Unit 4: Cash Flow Statement

Introduction to the Cash Flow Statement

What is a Cash Flow Statement?

• A Cash Flow Statement is a financial statement that shows how cash flows in and out of
a business during a specific accounting period (monthly, quarterly, or annually).

• It helps stakeholders (management, investors, creditors) understand the cash generation

and cash usage of a company.

Purpose of the Cash Flow Statement

1. Assess Liquidity:
Shows the company’s ability to pay its short-term obligations and meet operational
requirements.

2. Evaluate Cash Management:

Helps in assessing how effectively a company is using cash in its operations, financing, and
investing activities.

3. Decision-Making:
Provides insights into financial decisions by evaluating operating efficiency, investment
opportunities, and risk levels.

4. Investor Information:
Provides transparency to investors about cash flows and profitability.

Structure of the Cash Flow Statement

The Cash Flow Statement is divided into three main sections:

1. Operating Activities

2. Investing Activities

3. Financing Activities

The statement follows the Indirect Method for operating activities.

Components of the Cash Flow Statement

1️⃣ Operating Activities

• This section shows cash generated or spent from the core business operations of a
company.

Key Components:

• Net Income

• Depreciation and Amortization

• Changes in Working Capital (Accounts Receivable, Inventories, Accounts Payable)

Purpose:

• Helps assess cash flows from day-to-day operations.

2️⃣ Investing Activities

• This section includes cash transactions for purchasing and selling long-term assets and
investments.

Key Components:

• Purchase/Sale of Fixed Assets (Land, Equipment)

• Investments in Stocks, Bonds, or Long-term securities

Purpose:

• Reflects cash used in acquiring assets and investments.

3️⃣ Financing Activities

• This section outlines cash transactions that relate to funding the business through debt or
equity.

Key Components:

• Issuing Shares (Equity Financing)

• Borrowings (Loans)

• Repaying Loans

• Dividends Paid

Purpose:

• Shows how a company raises capital and repays stakeholders.

Indirect Method of Preparing the Cash Flow Statement

The Operating Activities section uses the Indirect Method to reconcile net income with net cash
flows.

Structure of the Cash Flow Statement (Indirect Method)

Cash Flow Statement (Indirect Method)

1️. Cash Flows from Operating Activities

• Start with Net Income

• Adjust Net Income for non-cash expenses and income, and changes in working capital.

Adjustment Effect

Add: Depreciation & Amortization + Non-cash Expenses

Add: Loss on Sale of Assets +

Less: Gain on Sale of Assets -

Change in Accounts Receivable Adjust +/−

Change in Inventories Adjust +/−

Change in Accounts Payable Adjust +/−

2️. Cash Flows from Investing Activities

• Includes cash transactions for acquiring or disposing of fixed assets, investments, etc.

Components Effect

Purchase of Equipment (Outflow)

Sale of Equipment + Inflow

Purchase/Sale of Investments +/−

3️. Cash Flows from Financing Activities

• Covers transactions that deal with equity or debt funding.

Components Effect

Issuing Shares + Inflow

Borrowing Loans + Inflow

Repayment of Loans - Outflow

Dividends Paid - Outflow

Interpreting the Cash Flow Statement

Key Insights to Analyze:

1. Operating Cash Flow:

o Positive operating cash flow indicates a healthy business operation.

o If it's negative, it suggests insufficient revenue to cover expenses.

2. Investing Cash Flow:

o Shows company investment decisions.

o Consistently high cash outflows in this section suggest expanding operations or

new projects.

3. Financing Cash Flow:

o Helps in understanding the source of funding for a company’s operations and

growth.

o Positive financing cash flow indicates capital raising and investments.

Numerical Questions

Numerical Question 1️: Operating Cash Flows (Indirect Method)

Given:

• Net Income: ₹5,00,000

• Depreciation: ₹1,00,000

• Increase in Accounts Receivable: ₹2,00,000

• Decrease in Inventory: ₹1,00,000

 • Increase in Accounts Payable: ₹1,50,000

Question:
Compute the Net Cash Flows from Operating Activities using the Indirect Method.

Numerical Question 2️: Investing Activities

Given:

• Purchase of Equipment: ₹3,00,000

• Sale of Fixed Asset: ₹2,00,000

Question:
Calculate Net Cash Flows from Investing Activities.

Numerical Question 3️: Financing Activities

Given:

• Issuing Shares: ₹4,00,000

• Borrowing a Long-Term Loan: ₹3,00,000

• Repayment of Loan: ₹1,00,000

• Dividends Paid: ₹2,00,000

Question:
Determine Net Cash Flows from Financing Activities.

Answers Template

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statement's computations.
 Numerical Question 1️: Operating Cash Flows (Indirect Method)

Given:

• Net Income: ₹5,00,000

• Depreciation: ₹1,00,000

• Increase in Accounts Receivable: ₹2,00,000

• Decrease in Inventory: ₹1,00,000

• Increase in Accounts Payable: ₹1,50,000

Objective:

Compute Net Cash Flows from Operating Activities using the Indirect Method.

Step-by-Step Calculation

Operating Cash Flows (Indirect Method) Formula:

Net Cash Flows from Operating Activities=Net Income+Non-

cash Adjustments+Changes in Working Capital\text{Net Cash Flows from Operating Activities} =
\text{Net Income} + \text{Non-cash Adjustments} + \text{Changes in Working
Capital}Net Cash Flows from Operating Activities=Net Income+Non-
cash Adjustments+Changes in Working Capital

1. Start with Net Income

Net Income = ₹5,00,000

2. Add Depreciation (Non-cash Expense)

Depreciation is added back because it's a non-cash expense:

Net Income+Depreciation=₹5,00,000+₹1,00,000=₹6,00,000\text{Net Income} + \text{Depreciation}

= ₹5,00,000 + ₹1,00,000 = ₹6,00,000Net Income+Depreciation=₹5,00,000+₹1,00,000=₹6,00,000

3. Adjust for Changes in Working Capital

o Increase in Accounts Receivable: This decreases cash flow (outflow).

Net Cash Flow−Increase in Accounts Receivable=₹6,00,000−₹2,00,000=₹4,00,000\text{Net Cash

Flow} - \text{Increase in Accounts Receivable} = ₹6,00,000 - ₹2,00,000 =
₹4,00,000Net Cash Flow−Increase in Accounts Receivable=₹6,00,000−₹2,00,000=₹4,00,000

o Decrease in Inventory: This increases cash flow (inflow).

₹4,00,000+₹1,00,000=₹5,00,000₹4,00,000 + ₹1,00,000 =
₹5,00,000₹4,00,000+₹1,00,000=₹5,00,000
 o Increase in Accounts Payable: This increases cash flow (inflow).

₹5,00,000+₹1,50,000=₹6,50,000₹5,00,000 + ₹1,50,000 =
₹6,50,000₹5,00,000+₹1,50,000=₹6,50,000

Net Cash Flows from Operating Activities:

₹6,50,000\textbf{₹6,50,000}₹6,50,000

Numerical Question 2️: Investing Activities

Given:

• Purchase of Equipment: ₹3,00,000 (cash outflow)

• Sale of Fixed Asset: ₹2,00,000 (cash inflow)

Calculation

1. Cash Outflow for Equipment Purchase:

Purchase of Equipment=−₹3,00,000\text{Purchase of Equipment} = -

₹3,00,000Purchase of Equipment=−₹3,00,000

2. Cash Inflow from Sale of Fixed Asset:

Sale of Fixed Asset=+₹2,00,000\text{Sale of Fixed Asset} = +

₹2,00,000Sale of Fixed Asset=+₹2,00,000

3. Net Cash Flows from Investing Activities:

Net Cash Flows=Inflow−Outflow=₹2,00,000−₹3,00,000=−₹1,00,000\text{Net Cash Flows} =

\text{Inflow} - \text{Outflow} = ₹2,00,000 - ₹3,00,000 = -
₹1,00,000Net Cash Flows=Inflow−Outflow=₹2,00,000−₹3,00,000=−₹1,00,000

Net Cash Flows from Investing Activities: - ₹1️,00,000 (cash outflow)

Numerical Question 3️: Financing Activities

Given:

• Issuing Shares: ₹4,00,000 (cash inflow)

• Borrowing Long-Term Loan: ₹3,00,000 (cash inflow)

• Repayment of Loan: ₹1,00,000 (cash outflow)

• Dividends Paid: ₹2,00,000 (cash outflow)

Calculation
 1. Total Inflows:

Total Inflows=Issuing Shares+Borrowing Loan=₹4,00,000+₹3,00,000=₹7,00,000\text{Total Inflows} =

\text{Issuing Shares} + \text{Borrowing Loan} = ₹4,00,000 + ₹3,00,000 =
₹7,00,000Total Inflows=Issuing Shares+Borrowing Loan=₹4,00,000+₹3,00,000=₹7,00,000

2. Total Outflows:

Total Outflows=Repaying Loan+Dividends Paid=₹1,00,000+₹2,00,000=₹3,00,000\text{Total

Outflows} = \text{Repaying Loan} + \text{Dividends Paid} = ₹1,00,000 + ₹2,00,000 =
₹3,00,000Total Outflows=Repaying Loan+Dividends Paid=₹1,00,000+₹2,00,000=₹3,00,000

3. Net Cash Flows from Financing Activities:

Net Cash Flows=Inflows−Outflows=₹7,00,000−₹3,00,000=₹4,00,000\text{Net Cash Flows} =

\text{Inflows} - \text{Outflows} = ₹7,00,000 - ₹3,00,000 =
₹4,00,000Net Cash Flows=Inflows−Outflows=₹7,00,000−₹3,00,000=₹4,00,000

Net Cash Flows from Financing Activities: ₹4,00,000 (cash inflow)

Final Cash Flow Statement Breakdown

Activity Cash Flow (₹)

Operating Activities ₹6,50,000

Investing Activities - ₹1,00,000

Financing Activities ₹4,00,000

Total Cash Flows ₹9,50,000

These detailed steps show the indirect method for all core sections of the cash flow statement.
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 Cash Flow Statement (Indirect Method) - Detailed Breakdown

Overview of the Indirect Method

The Indirect Method for the Operating Activities section starts with Net Income and adjusts it for:

1. Non-Cash Expenses

2. Non-Cash Income

3. Changes in Working Capital (i.e., accounts receivable, accounts payable, and inventory)

Let’s explore these adjustments step by step.

Step-by-Step Breakdown

1️. Operating Activities

Objective

• This section shows the cash generated or used in core business operations.

• It starts with Net Income and adjusts it for non-cash items and working capital changes.

Adjustments in the Operating Activities

Step 1️: Start with Net Income

Net Income is the starting point for operating cash flow.

Given:
Net Income = ₹5,00,000

Why Start with Net Income?

• Net income includes accrual-based revenues and expenses, which do not necessarily
result in cash transactions.

Step 2️: Add Non-Cash Expenses

Non-cash expenses do not involve actual cash payments but reduce reported net income.
Common examples include Depreciation and Amortization.
Given:

• Depreciation = ₹1,00,000

Adjustment:
Add Depreciation back to Net Income since it’s a non-cash expense.

Calculation:

Net Income+Depreciation=5,00,000+1,00,000=6,00,000\text{Net Income} + \text{Depreciation} =

5,00,000 + 1,00,000 = 6,00,000Net Income+Depreciation=5,00,000+1,00,000=6,00,000

Step 3️: Adjust for Non-Cash Income

Sometimes, companies report gains (like selling an asset at a profit), which increase net income
but do not result in cash inflow.

For example:
If there's a Gain on Sale of Fixed Assets, it should be subtracted.

In our case, there is no non-cash income mentioned.

Step 4: Adjust for Changes in Working Capital

Working capital includes current assets and current liabilities. Changes in these accounts
directly impact cash flow.

A) Change in Accounts Receivable

• Increase in Accounts Receivable: This means more sales were made on credit, resulting in
a cash outflow.

Given:

• Increase in Accounts Receivable = ₹2,00,000

Adjustment:
Subtract the increase because it reduces cash inflow.

Calculation:

6,00,000−2,00,000=4,00,0006,00,000 - 2,00,000 = 4,00,0006,00,000−2,00,000=4,00,000

B) Change in Inventory

• Decrease in Inventory: When inventory decreases, cash is freed up because goods were
sold and cash came in.
Given:

• Decrease in Inventory = ₹1,00,000

Adjustment:
Add the decrease back to cash flow.

Calculation:

4,00,000+1,00,000=5,00,0004,00,000 + 1,00,000 = 5,00,0004,00,000+1,00,000=5,00,000

C) Change in Accounts Payable

• Increase in Accounts Payable: More credit purchases mean cash outflows are delayed,
resulting in an increase in cash flow.

Given:

• Increase in Accounts Payable = ₹1,50,000

Adjustment:
Add the increase because it indicates cash retention.

Calculation:

5,00,000+1,50,000=6,50,0005,00,000 + 1,50,000 = 6,50,0005,00,000+1,50,000=6,50,000

Net Cash Flows from Operating Activities:

₹6,50,000\textbf{₹6,50,000}₹6,50,000

2️. Investing Activities

This section includes transactions for acquiring or selling long-term assets, like fixed assets and
investments.

Step-by-Step:

Cash Outflows for Asset Purchases

• If you purchase fixed assets, it’s a cash outflow.

• In our case:

Given:

• Purchase of Equipment: ₹3,00,000

Adjustment:
Subtract it as it’s a cash outflow.

Calculation:

−₹3,00,000- ₹3,00,000−₹3,00,000

Cash Inflows from Asset Sales

• Selling an asset brings cash into the business.

Given:

• Sale of Fixed Asset: ₹2,00,000

Adjustment:
Add this inflow to the investing cash flow.

Calculation:

+₹2,00,000+ ₹2,00,000+₹2,00,000

Net Cash Flows from Investing Activities

Net Cash Flows=₹2,00,000−₹3,00,000=−₹1,00,000\textbf{Net Cash Flows} = ₹2,00,000 - ₹3,00,000

= - ₹1,00,000Net Cash Flows=₹2,00,000−₹3,00,000=−₹1,00,000

3️. Financing Activities

This section includes cash flows from equity and debt financing, such as issuing shares,
borrowing loans, repaying loans, and paying dividends.

Adjustments for Financing Activities

1. Issuing Shares:

• Cash inflow from share capital increases the company's cash reserves.

Given:

• Issuing Shares: ₹4,00,000

Adjustment:
Add it as a cash inflow.

2. Borrowing Long-Term Loan:

• Borrowing from banks adds cash.

Given:

• Borrowing Loan: ₹3,00,000

Adjustment:
Add this amount.

3. Repaying Loan:

• Loan repayment is a cash outflow.

Given:

• Repayment of Loan: ₹1,00,000

Adjustment:
Subtract it.

4. Paying Dividends:

• Dividends paid reduce cash flow.

Given:

• Dividends Paid: ₹2,00,000

Adjustment:
Subtract it.

Net Cash Flows from Financing Activities:

Net Cash Flows=4,00,000+3,00,000−1,00,000−2,00,000=4,00,000\textbf{Net Cash Flows} =

4,00,000 + 3,00,000 - 1,00,000 - 2,00,000 =
4,00,000Net Cash Flows=4,00,000+3,00,000−1,00,000−2,00,000=4,00,000

Final Interpretation

Activity Type Cash Flow (₹)

Operating Activities 6,50,000

Investing Activities -1,00,000

Financing Activities 4,00,000

Total cash flows indicate the net liquidity impact on your business operations across all
sections.