A cash flow statement aims to determine the effects of cash of different type of cash inflows and outflows. In this process, all cash flows are classified into three categories:- 1. Cash flows from Operating Activities 2. Cash flows from Investing Activities 3. Cash flows from Financing Activities.
1. Cash Flows from Operating Activities:
The amount of cash flows arising from operating activities is a key indicator of the extent to which the operations of the enterprise 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. Information about the specific components of historical operating cash flows is useful, in conjunction with other information, in forecasting future operating cash flows.
Cash flows from operating activities are primarily derived from the principal revenue- producing activities of the enterprise. Therefore, they generally result from the transactions and other events that enter into the determination of net profit or loss.
Examples of cash flows from operating activities are:
(1) Cash receipts from the sale of goods and the rendering of services;
(2) Cash receipts from royalties, fees, commissions and other revenue;
(3) Cash payments to suppliers for goods and services;
(4) Cash payments to and on behalf of employees;
(5) Cash receipts and cash payments of an insurance enterprise for premiums and claims, annuities and other policy benefits;
(6) Cash payments or refunds of income taxes unless they can be specifically identified with financing and investing activities; and
(7) Cash receipts and payments relating to future contracts, option contracts and swap contracts when the contracts are held for dealing or trading purposes.
Some transactions, such as the sale of an item of plant, may give rise to a gain or loss which is included in the determination of net profit or loss. However, the cash flows relating to such transactions are cash flows investing activities.
An enterprise may hold securities and loans for dealing or trading purposes, in which case they are similar to inventory acquired specifically for resale. Therefore, cash flows arising from the purchase and sale of dealing or trading in securities are to be classified as operating activities. Similarly, cash advances and loans made by financial enterprises are usually classified as operating activities since they relate to the main revenue-producing activity of that enterprise.
2. Cash Flows from Investing Activities:
The separate disclosure of cash flows arising from investing activities is important because the cash flows represent the extent to which expenditures have been made for resources intended to generate future income and cash flows.
Examples of cash-flows arising from investing activities are:
(1) Cash payments to acquire fixed assets, including intangibles. These payments include those relating to capitalized research and development costs and self-constructed fixed assets;
(2) Cash receipts from disposal of fixed assets (including intangibles);
(3) Cash payments to acquire shares, warrants or debt instruments of other enterprises and interest in joint ventures (other than payments for those instruments considered to be cash equivalents and those held for dealing or trading purposes.);
(4) Cash receipts from disposal of shares, warrants or debt instruments of other enterprises and interests in joint ventures (other than receipts from those instruments considered to be cash equivalents and those held for dealing or trading purposes.);
(5) Cash advances and loans made to third parties (other than advances and loans made by a financial enterprise);
(6) Cash receipts from the repayment of advances and loans made to third parties (other than advances and loans of a financial enterprise);
(7) Cash payments for future contracts, forward contracts, option contracts and swap contracts except when the contracts are held for dealing or trading purposes, or the payments are classified as financing activities; and
(8) Cash receipts from future contracts, forward contracts, option contracts and swap contracts except when the contracts are held for dealing or trading purposes, or the receipts are classified as financing activities.
When a contract is accounted for as a hedge of an identifiable position, the cash flows of the contract are classified in the same manner as the cash flows of the position being hedged.
3. Cash Flows from Financing Activities:
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.
Examples, of cash flows arising from financing activities are:
(1) Cash proceeds from issuing shares or other similar instruments;
(2) Cash proceeds from issuing debentures, loans, notes, bonds, and other short or long-term borrowings; and
(3) Cash repayments of amounts borrowed.
Preparation of the Statement:
Cash Flow Statement is prepared with the help of the following:
(1) Balance Sheets (Opening and Closing):
Balance sheets at the beginning and at end of the accounting period are required to indicate the amount of changes that have taken place in assets, liabilities and capital.
(2) Income Statement or Profit and Loss Account:
It helps to determine the amount of cash provided by or used in operation during the accounting period, after making adjustments for non-cash items, current assets and current liabilities.
(3) Additional Data:
In addition to the Balance Sheets and Income Statement, additional data are collected to determine how cash has been provided or used. For examples during the period assets might have been purchased and sold, taxes paid, premium paid on redemption of debentures etc.