash flows
from operating activities. Tax arising out of investing activity e.g. tax on capital gains on sale of
fixed assets should be shown as cash flow from investing activities.
3. Foreign Currency Cash Flows:
These flows should be recorded in the organisation’s reporting currency by applying the
exchange rate at the date of cash flows. The effect of changes in the exchange rate on cash and
cash equivalents held in a foreign currency should be reported as a separate item as a part of
reconciliation of the changes in the ‘cash funds’ during the period under consideration.
4. Non- Cash Transactions:
Investing and financing transactions that do not require cash are excluded from a cash flow
statement. These transactions do not have a direct impact on current cash flow though they affect
the capital and assets of the enterprise. Non cash transactions include the purchase of assets by
issue of shares and debentures, conversion of debentures into shares and so on. These
transactions are shown as a footnote to the Cash Flow Statement.
5. Cash and Cash Equivalents:
1. Cash Equivalents 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.
2. Cash Equivalents are held for the purpose of meeting short-term cash commitments rather
than for investment or other purposes.
3. An investment normally qualifies as a cash equivalent only when it has a short maturity of
three months or less than that from the date of acquisition.
4. Cash Flows are inflows as well as outflows of cash and cash equivalents.
5. Cash Flows exclude movements between items that constitute cash or cash equivalents.
 Format of Cash Flow Statement as per AS-3
Particulars (₹ in (₹ in
Lakhs ) Lakhs )

(I) Cash From Operating Activities :

(i) Net profit
(ii) Adjustment for Non-Cash items and Profit & Loss A/c
items
Add: All Debit side items
Less: All Credit side items
Profit before Working Capital changes
(iii) Adjustment for Working Capital Changes
Add: Decrease in working capital
Less: Increase in working capital

Cash Flow Operations:

Less: Income tax paid
Net Cash From Operating Activities (I)

(II) Cash From Investing Activities

Purchase & Sale of Fixed Assets
Purchase & Sale of Investment
Dividend Received
Net Cash From Investing Activities (II)

(III) Cash From Financing Activities

Issue and Redemption of shares
Issue and Redemption of Debentures
Raising of Loans
Repayment of Loans
Interest & Dividend Paid
Net Cash From Financing Activities (III)

Net Increase/Decrease in cash and cash equivalent (I +II+III)

Opening Balance:
Cash
Bank
Closing Balance:
Cash
Bank