Preparation Of Cash Flow Statement Part 3

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There are two methods which are useful and give the same result in preparing cash flow statement. Those are direct and indirect methods. These two methods can be understood using an illustration given below.

Example:

From the summarized cash account of ABC Limited (Ltd.) prepare cash flow statement for the year ended 31st December 2006 in accordance with AS-3 (Revised) using the direct method and indirect method. The company does not have any cash equivalents:

Summarized Cash a/C

Table of Summarised Cash a/C
Title: Table of Summarised Cash A/c

Particulars

Amount (Rs. 000)

Particulars

Amount (Rs. 000)

Balance on 1.1.2006

50

Payment to Suppliers

2000

Issue of equity shares

300

Purchase of fixed assets

200

Receipts from customers

2800

Overhead expenses

200

Sale of fixed assets

100

Wages and salaries

100

Taxation

250

Dividend

50

Repayment of Bank Loan

300

Balance on 31.12.2006

150

3250

3250

Additional information: Net profit before tax for the yea 2006 was Rs 500000.

Solution:

Cash flow statement of ABC Ltd for the year ended 31st December 2006 (Indirect method)

Tabel of Cash Flow Statement of ABC Ltd for the Year Ended 31st December 2006 (Indirect Method)
Title: Tabel of Cash flow statement of ABC Ltd for the year ended 31st December 2006 (Indirect method)

Rs 000

Rs 000

A. Cash flows from operating activities

Net profit before tax

500

Income tax paid

(250)

Net cash from operating activities

250

B. Cash flows from investing activities

Purchase of fixed assets for cash

(200)

sale of fixed assets

100

Net cash used in investing activities

(100)

C. Cash flows from financing activities

Proceeds from issue of equity shares

300

Payment of bank loan

(300)

Dividend paid

(50)

Net cash used in financing activities

(50)

Net increase in cash (A+B+C)

100

i.e. Net cash from activities

Cash flow statement of ABC Ltd for the year ended 31st December 2006 (Indirect method)

Table of Cash Flow Statement of ABC Ltd for the Year Ended 31st December 2006 (Indirect Method)
Title: Table of Cash flow statement of ABC Ltd for the year ended 31st December 2006 (Indirect method)

Rs 000

Rs 000

A. Cash flows from operating activities

Cash receipts from customers

2800

Cash payments to suppliers

(2000)

Cash paid for wages and salaries

(100)

Cash paid for overhead expenses

(200)

Income tax paid

(250)

Net cash from operating activities

250

B. Cash flows from investing activities

Purchase of fixed assets for cash

(200)

Proceeds from sale of fixed assets

100

Net cash used in investing activities

(100)

C. Cash flows from financing activities

Proceeds from issue of equity shares

300

Payment of bank loan

(300)

Dividend paid

(50)

Net cash used in financing activities

(50)

Net increase in cash (A+B+C)

100

i.e. Net cash from activities

Cash at the beginning

50

Cash at the end

150

Treatment of Special Items:

  1. Payment of interim dividends:

    • The amount of interim dividend paid during the year is shown as outflow of cash in cash flow statement.

    • It will be added back to the profits for the purpose of calculating cash provided from operating activities.

    • No adjustment is necessary if the cash provided from operating activities is calculated on the basis of revised figure of net profit.

    • Proposed dividend: Dividend is fixed after general meeting. This is a non-operating item so it should be added back to current year’s profit and payments.

    • Share Capital:

    • Increase in share capital is cash inflow.

    • Redemption of preference share capital is cash outflow.

    • Issue of bonus shares does not cause any cash flows.

  2. Purchase or sale of fixed assets: Cash flows drawn from comparative balance sheet at two dates. Based on that we derive whether a particular fixed asset has been purchased or sold during the year. Purchased asset is cash outflow and sale is inflow.

  3. Provision for Taxation: It is a non-operating expense. So it should not be allowed to reduce the cash provided from operating expenses. If the profit is given after tax provisions for tax should be added back to the current year profit. In the cash flow statement, the tax paid would be recorded separately as an outflow of cash. Sometimes, the only information available about provision for taxation is two figures appearing in the opening balance sheet and closing balance. Tax in opening balance sheet is treated as cash outflow and tax provision in closing balance is treated as non-cash item and added back to the net income.

Exmple:

The following relevant Information is obtained from the book of Venugopalan Limited (Ltd.).

Liabilities in Various Years
Title: Liabilities in various years

Liabilities

2006

2007

Provision for Taxation

Rs

Rs

The amount of tax paid during 2007 amounted to Rs.40000. How would you deal with this item presuming to be non current? You are also given net profit after taxation was Rs.80000.

Solution:

Summarised Cash Account
Summarised Cash Account

Dr.

Cr.

Particulars

Amount

Rs.

Particulars

Amount Rs.

Bank (payment)

40,000

Balance b/d

50000

Balance c/d

70000

Profit and loss A/c

60000

(Balances Figure)

110000

110,000

  1. Rs. 40000 is an outflow of cash

  2. Cash provided from operating activities will be calculated as

Net Income after taxation

Add: Provision for taxation treated as non-cash expense

Limitations of Cash Flow Statement:

  • It is very difficult to precisely define the term ‘cash

  • There are controversies over a number of items like cheques, stamps, postal orders etc. to be included in cash or not.

  • As the present business moves from the cash basis to accrual basis, the prepaid and credit transactions might be represented an increase in working capital and it would be misleading to equate net income to cash flow because a number of non cash items would affect the net income.

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