Chapter 6 — Cash Flow Statement

Chapter 6 covers the Cash Flow Statement — its meaning, objectives, and benefits; the definitions of cash and cash equivalents; classification of cash flows into operating, investing, and financing activities; treatment of special items such as extraordinary items, interest, dividends, and taxes; and the preparation of the statement using both the direct and indirect methods as per AS-3.

A Cash Flow Statement provides information about historical changes in cash and cash equivalents of an enterprise by classifying cash flows into operating, investing, and financing activities. It shows inflows and outflows of cash and cash equivalents over a specific accounting period.

As per AS-3, cash comprises cash in hand and demand deposits with banks. Cash equivalents are short-term highly liquid investments that are readily convertible into known amounts of cash, subject to insignificant risk of changes in value, and normally have a maturity of three months or less from the date of acquisition.

Operating activities are the principal revenue-generating activities of an enterprise — for example, procurement of raw material, incurrence of manufacturing expenses, and sale of goods. Cash flows from operating activities generally result from transactions that enter into the determination of net profit or loss, and the net amount from operations indicates the internal solvency level of the company.

As per AS-3, investing activities are the acquisition and disposal of long-term assets and other investments not included in cash equivalents. Examples include cash payments to acquire fixed assets, purchase of shares or debt instruments of other enterprises, and cash receipts from disposal of fixed assets, repayment of advances, or dividends received from investments.

Financing activities are activities that result in changes in the size and composition of the owners' capital (including preference share capital) and borrowings of the enterprise. Examples include proceeds from issue of equity or preference shares, proceeds from issuing debentures or long-term borrowings, repayment of amounts borrowed, interest paid on debentures, and dividends paid.

Under the indirect method, cash flows from operating activities are determined by starting with net profit before tax and extraordinary items and adjusting it for non-cash items such as depreciation and goodwill written-off, non-operating items such as interest paid or profit on sale of fixed assets, and changes in working capital (current assets and current liabilities). This method is mostly used by companies in practice.

Under the direct method, major classes of gross cash receipts and gross cash payments are disclosed separately. For example, cash receipts from sale of goods and cash payments to suppliers and employees are shown individually. The direct method provides information useful in estimating future cash flows, though in practice the indirect method is predominantly used.

Cash flows associated with extraordinary items should be classified and disclosed separately as arising from operating, investing, or financing activities. This is done to enable users to understand the nature and effect of extraordinary items on present and future cash flows, since such items are non-recurring in nature.

Cash flows arising from taxes on income should be separately disclosed and classified as cash flows from operating activities unless they can be specifically identified with financing or investing activities. Accordingly, tax on operating profit is an operating cash flow, dividend distribution tax is a financing activity, and capital gains tax on sale of fixed assets is classified under investing activities.

No. As per AS-3, investing and financing transactions that do not require the use of cash or cash equivalents are excluded from the Cash Flow Statement. For example, acquisition of machinery by issue of equity shares or redemption of debentures by issue of equity shares are not shown in the statement; they should be disclosed elsewhere in the financial statements.

The primary objective is to provide useful information about cash inflows and outflows of an enterprise during a particular period under operating, investing, and financing activities. It helps users assess the ability of the enterprise to generate cash and cash equivalents, evaluate changes in net assets and financial structure including liquidity and solvency, and compare the operating performance of different enterprises.

Yes, the NCERT PDF for Chapter 6 — Cash Flow Statement — is free to download on cbseprepmaster.com with no sign-up required.