How To Prepare Cash Flow Statement?

As prescribed by the Accounting standard -3, there are two methods which can be used to prepare cash flow statements:

• Indirect method
• Direct method

Whichever method be used, the end result under all three activities i.e. operating, investing and financing will be the same.

Preparation under Indirect method

Operating Activities

The cash flow from operating activities are derived under two stages;

• Calculating the operating profit before changes in working capital
• The effect of changes in working capital

Stage 1: Operating profit before changes in working capital can be calculated as follows:

Net profit before Tax and extra ordinary Items	xxx
Add: Non-cash and non-operating Items which have already been debited to profit and Loss Account like;
Depreciation	xxx
Amortisation of intangible assets	xxx
Loss on the sale of Fixed assets	xxx
Loss on the sale of Long-term Investments	xxx
Provision for tax	xxx
Dividend paid	xxx	xxx
Less: Non-cash and Non-operating Items which have already been credited to Profit and Loss Account like
Profit on sale of fixed assets	xxx
Profit on sale of Long term investment	xxx	xxx
Operating profit before working Capital changes		xxx

Stage 2: Effect of changes in Working Capital is to be taken into as follows:

• Current Assets
  • An increase in an item of current assets causes a decrease in cash inflow because cash is blocked in current assets
  • A decrease in an item of current assets causes an increase in cash inflow because cash is released from the sale of current assets
• Current Liabilities
  • An increase in an item of current liability causes a decrease in cash outflow because cash is saved
  • A decrease in an item of current liability causes an increase in cash outflow because of payment of the liability

Thus, in a nutshell

Cash from operating activities = Operating profit before working capital changes + Net decrease in current assets + Net Increase in current liabilities – Net increase in current assets – Net decrease in current liabilities

Investing Activities

The cash flow from investing activities is derived by adding all the cash inflows from the sale or maturity of assets and subtracting all the cash outflows from the purchase or payment for new fixed assets or investments.

Cash flow arising from Investing activities typically are:

• Cash payments to acquire Fixed Asset
• Cash receipts from disposal of fixed asset
• Cash payments to acquire shares or debenture investment
• Cash receipts from the repayment of advances and loans made to third parties

Furthermore, Examples of Cash inflow from investing activities are:

• Cash sale of plant and machinery, land and Building, furniture, goodwill etc
• Cash sale of investments made in the shares and debentures of other companies

Cash receipts from collecting the Principal amount of loans made to third parties

Examples of Cash outflow from investing activities are:

• Purchase of fixed assets i.e. land, Building, furniture, machinery etc
• Purchase of Intangible assets i.e. goodwill, trademark etc
• Purchase of shares and debentures
• Purchase of Government Bonds
• Loan made to third parties

Financing activities

Cash flows from financing activities are the cash paid and received from activities with non-current or long-term liabilities and shareholder’s capital.

Cash flow arising from Financing activities typically are:

• Cash proceeds from the issue of shares or other similar instruments
• Cash proceeds from the issue of debentures, loans, notes, bonds, and other short-term borrowings
• Cash repayment of the amount borrowed

Examples of cash inflow from financing activities are:

• The issue of Equity and preference share capital for cash only
• The issue of Debentures, Bonds and long-term note for cash only

Examples of cash outflow from financing activities are:

• Payment of dividends to shareholders
• Redemption or repayment of loans i.e. debentures and bonds
• Redemption of preference share capital
• Buyback of equity shares

Illustration of Indirect method:
Net profit before Tax and extra ordinary Items	xxx
Cash flow from Operating activities
Add: Non-cash and non-operating Items which have already been debited to profit and Loss Account like;
Depreciation	xxx
Amortisation of intangible assets	xxx
Loss on the sale of Fixed assets	xxx
Loss on the sale of Long-term Investments	xxx
Provision for tax	xxx
Dividend paid	xxx	xxx
Less: Non-cash and Non-operating Items which have already been credited to Profit and Loss Account like
Profit on sale of fixed assets	(xxx)
Profit on sale of Long term investment	(xxx)	(xxx)
Operating profit before working Capital changes (A)		xxx
Changes in working capital:
Add: Increase in current liabilities	xxx
Decrease in current assets	xxx	xxx
Less: Increase in current assets	(xxx)
Decrease in current liabilities	(xxx)	(xxx)
Net increase / decrease in working capital (B)		xxx
Cash generated from operations (C) = (A+B)		xxx
Less: Income tax paid (Net tax refund received) (D)		(xxx)
Cash flow from before extraordinary items (C-D) = (E)		xxx
Adjusted extraordinary items (+/–) (F)		xxx
Net cash flow from operating activities (E+F) = (G)		xxx
Cash flow from Investing activities
Proceeds from sale of fixed assets	xxx
Proceeds from sale of investments	xxx
Purchase of shares/debentures/fixed assets	(xxx)
Net cash from investing activities (H)		xxx
Cash flow from Financing activities
Proceeds from issue of shares	xxx
Proceeds from issue of debentures	xxx
Payment of dividend	(xxx)
Net cash flow from financing activities (I)		xxx
Net increase in cash and cash equivalents (G+H+I) = (J)		xxx
Cash and cash equivalents and the beginning of the period (K)		xxx
Cash and cash equivalents and the end of the period (J+K)		xxx

Preparation under the Direct method

The fundamentals of preparation of cash flow statement under Direct method is more or less same as in Indirect method with only a few exceptions in terms of its presentation.

Illustration of an Indirect method

The Cash flow statement under Direct method is prepared as follows:

Cash flow from Operating activities
Add: Operating cash receipts: (A)
Cash sales	xxx
Cash received from customers	xxx
Trading commission received	xxx
Royalties received	xxx	xxx
Less: Operating cash payments: (B)
Cash purchase	(xxx)
Cash paid to suppliers	(xxx)
Cash paid for business expenses	(xxx)	(xxx)
Cash generated from operations (A-B) = (C)		xxx
Less: Income tax paid (Net of tax refund received) (D)		(xxx)
Cash flow before extraordinary items (C-D) = (E)		xxx
Adjusted extraordinary items (+/–) (F)		xxx
Net cash flow from operating activities (E-F) = (G)		xxx
Cash flow from investing activities (calculation same as under indirect method) (H)		xxx
Cash flow from financing activities (calculation same as under indirect method) (I)		xxx
Net increase in cash and cash equivalents (G+H+I) = (J)		xxx
Cash and cash equivalents and the beginning of the period (K)		xxx
Cash and cash equivalents and the end of the period (J+K)		xxx