Cash Flow Statement Introduction

 INTRODUCTION

Accounting Standard 3, Cash Flow Statements, was issued in March, 2004. This revised

Accounting Standard super seeded the Accounting Standard (AS 3) on changes in Financial

Position, issued in June 1981.

Cash flow statement provides information about the changes in cash and cash equivalents of

an enterprise. Cash flow statement is based on cash concept of profit. Cash flow statement

seems to be useful because it identifies cash generated from trading operations, the operating

cash surplus which can be applied for investment in fixed assets. In fact a portion of cash from

operations is used to pay dividend and tax and the other portion is ploughed back. What can

be ploughed back is directly identifiable from cash flow statement. In projected form, this

statement is a very useful tool of planning.

Cash flow statements are prepared to explain the cash movements between two points of

time.

Sources of Cash:

1. Issue of shares and debentures and raising long-term loan.

2. Sale of investments and other fixed assets.

3. Cash from operations.

4. Decrease in Cash.

Applications of Cash:

1. Redemption of preference shares and debentures and repayment of long-term loan. 

2. Purchase of investments and other fixed assets.

3. Payment of tax.

4. Payment of dividend.

5. Increase in cash.

Increase in cash or decrease in cash is put in the applications and the sources respectively

just to balance the cash flow statement. At this juncture students may note that in cash flow

statement changes in all balance sheet items are to be taken into consideration separately for

explaining movement of cash.

2.2 ELEMENTS OF CASH FUND

As per AS 3, issued by the Council of the ICAI, ‘Cash Funds’ include:

(i) Cash in hand,

(ii) Demand deposits with banks, and

(iii) Cash equivalents.

Cash equivalents which are considered as part of funds for calculation of cash flows are defined as

‘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”. Basic objective of acquisition of

cash equivalents is to deploy, for a short period, idle cash required to meet short-term cashcommitments. Securities with short maturity period of, say, three months or less from the date of

acquisition qualify as a cash equivalent. Examples are: acquisition of preference shares, shortly

before their specified redemption date, bank deposits with short maturity period, etc. Thus, cash

flow statement deals with flow of cash funds but does not consider the movements among cash,

bank balance payable on demand and investment of excess cash in cash equivalents. Examples

are cash withdrawn from current account, cash deposited in bank for 60 days, etc.

2.3 CLASSIFICATION OF CASH FLOW ACTIVITIES

Transactions, which increase cash, are classified as cash inflow and transactions which

decrease cash are classified as cash outflow. Thus, cash flow statement provides explanation

for changes in cash position of the business entity. Accounting Standard issued by the

Institute of Chartered Accountants of India require that the cash flow statement should report

cash flows during the period classified by operating, investing and financing activities:

2.3.1 Operating Activities: These are the principal revenue producing activities of the

enterprise. Net impact of operating activities on flow of cash is reported as ‘Cash flows from

operating activitiThe amount of cash flows from operating activities is a key indicator of the extent to which the

operations of the enterprises have generated sufficient cash flows to maintain the operating

capability of the enterprise, pay dividends, repay loans, and make new investments without

recourse to external sources of financing. It provides useful information about internal

financing. Information about the specific components of historical operating cash flows is

useful, in conjunction with other information, in forecasting future operating cash flows.

2.3.2 Investing activities: These are the acquisition and disposal of long-term assets and

other investments not included in cash equivalents. The separate disclosure of cash flows

arising from investing activities is important because the cash flows represent the extent to

which the expenditures have been made for resources intended to generate future incomes

and cash flows.

2.3.3 Financing activities: These are the activities that result in changes in the size and

composition of the owner’s capital (including preference share capital) and borrowings of the

enterprise. The separate disclosure of cash flows arising from financing activities is important

because it is useful in predicting claims on future cash flows by providers of funds (both

capital and borrowings) to the enterprise. es’ or ‘cash from operation’.