Preparation of Cash Flow Statement and it’s Analysis

Preparing a Cash Flow Statement involves summarizing and categorizing the cash inflows and outflows of a business over a specific period. This statement is crucial for understanding how cash is generated and utilized, providing insights into liquidity, operational efficiency, and financial health.

Preparation of Cash Flow Statement:

1. Operating Activities:

   • Start with Net Income from the Income Statement.
   • Adjust for non-cash items such as depreciation and amortization.
   • Adjust for changes in working capital:
     • Increase in current assets (subtract from net income).
     • Decrease in current assets (add to net income).
     • Increase in current liabilities (add to net income).
     • Decrease in current liabilities (subtract from net income).

2. Investing Activities:

   • Include cash flows from the purchase and sale of long-term assets:
     • Proceeds from sales of assets (add to net cash flow).
     • Cash paid for acquisitions of assets (subtract from net cash flow).
     • Cash received from loans to others (add to net cash flow).
     • Cash paid for loans to others (subtract from net cash flow).

3. Financing Activities:

   • Include cash flows from financing sources and activities:
     • Proceeds from issuing stocks or bonds (add to net cash flow).
     • Repayment of debt (subtract from net cash flow).
     • Dividends paid (subtract from net cash flow).
     • Repurchase of company stock (subtract from net cash flow).

4. Net Cash Flow:

   • Sum the cash flows from operating, investing, and financing activities to arrive at the Net Increase or Decrease in Cash for the period.
   • Adjust for the beginning and ending cash balances to reconcile the cash flow statement.

Analysis of Cash Flow Statement:

• Operating Cash Flow (CFO):

Assess the adequacy of cash generated from core business operations. Compare CFO to Net Income to evaluate how much of the reported profit translates into actual cash flow.

• Investing Cash Flow (CFI):

Evaluate the cash spent on investments in property, plant, equipment, and other long-term assets. Analyze the proceeds from the sale of investments to understand the company’s investment strategies.

• Financing Cash Flow (CFF):

Review cash flows from financing activities to understand how the company raises and repays capital. Assess the impact of dividend payments and share repurchases on cash flow.

• Overall Cash Position:

Analyze the Net Increase or Decrease in Cash to determine if the company is building or depleting its cash reserves. Evaluate the ending cash balance and compare it with the beginning balance to assess liquidity trends.

• Cash Flow Ratios:

Calculate and analyze key ratios such as the Operating Cash Flow Ratio (CFO/Net Sales) and Free Cash Flow to Equity (FCFE) to gauge financial health and cash flow efficiency.

Importance of Cash Flow Analysis:

• Liquidity Management:

Helps in managing cash reserves and ensuring the availability of funds to meet short-term obligations.

• Investment Decision-making:

Provides insights into the company’s ability to fund growth initiatives and capital expenditures.

• Debt Management:

Assists in assessing the company’s capacity to service debt and meet interest payments.

• Investor and Creditor Confidence:

Enhances transparency and provides stakeholders with a clear view of the company’s cash flow dynamics.

Example of Preparation of Cash Flow Statements:

Company XYZ has the following financial data for the year ending 31st December 2023:

Now, let’s prepare the Cash Flow Statement step-by-step.

Step 1: Cash Flow from Operating Activities

Under the Indirect Method, we start with the net profit and adjust for non-cash items and changes in working capital.

Net Profit: ₹5,00,000

Adjustments for Non-Cash Items:

1. Depreciation (non-cash item) is added back to the net profit.
   • Depreciation = ₹1,00,000

Changes in Working Capital:

2. Increase in Trade Receivables: Cash inflow decreases as more sales are on credit.
   • Trade Receivables increase = ₹(50,000) (subtract)
3. Decrease in Inventories: Cash inflow increases as inventory is sold.
   • Inventories decrease = ₹20,000 (add)
4. Increase in Trade Payables: Cash inflow increases as the company delays payments to suppliers.
   • Trade Payables increase = ₹30,000 (add)

Step 2: Cash Flow from Investing Activities

This section reflects cash flows from the purchase and sale of long-term assets.

1. Purchase of Fixed Assets: Cash outflow as the company invests in fixed assets.
   • Purchase of Fixed Assets = ₹(2,00,000)

Step 3: Cash Flow from Financing Activities

This section reflects cash flows from raising capital and repaying debt.

1. Proceeds from Issue of Shares: Cash inflow from new equity raised.
   • Proceeds from Issue of Shares = ₹1,50,000
2. Loan Repayment: Cash outflow as the company repays loans.
   • Loan Repayment = ₹(1,00,000)

Step 4: Net Increase in Cash and Cash Equivalents

Now, calculate the total cash flow by summing up the changes in all activities.

Cash Flow Statement for the year ending 31st December 2023

Explanation of the Cash Flow Statement:

• Operating Activities:

Company generated ₹5,00,000 in profit, but after adjusting for non-cash expenses like depreciation and changes in working capital (like an increase in trade receivables and trade payables), the net cash from operating activities is ₹5,00,000.

• Investing Activities:

The company spent ₹2,00,000 on purchasing fixed assets, which resulted in a cash outflow of ₹2,00,000.

• Financing Activities:

Company raised ₹1,50,000 by issuing new shares but repaid ₹1,00,000 as loan, resulting in a net cash inflow of ₹50,000.

• Net Cash Position:

Combining all the activities, the company had a net increase in cash and cash equivalents of ₹3,50,000. The cash at the end of the period was ₹4,50,000, considering the opening balance of ₹1,00,000.