COMPONENTS OF CASH FLOW STATEMENT The cash flow statement should report cash flows during the period classified by operating, investing and financing activities. Cash flow statement explains the reasons for changes in cash and cash equivalents detailing out cash flow on various heads. Three are important components of the CFS are: Cash flow from financing activities. Cash flow from investing activities; Cash flow from operating activities; Cash flow from financing activities (CFF) Financing activities are those activities that result in changes in the size and composition of the equity capital and borrowing of the enterprise. Cash inflows from financing activities include the following: Proceeds from issuing equity instruments; Proceeds from issuing bonds, mortgages, notes and from other short or long term borrowing. Cash outflows from financing activities include the following Repayment of amount borrowed; Capital element of finance lease payments; Buyback of shares; Payment of expenses or commissions on any issue of shares, debentures, loans, notes, bonds and other financing. Cash from financing activities may be negative or positive. Negative CFF means the company has paid off loans or redeemed capital or bought back capital or distributed dividend. Positive cash flows may be due to raising of funds in the form of capital or loans. Exhibit 8.1 shows the cash from financing activities of NALCO Exhibit 8.1: (Rs. in crores) 2006 2005 S Source: Annual Report of NALCO 7
It can be seen from the Exhibit 8.1 that during the year 2006, NALCO did not raise any funds from the market. However, during 2005, the company redeemed more than Rs. 650 crores. Negative cash from financing activities of NALCO was due to distribution of dividend. Example 8.1 ABC started business with capital of Rs. 10,000. It took 12% loan of Rs. 200,000; from IDBI bank. Used the funds to purchase stock of goods. Sold entire stock for 400,000. Interest for the year was fully paid. The company also paid 25,000 towards other expenses. Table 8.3 shows the cash from financing activities. Table 8.3 Cash Flow From Financing Activities Capital 100,000 12% Loan 200,000 Total 300,000 Interest 24000 Total 24000 CFF 276,000 Example 8.2 Assets and sources of ABC ltd as on 1 st April 2006 were as follows: Capital : 100,000 12% Loan: 200,000 Cash: 50,000 Other assets : 250,000 During the year, the company declared 20% dividdend and distributed the amount. At the beginning of the year (on 1 st May) repaid 50% of loan. Interest on balance amount paid on time. Table 8.4 shows the cash from financing activities. Table 8.4 Cash Flow From Financing Activities Total 0 Loan repaid 100000 Interest 13000 Dividend paid 20000 Total 133000 CFF -133,000 Cash flow from investing activities (CFI) Investing activities relate to the acquisition and disposal of long term assets and other investments not included in cash equivalents. Cash inflows from investing activities include the following: Sale of shares of other companies Sale of bonds and,debentures of other companies 8
Dividend received Interest received. from sale of property, plant equipment and other productive assets; from derivative transactions Cash outflows from investing activities include the following: Purchase of shares of other companies Purchase of bonds and,debentures of other companies Purchase of property, plant equipment and other productive assets; for derivative transactions Cash from investing activities may be negative or positive. Negative CFI means the company has paid for acquiring assets. Positive cash flows may be due to the sale of assets or due to the receipt of dividend and interest on the investments made. Exhibit 8.2 shows the cash from investing activities of NALCO Exhibit-8.2: Rs. in crores 2005 2006 Exhibit 8.2 shows that NALCO increased continued to acquire fixed assets. During the last two years the company did not make any non-operating investment. The negative CFI in 2006 is exclusively due to the acquisition of fixed assets. 9
Example 8. 3 On 1 st April 2005, ABC started business with capital of Rs. 10,000. It took 12% loan of Rs. 200,000; from IDBI bank. Used the funds to purchase stock of goods for Rs. 50,000. It acquired plant costing 100,000 on credit and shares costing 100,000 for cash. Sold entire stock for 400,000. Interest for the year was fully paid. The company also paid 25,000 towards other expenses. Sold 50% of the shares at Rs. 60,000. During the year it also received Rs. Rs. 5000 as dividend. Table 8.5 shows the cash flow from investing activities (CFI). Table 8.5 Cash Flow From Investing Activities Sale of share 60000 Dividend received 5000 Total 65000 Purchase of shares 100000 Total 100000 CFI -35,000 Example 8. 4 Refer to the example 8.3.During 2006, company received dividend of Rs. 10,000. No other transactions. Table 8.6 shows the cash from investing activities (CFI). Table 8.6 Cash Flow From Investing Activities Dividend received 100000 Total 100000 Purchase of shares 0 Total 0 CFI 100,000 Example 8. 5 Transactions of ABC ltd for the year 2005 were as follows. Started business with capital 100,000 Took 12% loan on 1st July 200,000 Purchased plant on credit 50,000 Purchased stock for cash 50,000 Purchased furniture for cash 10,000 Purchased stock on credit from X 100,000 Sold 50% stock for cash 200,000 Rent per month 2,000 10
Purchased 12% Bonds of Z ltd 25,000 Rent paid 24,000 Interest on bonds received 3000 Dividend paid : 20,000 Interest on loan paid 24,000 Table 8.7 shows cash flow from financing and cash from investing activities. Table 8.7 Cash Flow From Investing Activities Cash Flow From Financing Activities Interest received on bonds 3,000 Capital received 100,000 12% Loan 200,000 Total 3,000 Total 300,000 Purchase of bonds 25,000 Interest paid 24,000 Purchase of furniture 10,000 Dividend paid 20,000 Total 35,000 Total 44,000 CFI -32,000 CFF 256,000 Observe that interest received on bonds is cash from investing activities, whereas interest paid on loan is cash from financing activities. Issues of shares is a financing activities, whereas purchase of shares of another company purchased is an investing activity. Dividend paid is a financing activity, whereas dividend received is an investing activity. Cash flow from operating activities (CFO) Operating activities are principal revenue producing activities of the enterprise and other activities that are not investing or financing activities. Some example of cash flow from operating activities: Cash receipts from the sale of goods and the rendering of services; Cash receipts from royalties, fees, commissions and other revenue; Cash receipts and payments from contracts held for dealing or trading purposes; Cash payments to suppliers for goods and services; Cash payment to and on behalf of employees; Cash payments for income tax and refunds of income tax unless specifically identified with financing or investment activities. According to the AS-3, a company can prepare cash flows from operating activities using either: the direct method, whereby major classes of gross cash receipts and gross cash payments are disclosed; or the indirect method, whereby net profit or loss is adjusted for the effects of transactions of a non-cash nature, any deferrals or accruals of past or future operating cash receipts or payments, and items of income or expense associated with investing or financing cash flows. 11
Direct approach Under direct approach operating cash flow information is obtained from the cash book- cash receipts and payments can be classified and aggregated under the usual heads of accounts. Cash from Operations : = (Cash Sales + Collections from Customers) less ( Payment for purchase of revenue goods and Payment towards revenue expenses) Example 8.6 Refer to the 8.5. Table 8.8 shows cash from operating activities using the direct method. Table 8.8 Cash Flow From Operating Activities Cash sales 200,000 Total 200,000 for stock 50,000 Rent paid 24,000 Dividend paid 0 Total 24,000 CFO 176,000 Example 8.7 Some of the transactions of ABC for the year ending March 2006 were as follows: Started business with capital 100,000 Purchased goods for cash 80,000 Paid salaries 20,000 Sold 20% of goods for cash 40,000 Paid rent 8,000 Table 8.9 shows the cash from operating activities. Table 8.9 Cash Flow From Operating Activities Cash sales 40,000 Total 40,000 for stock 80,000 Rent paid 8,000 Total 88,000 CFO -48,000 12
Though the cash from operating activities is negative, profit for the period is positive as shown by the table 8.10. Table 8.10 Income Statement Income Sales 40,000 Total Income 40,000 COGS 16,000 Rent paid 8,000 Total Expenses 24,000 Profit 16,000 Indirect Approach Direct method is most appropriate for deriving operating cash flow because major heads of cash receipts and payments are disclosed. However, the SEBI has recently notified to follow indirect method only. Indirect method helps in reconciling the cash with profits. Table 8.11 shows cash from operating activity and profit before taxes. Table 8.11 Cash from Operations and Profit of NALCO (in crores) 2006 2005 Profit before Taxes 2753 2359 Cash from Operations 1965 1723 Why is Cash from operations different from profit? We had seen in the previous chapter that every receipt is not an income and every payment is not an expense. So profit, which is the excess of income over the expense, may not be equal to the cash in hand. Some of the reasons may be as follows: Depreciation Financing charges (interest) Provisions Change in Creditors/Debtors Capital losses or profit (profit/loss on sale of assets ) Under indirect cash approach cash flow form operating activities can be derived as follows: Net profit or loss Add : Non-cash charge such as depreciation, provisions, deferred taxes, unrealized foreign exchange losses; Add: Charges which are classified as part of investment or financing activities; Less : Non-cash income such as depreciation and other write backs; Less : Income which are classified as part of investment or financing activities. Add/Less : Changes in inventories, operating receivables and payables. 13
Exhibit 8.3 shows CFO of NALCO (Rs. in crores) Source: Annual Report of NALCO In the indirect method effort is being made to reconcile profit with cash from operating activities. We had discussed in the chapter 7 that Profit is determined on the basis of the accrual concept and matching concept. Profit in the income statement also shows income and expense relating to other non-operating activities. Figure 8.1 shows the relationship between CFO and profit for the period. CFO = Profit Non cash or items - + + or - Changes in working capital Non-cash items: While preparing the income statement some non-cash items are also recorded. Some of the common non-cash items are: depreciation, amortisation, writing off research expenses, provisions for doubtful debts. Changes in working capital: Income statement is prepared on the basis of the accrual concept. So expenses due but not paid and incomes due but not received are also recorded in the income statement. Such items are reflected through current assets and current liabilities. Difference between current assets and current liabilities is called working capital. 14
Example 8.8 Following are the assets and corresponding sources of ABC ltd.: Capital= 20,000; 12% loan = 50,000; Debtors = 30,000; and Furniture = 40,000 as on 1 st April 2006. During the first quarter of 2006 the company had the following transactions: Purchased stock on credit = Rs. 30,000 Sold 50% of the stock for cash = Rs. 30,000 Paid rent = Rs. 3,000 Collection from the debtors = Rs.20,000 Interest due but not paid Table 8.12 shows the profit for the first quarter and the corresponding cash from operating activities using the direct method. Table 8.12 Income Statement for the quarter CFO for the quarter Income Sales 30,000 Cash sales 30,000 Total Income 30,000 Collections 20,000 COGS 15,000 Total 50,000 Rent 3,000 for stock 0 Depreciation 2000 Rent paid 3,000 Interest 1,500 Total Expenses 21,500 Total 3,000 Profit 8,500 CFO 47,000 Now let us find CFO using the indirect method and reconcile profit with CFO. However, to determine the CFO through indirect method we the opening and closing balance sheet. Table 8.13 show the opening and closing balance sheet. Table 8.13 Balance sheet of ABC ltd. Opening Closing Capital 20,000 20,000 Loan 50,000 50,000 Profit 8,500 Creditors 30000 Outstanding Interest 1,500 70,000 110,000 Debtors 30,000 10,000 Furniture 40,000 38,000 Cash 47,000 Stock 15,000 70,000 110,000 We had discussed in the previous paragraph that the to determine CFO from profit, we have to find the determine the non-cash item, non-operating, and working capital changes. Non cash items = Depreciation =Rs. 2,000 Non operating items= Interest = 1,500 Working capital change 15
o Increase in creditors = 30,000 o Decrease in debtors = 20,000 o Increase in stock = 15,000 CFO = 47,000 Profit 8,500 + Non cash items 2000 + Non Operating items 1500 + Changes in working capital 35,000 Table 8.14 shows the CFO using the indirect method Table 8.14 Cash Flow from Operating Activities Profit 8,500 Add Non Cash item Depreciation 2000 Add Non-Operating Item Interest 1,500 Change in the working capital Add Increase in creditors 30,000 Decrease in debtors 20,000 Less Increase in stock 15,000 CFO 47,000 Depreciation is a non-cash item. While calculating profit, it has been deducted so it has to added back to be profit to determine the cash from operating activities. Interest is a non-operating item. While calculating profit, interest has been deducted so it has to be added back to profit to determine the cash from operating activities. Decrease in debtors. Debtors decreased from 30,000 to 10,000 due to collections. However, collection is not an income of the current year. It has not been shown while calculating the profit. So it has to be added to the profit to determine the cash flow. Increase in creditors. COGS is shown as an expense. However, money had not been paid. Increase in creditors show that the company has purchased goods on credit. So it has to be added to the profit to determine the CFO. Increase in Current Assets reduces CFO Decrease in Current Asset increases CFO Decrease in Current Liabilities reduces CFO Increase in Current Liability increases CFO 16
Example 8.9 Following are the relevant financial transactions of ABC ltd for the year ending March 2006.: Started business with Capital 50000 Took 12% loan 50000 Purchased stock on credit 50000 Sold 50% of stock for cash 50000 Purchased furniture for cash 20000 Purchased shares for cash 20000 Depreciation on furniture 2000 Expenses for the year 10000 Expenses paid 6000 Dividend received 10000 Dividend distributed 5000 Table 8.15 shows different cash flows Table 8.15 Cash from Investing Activities Cash from Operating Cash from Financing (CFF) (CFI) Activities(CFO) Capital 50,000 Sales 50,000 12% Loan 50,000 Dividend 10,000 Total 100,000 Total 10,000 Total 50,000 Less Dividend distributed 5,000 Payment for furniture 20,000 Expenses 6,000 Payment for shares 20,000 Total 5,000 Total 40,000 Total 6,000 CFF 95,000 CFI - 30,000 CFO 44,000 17