Introduction of the Host
Mrs.Geetha Dasaraty is a commerce graduate with a Masters in Business Administration specialising in finance. Her stint with a Coimbatore based company and later with a consulting firm in Chennai has provided her with a decade of experience in project finance and appraisals, accounting and tax laws. She is a freelance writer and money matters are her forte. She is currently pursuing her final course in Company Secretaryship and is doing a course on Vaishnavism. She has a passion for literature and Carnatic music. She is also a violinist.

About the Class
We bring you an online class titled 'Elementary Finance'. This will have 12 lessons - one a month. Each lesson is further subdivided into 4 chapters. And we will give you one new chapter every week.

Chapter 5 Lesson A - Cash Flow Statements

We have seen in the previous chapters about Profit and Loss account and Balance Sheet.In this lesson we will see about yet another financial statement called the 'cash flow statement'.

A financial statement is a collection of data organised according to logical and consistent accounting procedures. A financial statement conveys an understanding of the financial aspects of a business firm.

Cash flow is a measurement of the money going into and coming out of a company. Cash flow implies the cash arising from the operations of the company for the financial year. The fund thus available is pooled into the internal funds for further deployment.

A cash flow statement is prepared to show the effect of various transactions on the cash position of the firm.

A cash flow statement is a summary of the receipts and payments. The transactions which increase the cash in the firm is called 'inflow' and the transactions that decrease the cash position are the 'outflow'.

The various sources of inflow of cash are the cash received from the normal operations of the firm; cash received from the sale of fixed assets and current assets, issue of shares and debentures.

The various sources of outflow are expenditure or losses in operation of the firm, redemption of long term debts of the firm and purchase of assets.

Objectives of cash flow:

• A cash flow statement indicates the cash, which is generated from the regular operations of a concern.
• A cash flow statement acts as a planning tool. It gives an idea of the amount of cash that can be generated internally. Based on this the concern can plan for raising funds from outside sources.
• Cash flow statements also act as a control tool by comparing it with the budget. Based on this necessary action can be taken.
• These statements enable one to find out about the liquidity position of the firm. These statements when prepared on a monthly or quarterly basis help to understand the liquidity position better. Financial institutions can understand the liquidity of a concern based on these statements.
• The financial ratios obtained from these statements enable ratio analysis.
• Where there is a continuous loss of cash, the concern will be able to take remedial action as early as possible.
• Dividends to be paid can be decided upon based on these statements.

Cash flow statements are prepared based on the profit and loss account and balance sheet. In the case of the above two transactions are taken on an accrual basis, but in a cash flow statement the transactions are considered only on cash basis.

Calculation of operating profit

The net profit depicted in the profit & loss account is inclusive of items that do not affect the position of cash. Hence to find out the exact profit from operations these items have to be adjusted in the following manner.
1. Take the profit shown in the Profit and Loss Account
2. Add items that are mere book entries like depreciation. These are added back, as there is no real cash outflow.
3. Deduct profits arising out of sale of fixed assets or redemption of any liability.

Calculation of cash from operations.
In addition to cash sales, any increase or decrease in the assets or liabilities of the firm also affects the cash flow from operations.
1. Increase or decrease in debtors: Where the closing balance is more than the opening balance there is an increase in debtors and vice versa. Increase in debtors should be reduced from the net operating profit and any decrease in debtors has to be added. This is done because an increase in debtors means that the cash collection is less than the sales revenue and hence is deducted from operating profit and vice-versa.

2. Effect of increase or decrease in prepaid expenses: Any increase in prepaid expenses has to be reduced from net operating profit and a decrease in the prepaid expenses have to be added.

3. Effect of increase or decrease in stock: A decrease in stock has to be added to the net operating profit and any increase has to be reduced from the net operating profit.

4. Effect of increase or decrease in accrued incomes: Increase in accrued income has to be reduced from net operating profit and any decrease in accrued incomes has to be added to the net operating profit.

5. Effect of increase or decrease in creditors: Increase in creditors has to be added to the net operating profit and decrease in creditors has to be reduced from the net operating profit.

6. Effect of increase or decrease in outstanding expenses: Increase in outstanding expenses should be added to the net operating profit and the decrease in outstanding expenses should be reduced from the net operating profit.

7. Effect of increase or decrease in income-in-advance: Increase in income-received- in advance should be added to net operating profit and decrease in income should be reduced from the net operating profit.

Cash from Non-Current Items:

1. Purchase of fixed assets: Where fixed assets are purchased it implies the use of cash, thereby reducing the cash balance.

2. Sale of fixed assets:A decrease in fixed assets means the sale of assets which in turn implies the inflow of cash. Hence the cash balance increases.

3. Redemption of shares and debentures: Any decrease in any fixed liability implies the uses of cash. This means a reduction in cash.

4. Issue of shares or debentures for cash: An increase in fixed liability or share capital is a source of cash. Any issue of shares or debentures for cash increases the inflow of cash.

Preparation of Cash Flow Statement:
Take the opening balance of cash.
Add to it all the cash inflow i.e. Receipts
Deduct all the cash outflows i.e. Payments
The balance will be the closing cash balance on hand.

A cash flow statement shows the sources of cash on one hand and the applications of cash on the other hand. The difference between the two indicates the closing balance of cash.

Questions on Chapter 4 Lesson D
1.What is the eligibility criteria for a person to open an account?
2.What are the requirements for opening an account?