Understanding Cash Flow

Statements
Learning Outcomes
• Compare cash flows from operating, investing, and financing activities and
classify cash flow items as relating to one of those three categories given a
description of the items
• Describe how non-cash investing and financing activities are reported
• Distinguish between the direct and indirect methods of presenting cash
from operating activities and describe arguments in favor of each method
• Describe how the cash flow statement is linked to the income statement
and the balance sheet
• Analyze and interpret both reported and common-size cash flow
statements
Few Questions and discussion
• What is a cash flow statement?
• What is the difference between information provided by cash flow
statement and income statement?
• This information allows the analyst to answer such questions as:
• Does the company generate enough cash from its operations to pay for its
new investments, or is the company relying on new debt issuance to
finance them?
• Does the company pay its dividends to common stockholders using cash
generated from operations, from selling assets, or from issuing debt?
• What are the components of cash flow statement?
• What are the methods of preparing cash flow statement?
Classification of Cash Flows and Non-cash
Activities – Operating Activities
• What does operating activities include?
• Cash inflows result from cash sales and from collection of accounts
receivable.
• Also cash receipts from the provision of services and royalties,
commissions, and other revenue.
• Cash outflows result from cash payments for inventory, salaries, taxes,
and other operating-related expenses and from paying accounts
payable.
Classification of Cash Flows and Non-cash
Activities – Investing Activities
• What does investing activities include?
• Investing activities include purchasing and selling long-term assets and
other investments. E.g., property, plant, and equipment; intangible assets.
• Both long-term and short-term investments in the equity and debt (bonds
and loans) issued by other companies.
• Cash inflows in the investing category include cash receipts from the sale of
non-trading securities; property, plant, and equipment; intangibles; and
other long-term assets.
• Cash outflows include cash payments for the purchase of these assets.
Classification of Cash Flows and Non-cash
Activities – Financing Activities
• What does financing activities include?
• Financing activities include obtaining or repaying capital, such as
equity and long-term debt.
• The two primary sources of capital are shareholders and creditors.
Cash inflows in this category include cash receipts from issuing stock
(common or preferred) or bonds and cash receipts from borrowing.
• Cash outflows include cash payments to repurchase stock (e.g.,
treasury stock) and to repay bonds and other borrowings.
• Under which activity is indirect borrowing using accounts payable
considered?
EXAMPLE
• A company recorded the following in Year 1:
• Proceeds from issuance of long-term debt Rs. 300,000
• Purchase of equipment Rs. 200,000
• Loss on sale of equipment Rs. 70,000
• Proceeds from sale of equipment Rs. 120,000
• Equity in earnings of affiliate Rs. 10,000
• On the Year 1 statement of cash flows, how much would the company
report as net cash flow from investing activities?
Interest paid and received – Ind AS 7
• As per Ind AS 7 financial institution interest paid and received would
normally be classified as 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.
Interest paid and received – IFRS
Topic IFRS
Classification of cash flows:

•Interest received Operating or investing

•Interest paid Operating or financing
•Dividends received Operating or investing
•Dividends paid Operating or financing
•Bank overdrafts Considered part of cash equivalents

•Taxes paid Generally operating, but a portion can

be allocated to investing or financing if
it can be specifically identified with
these categories

Format of statement Direct or indirect; direct is encouraged

Question
• If a company exchanges one non-monetary asset for another non-
monetary asset or when a company issues common stock either for
dividends or in connection with conversion of a convertible bond or
convertible preferred stock. Where in cashflow statement will these
two appear?
Cash Flow Statement: Direct and Indirect Methods
for Reporting Cash Flow from Operating Activities
• What are the two acceptable formats for reporting cash flow from
operating activities?
• What is the difference in the methods?
• Only the presentation format of the operating cash flow section differs.
The presentation format of the cash flows from investing and financing is
exactly the same, regardless of which method is used to present operating
cash flows.
• What is the primary argument in favour of direct method?
• What is the primary argument in favour of indirect method?
• Which method is preferred by the analysts?
• What about presentation of cash flows from investing and financing ?
Cash Flow Statement: Ind As 7
• The standard gives an option to the entity in presentation of
operating activities i.e., it can present either in direct method or
indirect method.
• The standard encourages direct method.
Cash Flow Statement: Ind As 7
Direct Method
• Under the direct method, the entity gives information about major
classes of
• Gross cash receipts; and
• Gross cash payments.
• Gross cash receipts or payments of the entity can be obtained from
either
• Cash/bank book;
• Alternatively non-cash and non operating items (i.e., investing or
financing items) can be eliminated from P&L statement
Cash Flow Statement: Ind As 7
The format of cash flows from operating activities under direct method:
Cash Flow Statement: Ind As 7
Indirect Method
• Under this method, the net cash flows from operating activities are
determined by adjusting (add/less) profit or loss before tax and before
extraordinary/exceptional items with:
• Non-cash items such as depreciation, provisions, goodwill written off, etc.
• Non-operating items i.e., investing or financing items which are considered
in calculation of profit or loss before tax – such as interest receipt or
payment, dividend receipt in case of non-financing entity, etc.
• Changes in inventories and operating receivables and payables;
• Actual income tax payment;
• Receipts/payments from extraordinary/exceptional items.
Cash Flow Statement: Ind As 7
Format of cash flows from operating activities under indirect method:

Page 282 HUL

Some observations from HUL Cashflow
statement
• Beginning first at the bottom of the statement, we note that cash decreased from
Rs 1,842 crores at the beginning of 2022 to Rs 701 crores at the end of 2023.
• To understand the changes, we next examine the sections of the statement.
• In each year, the primary cash inflow derived from operating activities, as would
be expected for a mature company in a relatively stable industry.
• In each year, the operating cash flow was less than the reported net profit,
something not expected from a mature company, with the largest differences
primarily arising from the add-back of depreciation.
• In each year, the operating cash flow was more than enough to cover the
company’s capital expenditures. In 2023, the company generated Rs 9,991 crores
in net cash from operating activities and—as shown in the investing section—
spent Rs 1,174 crores on property, plant, and equipment. The operating cash flow
was also sufficient to cover joint ventures and intangible assets.
• The company returned cash to its equity investors through dividends in each year.
Linkages of Cash Flow Statement with the
Income Statement and Balance Sheet
Balance sheet and Cash flow statement

1. The beginning and ending balance sheet values of cash and cash equivalents are linked
through the cash flow statement.

Beginning Balance Sheet Statement of Cash Flows for Year Ended 31 March Ending Balance Sheet at 31
at 1 April 20XX 20XX March 20X1
Beginning cash Plus: Cash receipts (from Less: Cash payments (for Ending cash
operating, investing, and operating, investing, and
financing activities) financing activities)
Linkages of Cash Flow Statement with the Income
Statement and Balance Sheet
• The current assets and current liabilities sections of the balance sheet
typically reflect a company’s operating decisions and activities.
• Because a company’s operating activities are reported on an accrual
basis in the income statement, any differences between the accrual
basis and the cash basis of accounting for an operating transaction
result in an increase or decrease in some (usually) short-term asset or
liability on the balance sheet.
• For example, if revenue reported using accrual accounting is higher
than the cash actually collected, the result will typically be an
increase in accounts receivable.
• If expenses reported using accrual accounting are lower than cash
actually paid, the result will typically be a decrease in accounts.
Linkages of Cash Flow Statement with the Income Statement and Balance Sheet
• As an example of how items on the balance sheet are related to the income statement
and/or cash flow statement through the change in the beginning and ending balances,
consider accounts receivable:
Statement of Cash Flows
Beginning Balance Sheet Income Statement for Year for Year Ended 31 March Ending Balance Sheet
at 1 April 20XX Ended 31 March 20X1 20X1 at 31 March 20X1
Beginning accounts Plus: Revenues Minus: Cash collected from Equals: Ending accounts
receivable customers receivable

• Knowing any three of these four items makes it easy to compute the fourth. For
example, if you know beginning accounts receivable, revenues, and cash collected
from customers, you can compute ending accounts receivable.
• Understanding the interrelationships among the balance sheet, income statement,
and cash flow statement is useful not only in evaluating the company’s financial
health but also in detecting accounting irregularities.
Cash Flow Statement Analysis
• Evaluation of the cash flow statement should involve an overall
assessment of the sources and uses of cash between the three main
categories as well as an assessment of the main drivers of cash flow
within each category, as follows:

• Evaluate where the major sources and uses of cash flow are between
operating, investing, and financing activities.\
• Evaluate the primary determinants of operating cash flow.
• Evaluate the primary determinants of investing cash flow.
• Evaluate the primary determinants of financing cash flow.
Cash Flow Statement Analysis
• What are the major sources and uses of cash flow?
• Growth vs mature company
• Is operating cash flow positive and sufficient to cover capital expenditures?
• What are the major determinants of operating cash flow?
• Is operating cash flow higher or lower than net income? Why?
• How consistent are operating cash flows?
• Why each line item in investing activity is important?
• What are the sources of investing activities?
• Why assets are sold?
• What are the sources of finances for the company?
• How much is the repayment? Debt schedule and dividend/share repurchase.
Common-Size Analysis of the Statement of
Cash Flows
• For the common-size cash flow statement, there are two alternative
approaches.
• The first approach is to express each line item of cash inflow (outflow)
as a percentage of total inflows (outflows) of cash, and
• the second approach is to express each line item as a percentage of
net revenue.
Caselet and last question
Conversion of Cash Flows from the Indirect to the Direct Method
Step 1 Total revenues 60,580
Aggregate all revenue and all expenses Total expenses 47,682
Net income 10,144

Step 2 Total revenue less noncash item

Remove all noncash items from revenues:
aggregated revenues and expenses and 60,580
break out remaining items into relevant Revenue 60,580
cash flow items
Total expenses less noncash item
expenses:
(47,682 46,545
– 1,137) =
Total 46,545

a
Step 3 Cash received from customers $59,737
b
Convert accrual amounts to cash flow Cash paid to suppliers (11,900)
amounts by adjusting for working capital Cash paid to employeesc (4,113)
changes d
Cash paid for other operating expenses (3,532)
e
Cash paid for interest (258)
f
Cash paid for income tax (1,134)
Net cash provided by operating activities $2,606
• Revenue less increase in accounts receivable
• Cost of goods sold plus increase in inventory less increase in accounts
payable.
• Salary and wage expense less increase in salary and wage payable.
• Other operating expenses of $3,577 less decrease in prepaid expenses of
$23 less increase in other accrued liabilities of $22.

• e Interest expense of $246 plus decrease in interest payable of $12.

• f Income tax expense of $1,139 less increase in income tax payable of $5.