Financial and Management Accounting Unit 10

Unit 10 Cash Flow Analysis

Structure:
10.1 Introduction
Objectives
10.2 Meaning of Cash Flow Analysis
10.3 Objectives of Cash Flow Analysis
10.4 Preparation of Cash Flow Statement
10.5 Format of Cash Flow Statement (AS3: Revised Method)
10.6 Cash Flow from Operating Activities
10.7 Differences Between Cash Flow Analysis and Fund Flow Analysis
10.8 Summary
10.9 Glossary
10.10 Terminal Questions
10.11 Answers
10.12 Case Study

10.1 Introduction
In the previous unit we learnt about fund flow analysis with the help of fund
flow statement. We also analysed the objectives and the steps involved in
analysing flow of funds. Cash is the most likeable asset and aspect in our
daily lives. We all like to receive cash and also hold favourable cash
balances. At the same time, it is also an asset that can be most easily
misappropriated. Hence, it is important for a company to give a complete
explanation of the sources of cash and the ways in which cash was applied
during the year. This is the reason why the accounting standard on cash
flow analysis - AS3 has been made mandatory. It requires that every
company must give a statement of the sources of cash and applications of
cash along with the financial statements. In this unit, we shall understand in
detail how to make cash flow analysis and how to present it.

Objectives:
After studying this unit, you should be able to:
• explain the meaning of cash flow analysis
• analyse the objectives of cash flow analysis

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• prepare cash flow statement as per accounting standard 3 using direct

method and indirect method
• interpret the cash flow statement and comment on the appropriateness
of investing and financing decisions
• distinguish between cash flow analysis and funds flow analysis

10.2 Meaning of Cash Flow Analysis

Cash flow analysis is an important tool of financial analysis. It is the process
of understanding the change in position with respect to cash in the current
year and the reasons responsible for such a change. Incidentally, the
analysis also helps us to understand whether the investing and financing
decision taken by the company during the year are appropriate are not.
Cash flow analysis is presented in the form of a statement. Such a
statement is called a cash flow statement.

10.3 Objectives of Cash Flow Analysis

Cash flow analysis is done with the objective of understanding some of the
following important questions:
• What is the change in the cash position of the firm for the current year
as compared to the previous year?
• How good was the liquidity position of the firm?
• What were the sources of cash during the current year?
• How much cash was generated from operations?
• What were the applications of cash during the current year?
• How much cash was spent on investment activities, such as purchase of
new plant and machinery, purchase of land?

10.4 Preparation of Cash Flow Statement

The preparation of cash flow statement is similar to the preparation of fund
flow statement. It requires the identification of the sources of cash and the
uses of cash.
A source of cash is a transaction which brings an inflow of cash. An
application of cash is a transaction which leads to an outflow of cash.

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Following is the list of transactions that results in a source of cash or

application of cash.
Sources of cash:
• Cash from operations
• Proceeds of issue of
o Equity shares
o Preference shares
• Proceeds of issue of
o Debentures
o Bonds
• Raising long-term debts from banks and financial institutions
• Raising mortgage loans (long-term)
• Sale of assets
o Tangible assets like land, buildings, equipments, machinery,
vehicles, etc.
o Intangible assets like patent rights, copyrights, brand names,
goodwill, licences, etc.
• Sale of investments like shares, bonds, debentures, etc.
Applications or uses of cash:
• Cash lost in operations (adjusted net loss)
• Buy back of equity shares
• Redemption of redeemable preference shares
• Redemption of redeemable bonds or debentures
• Repaying of long-term debts from banks and financial institutions
• Repaying of mortgage loans (long-term)
• Purchasing of assets
o Tangible assets like land, buildings, equipments, machinery,
vehicles, etc.
o Intangible assets like patent rights, copyrights, brand names,
goodwill, licences, etc.
• Purchasing of investments like shares, bonds, debentures, etc.
It may be noted that the sources of cash increase the cash balance and
applications of cash decrease the cash balance.

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10.5 Format of Cash Flow Statement (AS3: Revised Method)

The format of a cash flow statement is given below. Accounting Standard 3
(AS3) - cash flow statement
The Institute of Chartered Accountants of India has issued AS3 on cash flow
statement. AS3 is now mandatory. It is applicable to every company listed
on a stock exchange with a turnover of Rs.50 crore or more. It is mandatory
for such companies to prepare a cash flow statement every year and
present it along with financial statements (profit and loss account and
balance sheet). Therefore, it is important for us to understand the important
definitions and provisions of the Standard.
The important paragraphs from AS3 are reproduced below.

Cash comprises cash on hand and demand deposits with banks.

Cash equivalents are short term, highly liquid investments that are readily
convertible into known amounts of cash and which are subject to an
insignificant risk of changes in value.
Cash flows are inflows and outflows of cash and cash equivalents.
Operating activities are the principal revenue-producing activities of the
enterprise and other activities that are not investing or financing activities.
Investing activities are the acquisition and disposal of long-term assets
and other investments not included in cash equivalents.
Financing activities are activities that result in changes in the size and
composition of the owners’ capital (including preference share capital in
the case of a company) and borrowings of the enterprise.
Examples of cash flows from Operating activities are:
a) cash receipts from the sale of goods and the rendering of services;
b) cash receipts from royalties, fees, commissions and other revenue;
c) cash payments to suppliers for goods and services;
d) cash payments to and on behalf of employees;
e) cash receipts and cash payments of an insurance enterprise for
premiums and claims, annuities and other policy benefits;
f) cash payments or refunds of income taxes unless they can be
specifically identified with financing and investing activities; and

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g) cash receipts and payments relating to futures contracts, forward

contracts, option contracts and swap contracts when the contracts
are held for dealing or trading purposes.
Examples of cash flows arising from Investing activities are:
a) cash payments to acquire fixed assets (including intangibles). These
payments include those relating to capitalised research and
development costs and self-constructed fixed assets;
b) cash receipts from disposal of fixed assets (including intangibles);
c) cash payments to acquire shares, warrants or debt instruments of
other enterprises and interests in joint ventures (other than payments
for those instruments considered to be cash equivalents and those
held for dealing or trading purposes);
d) cash receipts from disposal of shares, warrants or debt instruments
of other enterprises and interests in joint ventures (other than
receipts from those instruments considered to be cash equivalents
and those held for dealing or trading purposes);
e) cash advances and loans made to third parties (other than advances
and loans made by a financial enterprise);
f) cash receipts from the repayment of advances and loans made to
third parties (other than advances and loans of a financial
enterprise);
g) cash payments for futures contracts, forward contracts, option
contracts and swap contracts except when the contracts are held for
dealing or trading purposes, or the payments are classified as
financing activities; and
h) cash receipts from futures contracts, forward contracts, option
contracts and swap contracts except when the contracts are held for
dealing or trading purposes, or the receipts are classified as
financing activities.
Examples of cash flows arising from Financing activities are:
a) cash proceeds from issuing shares or other similar instruments;
b) cash proceeds from issuing debentures, loans, notes, bonds, and
other short or long-term borrowings; and
c) cash repayments of amounts borrowed.

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Cash flows from operating activities can be found out by

a) the direct method, whereby major classes of gross cash receipts and
gross cash payments are disclosed; or
b) the indirect method, whereby net profit or loss is adjusted for the
effects of transactions of a non-cash nature, any deferrals or
accruals of past or future operating cash receipts or payments, and
items of income or expense associated with investing or financing
cash flows.

(Source: Institute of Chartered Accountants of India www.icai.org )

Cash Flow Statement (Indirect Method) for the year ending on……
1. Cash flow from operating activities
Net profit before taxation and extraordinary items:
Adjustments for
• Depreciation
• Foreign exchange loss
• Interest income
• Dividend income
• Interest expenses
Operating profit before working capital changes
(+) Decrease/(-)Increase in Sundry Debtors
(+) Decrease/(-)Increase in Inventories
(-) Decrease/(+)Increase in Sundry Creditors
Cash generated from operations
Income tax paid
Cash flow from extraordinary items
Proceeds from earthquake disaster settlement
Net cash flow from operating activities (i)
Cash flow from investing activities
Purchase of fixed assets
Proceeds from sale of equipment
Interest received
Dividends received
Net cash flow from investing activities (ii)

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Cash flow from financing activities

Proceeds from issuance of share capital
Proceeds from long-term borrowings
Repayment of long-term loans
Interest paid
Dividends paid
Net cash used in financing activities (iii)
Net increase in cash and cash equivalent (i)+(ii)+(iii)
(+)Cash and cash equivalents at the beginning of the
period
= Cash and cash equivalents at the end of the period

The closing balance of cash and cash equivalent should tally with the cash
and bank balance of the balance sheet.

10.6 Cash Flow from Operating Activities

While the cash flow from investing and financing activities can be directly
assessed, cash flow from operating activities needs to be computed as it is
not directly available.
As provided in the Standard, the cash flow arising from operating activities
can be computed using direct method or indirect method.
Direct Method
Under this method, the major classes of gross cash receipts are added.
From this, the total of major classes of gross cash payments is deducted.
The balance is taken as the net cash flow from operating activities.

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The format is given below.

Particulars Rs.
Sales
+Royalties
+Other operating incomes (if any)
Total cash receipts (A)
Less:
Production OHs
Administrative OHs
Selling and distribution OHs
Other operating expenses (if any)
Total cash payments (B)
Net cash flow from operating activates (A)-(B)

Indirect Method
Under this method, the net profit shown in the profit and loss account has to
be adjusted for non-cash items to find out the operating profit before the
working capital changes. Some of these items are as follows:
i. Depreciation
ii. Amortisation of intangible assets like goodwill, preliminary expenses,
etc.
iii. Loss on sale of fixed assets
iv. Gains from sale of fixed assets
v. Creation of reserves like reserves for bad debts, general reserve,
etc.
Cash generated from operations
To find the cash from operations, adjustments will have to be made for
‘changes’ in current assets and current liabilities arising on the account of
operations.
• Any decrease in current assets or any increase in current liabilities
between two periods should be added back to the operating profit before
the working capital changes.
• Likewise, any increase in current assets or any decrease in current
liabilities should be deducted from the operating profit before the
working capital changes to arrive at the cash generated from operations.

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Figure 10.1 depicts the operating profit before the working capital changes.

= Cash Generated from Operations

Figure 10.1: Operating Profit Before Working Capital Changes

Computation of net cash flow from operating activities

Through cash generated from operations, income tax paid and cash flow
from extraordinary items (if any) should be adjusted (subtracted) to arrive at
net cash flow from operating activities.
Computation of net increase in cash and cash equivalent
The net cash flow from operating, investing, and financing activities is added
to arrive at net increase in cash and cash equivalent. To this, cash and cash
equivalent at the beginning of the period are added to get cash and cash
equivalent at the end of the period.

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Self Assessment Questions

1. Preparation and submission of cash flow statement is mandatory
according to ______________.
2. Cash flow statement has three sub divisions- _________________,
________________________, and ______________________.
3. Since depreciation, a component of internal source does not result in
outflow of cash; the depreciation amount is ______ to the net profit.
4. Give any three internal sources of cash that do not result in outflow of
cash.
5. Decrease in liability denotes ____________ of cash.
6. Purchase of plant and machinery on deferred payment basis is shown
separately as a source of cash or ________________.
7. Income tax paid is __________activity. (operating/investing/financing).
8. Purchase of fixed assets is cash flow from ______________ activity.
(financing/ investing).
9. Repayment of long-term loans and dividend paid is _____________
activity (financing/investing).
10. Net increase in cash and cash equivalent + ____________________ =
cash and cash equivalent at the end of the period.
11. Decrease in sundry debtors should be _________ to operating profit
before working capital changes.
12. Increase in sundry creditors should be _________ to operating profit
before working capital changes.
Let us now look at some illustrations to understand the cash flow
computations and analysis.
Illustration 1: Compute cash flow from operating activities from the profit
and loss account and the balance sheet given below.

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Profit and Loss Account

To By
Cost of goods sold 4,00,000 Sales including cash sales 5,00,000
1,00,000
Office expenses 12,000 Profit on sale of land 30,000
Depreciation 6,000
Loss on sale of plant 4,000
Goodwill written off 3,000
Income tax 7,000
Net profit 1,10,000
5,50,000 5,50,000

Balance Sheet as on ……….

MARCH 31
2006 2007
Stock 30,000 28,000
Debtors 15,000 12,000
Bills receivable 6,000 8,000
Creditors 10,000 12,000
Bills payable 8,000 5,000
Outstanding expenses 4,000 5,000

Solution:
Statement showing cash flow from operating activities
Net Profit before tax and extraordinary items 1,10,000
Add : income tax 7,000
Adjustments for Depreciation 6,000
Goodwill written off 3,000
Loss on sale of plant 4,000
1,30,000
Less: Profit on sale of land 30,000
Interest received 20,000 (50,000)

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Operating profit before working capital changes 80,000

Add : Decrease in current assets
Stock 2,000
Debtors 3,000
Increase in current liabilities : Creditors 2,000
Outstanding expenses 1,000 8,000
Less :Increase in current assets : Bills Receivable 2.000
Decrease in current liabilities : Bills payable 3,000 (5,000)
Cash generated from operating activities 83,000
Less : Payment of income tax (7000)
Net Cash from operating Activities 76,000

Illustration 2: Following is the balance sheet for the period ending 31st
March 2006 and 2007. If the current year’s net loss is Rs.38,000, calculate
the cash flow from operating activities.
31st MARCH
2006 2007
Short-term loan to employees 15,000 18,000
Creditors 30,000 8,000
Provision for doubtful debts 1,200 -
Bills payable 18,000 20,000
Stock in trade 15,000 13,000
Bills receivable 10,000 22,000
Prepaid expenses 800 600
Outstanding expenses 300 500

Solution:
Statement Showing Cash Flow from Operating Activities
Net Loss (38,000)
Add: Decrease in current assets
Decrease in stock 2,000
Decrease in prepaid expenses 200
Increase in current liabilities
Increase in outstanding expenses 200
Increase in bills payable 2,000 + 4,400
(33,600)

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Less: Increase in current assets

Increase in short-term loan to the employees 3,000
Increase in bills receivable 10,000
Decrease in creditors 22,000
Decrease in provision for doubtful debts 1,200 (36,200)
Net cash lost in operating activities (69,800)

Illustration 3: Following is the balance sheet of Amit and Bros. for the year
ending 31st March 2006 and 2007. You are required to prepare cash flow
statement using indirect method.
Balance Sheet as on 31st March, 2006 and 2007
Liabilities 2006 2007
Share capital 2,00,000 2,50,000
General reserve 50,000 60,000
Profit and loss 30,500 30,600
Bank loan (long-term) 70,000 -
Sundry creditors 1,50,000 1,35,200
Provision for taxation 30,000 35,000
Total 5,30,500 5,10,800
Assets
Land and building 2,00,000 1,90,000
Machinery 1,50,000 1,69,000
Stock 1,00,000 74,000
Sundry debtors 80,000 64,200
Cash 500 600
Bank - 8,000
Goodwill - 5,000
Total 5,30,500 5,10,800

Additional Information:
During the year ended 31st December, 2007
1. Dividend of Rs. 23,000 was paid
2. Assets of another company were purchased for a consideration of
Rs. 50,000 payable in shares. The assets include Stock Rs. 20000,
Machinery Rs. 25,000
3. Machinery was further purchased for Rs. 8000

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4. Depreciation written off on machinery Rs. 12,000

5. Income tax provided during the year Rs. 33,000
6. Machinery worth Rs. 2000 was sold for Rs. 1800. Loss on sale of
machinery Rs. 200 was transferred to general reserve.

Solution:
Cash Flow Statement
for the year ending 31st December, 2007
(Indirect Method)
1. Cash flow from operating activities
Net profit during the year 100
Add: Provision for taxation 33,000
transfer to general reserve 10,200
dividend paid 23,000 66,300
Add: Depreciation on machinery 12,000
Add: Depreciation on building 10,000
Operating profit before working capital changes 88,300
Add: Decrease in stock 46,000
Add: Decrease in debtors 15,800
Less: Decrease in creditors (14,800)
Less: Income tax paid during the year (28,000)
Net cash flow from operating activities 1,07,300
II. Cash flow from investing activities:
Sale of machinery 1,800
Purchase of machinery (8000)
Net cash flow from investing activities (6,200)

III. Cash flow from financing activities

Mortgage loan repaid (70,000)
Dividend paid (23,000)
Net cash flow from financing activities (93,000)
Net Increase in cash and cash equivalents 8,100
Cash and cash equivalents at the beginning 500
Cash and cash equivalents at the end of the period 8,600

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Comment:
There has been a net cash outflow (Rs. 93,000) on account of financing
activities, which is the repayment of mortgage loan. From the statement, it is
obvious that this repayment of loan has been funded from the net cash
inflows from operating activities (Rs.1,07,300). This is a good way of funding
repayment of loans.
Working Notes:
Land and Building A/c
Particulars Rs. Particulars Rs.
To Op. bal b/d 2,00,000 By Adjusted P & L A/c 10,000
[Depreciation – Bal. Fig.]
By Cl. Balance C/d 1,90,000
2,00,000 2,00,000

Machinery A/c
Particulars Rs Particulars Rs.
To Op. Balance B/d 1,50,000 By Adjusted P & L A/c 12,000
[Depreciation]
To Share Capital A/c 25,000 By Gen. Reserve A/c 200
[Purchase of Shares] [Loss on Sale]
To Cash A/c [Purchase] 8,000 By Cash A/c [Sale] 1,800
By Cl. Balance C/d 1,69,000
1,83,000 1,83,000

Goodwill A/c
Particulars Rs. Particulars Rs.
To Op. Balance B/d - By Cl. Balance C/d 5,000
To Share Capital A/c 5,000
5,000 5,000

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Share Capital A/c

Particulars Rs. Particulars Rs.
To Cl. Balance C/d 2,50,000 By Op. Balance B/d 2,00,000
By Stock 20,000
By Machinery A/c 25,000
By Goodwill A/c 5,000
2,50,000 2,50,000

General Reserve A/c

Particulars Rs. Particulars Rs.
To Machinery A/c 200 By Op. Balance B/d 50,000
To Cl. Balance C/d 60,000 By Adjusted P & L A/c 10,200
60,200 60,200

Bank Loan A/c

Particulars Rs Particulars Rs.
To Cash A/c [Repayment] 70,000 By Op. Bal b/d 70,000
[Trf. to Fund Flow Stnt.]
To Cl. Balance c/d -
70,000 70,000

Provision for Tax A/c

Particulars Rs. Particulars Rs.
To Cash A/c [I - Tax Paid] 28,000 By Op. Balance B/d 30,000
To Cl. Balance C/d 35,000 By Adjusted P & LA/c 33,000
Balancing Fig.]
63,000 63,000

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Adjusted Profit and Loss A/c

Particulars Rs. Particulars Rs.
To Depreciation on Land 10,000 By Balance C/d 30,500
and Building.
To Depreciation on 12,000 By Funds from Operation 88,300
Machinery [Balancing Fig.]
To Gen. Reserve A/c 10,200
To Provision for Taxation 33,000
To Dividend 23,000
To Balance C/d 30,600
1,18,800 1,18,800

Self Assessment Questions

13. Dividend received is ____________ activity because income is
received from investment in shares of another company.
14. Dividend paid is _____________ activity.

Activity 1:
State whether the following cash flows are Operating, Investing, or
Financing.
1. Cash paid for purchase of machinery.
2. Payment of loan instalment.
3. Cash receipts from the sale of goods and rendering of services.
4. Sale of patent rights.
5. Cash payments to trade creditors.
6. Proceeds of debenture issue.
7. Copyrights purchased.
8. Tax on profit paid.
9. Customs duty paid for importing machinery.
10. Purchase of shares or debentures of other enterprises.
11. Advances and loans made to third parties by a non-financial
enterprise.
12. Cash receipts from the repayment of advances and loans of a
financial enterprise.
13. Shares bought by RD ltd.
14. Shares bought by Mr. Rangadas, a stock broker.
15. Redemption of preference shares.
16. Purchase of interests in joint ventures.
17. Advances and loans made to third parties by a financial enterprise.

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Activity 1: Solution
Operating:3,5,8,12,14,17,
Investing: 1,4,7,9,10,11,13,16
Financing:2,6,15

10.7 Difference Between Cash Flow Analysis and Fund Flow

Analysis
Table 10.1 shows the differences between cash flow analysis and fund flow
analysis.
Table 10.1: Difference Between Cash Flow Analysis and Fund Flow Analysis
Cash Flow Analysis Fund Flow Analysis
1. It is concerned only with the 1. It is concerned with change in working
change in cash position capital position between two balance
sheet dates.
2. It is merely a record of cash 2. Net effect of receipts and
receipts and disbursements disbursements are recorded.
3. Cash is part of working capital and 3. An improvement in funds positions
therefore an improvement in cash need not result in improvement in cash
position results in improvement in position
the funds position
4. It is cash based 4. It is accrual based

10.8 Summary
Let us recapitulate the important concepts discussed in this unit:
• Cash flow statement shows the movement of cash and their causes.
According to Accounting Standard 3, it is mandatory to prepare and
present cash flow statements along with the statement of financial
position and statement of income position at the end of the accounting
period.It may be prepared using the direct method or the indirect
method.
• Under direct method, major gross cash receipts are added. From this,
the major gross cash payments are deducted to arrive at the cash flow
from operating activates.
• Under indirect method, non-operating and non-cash debits to P/L are
added back to net profit to arrive at the cash flow from operating
activates.
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10.9 Glossary
Financing activities: Activities that result in changes in the size and
composition of the owners’ capital.
Investing activities: Acquisition and disposal of long-term assets and
other investments not included in cash equivalents.
Operating activities: Principal revenue producing activities of the
enterprise.

10.10 Terminal Questions

1. What is cash flow statement and how is the cash flow statement
subdivided?
2. Bring out the draft format of cash flow statement as per AS3 (revised)
method?
3. What is cash flow from operating activities?
4. Bring out the difference between cash flow analysis and fund flow
analysis.
5. From the following balance sheets of Joy Ltd., prepare a cash flow
statement under indirect method.
Liabilities 2005 2006
Equity share capital 3,00,000 4,00,000
8% redeemable pref. share capital 1,50,000 1,00,000
General reserve 40,000 70,000
Profit and loss 30,000 48,000
Proposed dividend 42,000 50,000
Sundry creditors 55,000 83,000
Bills payable 20,000 16,000
Provision for taxation 40,000 50,000
Total 6,77,000 8,17,000
Assets
Goodwill 1,15,000 90,000
Land and building 2,00,000 1,70,000
Plant 80,000 2,00,000
Sundry debtors 1,60,000 2,00,000
Stock 77,000 1,09,000
Bills receivable 20,000 30,000
Cash 15,000 10,000
Bank 10,000 8,000
Total 6,77,000 8,17,000

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Additional Information
a) Depreciation of Rs.10,000 and Rs.20,000 has been changed on plant
and building during the current year.
b) An interim dividend of Rs.20,000 has been paid during the current year.
c) Rs.35,000 was paid during the current year for income tax.

10.11 Answers

Self Assessment Questions

1. AS3
2. a. Net cash flow from operating activities
b. Net cash flow from investment activities
c. Net cash flow from financing activities
3. Added back
4. Depreciation, amortisation of intangible assets, gains from sale of fixed
assets
5. Outflow
6. Deferred credit
7. Operating
8. Investing
9. Financing
10. Cash and cash equivalent at the beginning of the year
11. Added
12. Added
13. Investment
14. Financing

Terminal Questions
1. Cash flow analysis is presented in the form of a statement. Such a
statement is called a cash flow statement. Refer to unit 10.2 and 10.5
2. The Institute of Chartered Accountants of India has issued AS3 on cash
flow statement. Refer to unit 10.5
3. The cash flow arising from operating activities can be computed using
direct method or indirect method. Refer to unit 10.6
4. Refer to unit 10.7 for differences between cash flow analysis and fund
flow analysis.
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5. Cash flow from operating activities Rs.1,25,000; Cash flow from

investing activities (Rs.1,20,000); Cash flow from financing activities
(Rs.12,000).

10.12 Case Study

Cash Flow Statement
Western Telecommunication Company’s profit and loss account for the year
ended 31st January, 2008 and balance sheet on 31st January, 2007 and
2008 are as follows:
Western Telecommunitcation Company: Profit and Loss Account,
For the year ended 31st January, 2008
Rs.
Sales 570,000
Interest income 2,000
Gain on sale of investments 7,000
Cost of goods sold 445,000
Depreciation expense 89,000
Selling and administrative expenses 46,000
Interest expense 14,000
Loss on sale of plant and machinery 3,000
Profit before income tax and extraordinary item (18,000)
Income tax 0
Profit before extraordinary item (18,000)
Extraordinary item
Insurance proceeds from earthquake loss claim 0
Net profit (18,000)

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Western Telecomminication Company

Balance sheet, 31st January
2008 2007
Sources of funds
Shareholders’ funds Rs. Rs.
Equity share capital 155,000 85,000
Profit and loss account 102,000 120,000
Total shareholders’ funds 257,000 205,000

Loan funds
Secured loans 97,000 57,000
Unsecured loans 181,000 191,000
Total loan funds 278,000 248,000

Current liabilities
Bills payable 6,000 9,000
Creditors 24,000 178,000
Income tax payable 9,000 17,000
Total current liabilities 39,000 2,04,000
574,000 657,000

Application of Funds
Rs Rs
Fixed assets 720,000 540,000
Plant and machinery cost 362,000 305,000
Less: accumulated depreciation, plant and 358,000 235,000
machinery 18,000 66,000
Fixed assets, net

Investments 119,000
Current assets 151,000
Inventories 29,000 166,000
Debtors (less provision for doubtful debts Rs.8,000 6,000 2,000
and Rs.12,000) 12,000 69,000
Prepaid expenses 198,000 356,000
Cash and cash equivalents
Total current assets 574,000 657,000

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Financial and Management Accounting Unit 10

Additional information:
1. Purchased machinery costing Rs.150,000 with cash.
2. Sold machinery with cost of Rs.45,000 and accumulated depreciation
of Rs.32,000 for Rs.10,000.
3. Purchased investment for Rs.30,000.
4. Sold investments costing Rs.78,000 for Rs.85,000
5. Purchased machinery for Rs.75,000 in exchange for secured
debentures.
6. Issued at par shares for Rs.50,000.
7. Convert secured debentures of Rs.20,000 to equity shares of Rs.10
par.
8. Repaid unsecured loans of Rs.10,000.
9. Redeemed secured debentures of Rs.15,000 at par.
10. Wrote off Rs.14,000 of debtors when a customer became insolvent and
provided Rs.10,000 for doubtful debts, included in selling and
administrative expenses.
Discussion Questions:
1. Prepare the cash flow statement according to the direct method.
2. Prepare the cash flow statement according to the indirect method.
3. Clearly mention the disclosures required.
Source: Narayanaswamy, R., Financial Accounting, A Managerial Perspective
3/e, by PHI

Solution to Case study

1. Cash flow statement – Direct method
Western Telecomminication Company:
Cash Flow Statement for the year ended 31st January, 2008
Cash flow from operating activities
Cash received from customers (i) Rs.697,000
Cash paid to suppliers and employees (ii) (674,000)
Cash generated from operations 23,000
Income tax paid (iii) (8,000)
Cash flow before extraordinary item 15,000
Extraordinary item 0
Net cash provided by operating activities Rs 15,000

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Financial and Management Accounting Unit 10

Cash flow from investing activities

Purchase of plant and machinery Rs.(150,000)
Proceeds from sale of plant and machinery 10,000
Purchase of investment (30,000)
Proceeds from sale of investments 85,000
Interest received 2,000
Net cash provided by investing activities (83,000)

Cash flow from financing activities

Proceeds from issuance of share capital Rs. 50,000
Repayments of unsecured loan (10,000)
Redemption of secured debentures (15,000)
Interest paid (14,000)
Net cash provided by financing activities 11,000
Net decrease in cash and cash equivalents (57,000)
Cash and cash equivalents at the beginning of
period 69,000
Cash and cash equivalents at the end of period 12,000

The following is a supplemental schedule of non-cash investing and

financing activities.
1. The company purchased machinery for Rs.75,000 in exchange for
secured debentures.
2. The company converted secured debentures of Rs.20,000 into equity
shares of Rs.10 at par.
Disclosure of Accounting Policy
For purposes of the cash flow statement, the company considers all highly
liquid debt instruments purchased with a maturity of three months or less
from the date of acquisition to be cash equivalents.
Notes:
(i) (570,000 + 178,000 – 37,000 – 14,000)
(ii) (445,000 + 46,000 – 119,000 – 2,000 + 9,000 + 178,000 + 151,000 +
6,000 – 6,000 – 24,000 – 10,000)
(iii) (17,000 – 9,000)

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Financial and Management Accounting Unit 10

2. Cash flow statement – Indirect method

Western Telecommunication Company:
Cash Flow Statement for the year ended 31st January, 2008
Cash flow from operating activities Rs.
Net profit before income tax and extraordinary item (18,000)
Adjustments to reconcile net profit to net cash flow
from operating activities
Depreciation 89,000
Provision for doubtful debts 10,000
Loss on sale of plant and machinery 3,000
Gain on sale of investments (7,000)
Interest expense 14,000
Interest income (2,000)
Operating profit before working capital changes 89,000
Decrease in debtors (including bad debts written off) 127,000
Increase in inventories (32,000)
Increase in prepaid expenses (4,000)
Decrease in bills payable (3,000)
Decrease in creditors (154,000)
Cash generated from operations 23,000
Income tax paid (8,000)
Cash flow before extraordinary item 15,000
Extraordinary item:
Proceeds from earthquake insurance
claim 0 Rs
Net cash provided by operating activities 15,000
Cash flow from investing activities Rs
Purchase of plant and machinery (150,000)
Proceeds from sale of plant and machinery 10,000
Purchase of investments (30,000)
Proceeds from sale of investments 85,000
Interest received 2,000
Net cash provided by investing activities (83,000)

Cash flow from financing activities Rs

Proceeds from issuance of share capital 50,000
Repayment of unsecured loan (10,000)
Redemption of secured debentures (15,000)
Interest paid (14,000)
Net cash provided by financing activities 11,000
Net decrease in cash and cash equivalents (57,000)
Cash and cash equivalents at the beginning of period 69,000
Cash and cash equivalents at the end of period 12,000

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Financial and Management Accounting Unit 10

The following is a supplemental schedule of non–cash investing and

financing activities.
1. The company purchased machinery for Rs.75,000 in exchange for
secured debentures.
2. The company converted secured debentures of Rs.20,000 to equity
shares of Rs.10 at par.
Disclosure of Accounting Policy
For purposes of the cash flow statement, the company considers all highly
liquid debt instruments purchased with a maturity of three months or less
from the date of acquisition to be cash equivalents.

References:
• Narayanaswamy R., Financial Accounting, A Managerial Perspective
3/e, by PHI
• Khan and Jain, Management Accounting 4/e, TMH
• Dr. Lal J., Accounting for Management, HPH
• Chandra P., Financial Management, TMH

E-Reference:
• www.icai.org – retrieved on 24th December 2011

Manipal University Jaipur Page No.: 272