What a Cash Flow Statement Is
Chapter Forty-Three
Syllabus topic 1, "Meaning, objectives, significance, advantages and limitations of Cash Flow Statements"
Pages 117 to 119 of 162
In one line
A cash flow statement explains how the cash balance moved between two balance sheet dates, by classifying every movement as operating, investing or financing.
Why profit is not cash
Sunrise Industries Ltd earned Rs 2,38,000 after tax and its bank balance rose by Rs 30,000. Both figures are correct and neither is the other.
| Reason for the gap | Direction |
|---|---|
| Sales are recorded when made, not when collected | Debtors rose Rs 80,000, so that much of the profit is not yet money |
| Purchases are recorded when made, not when paid | Creditors rose Rs 80,000, so that much of the cost has not yet cost cash |
| Depreciation is a charge that pays nobody | Rs 1,00,000 was deducted from profit and no cash left |
| Assets are bought out of cash and not out of profit | Rs 2,50,000 went on fixed assets and appears in no expense line |
| Dividends are paid out of profit already earned | Rs 78,000 left the company and reduced no profit of this year |
Every one of those is a legitimate accounting treatment, and together they are why a profitable company can be unable to pay its wages. The cash flow statement lists them.
What it is, precisely
AS 3's own definitions, and the wording is worth having.
| Term | AS 3's definition |
|---|---|
| Cash | Cash on hand and demand deposits with banks |
| Cash equivalents | Short term, highly liquid investments readily convertible into known amounts of cash and subject to an insignificant risk of changes in value |
| Cash flows | Inflows and outflows of cash and cash equivalents |
And the statement itself, from AS 3 paragraph 8: the cash flow statement should report cash flows during the period classified by operating, investing and financing activities.
The three activities, in one line each
| Activity | AS 3's definition, in short |
|---|---|
| Operating | The principal revenue-producing activities, and everything that is not investing or financing |
| Investing | The acquisition and disposal of long-term assets and other investments not included in cash equivalents |
| Financing | Activities that change the size and composition of the owners' capital and the borrowings |
Notice the shape of the operating definition. It is a residual: whatever is not investing and not financing is operating. So classify by elimination where an item is doubtful.
Where it sits among the statements
| Statement | Question it answers | Basis |
|---|---|---|
| Balance sheet | What do we own and owe, at a date | Accrual |
| Revenue statement | What did we earn, over a period | Accrual |
| Cash flow statement | Where did the money come from and go, over a period | Cash |
It is the only one of the three prepared on a cash basis, and that is what it adds. It is also the only one that cannot be window dressed by an accounting policy, because a policy cannot change what left the bank.
The rest of this chapter
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The rest of this subject
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