Fundamentals of Management Accounting · Ch 4 — Working Capital Management and Cash Flow Statements
Preparation of a Cash Flow Statement as per AS-3
Preparation of a Cash Flow Statement as per AS-3
AS-3 requires cash flows to be classified into three activities, and the cash flow statement is built by finding the net cash flow under each and reconciling to the change in cash.
1. Operating activities are the principal revenue-producing activities of the enterprise and other activities that are not investing or financing. These are the cash effects of the firm's main business — cash received from customers, cash paid to suppliers and employees, cash operating expenses, and tax paid. Cash flow from operating activities is the single most important figure, because it shows whether the core business itself generates cash.
2. Investing activities are the acquisition and disposal of long-term assets and investments not counted as cash equivalents — for example, purchase and sale of machinery, land or long-term investments, and interest/dividend received on investments.
3. Financing activities are activities that change the size and composition of the firm's owned and borrowed funds — for example, cash from issuing shares or debentures, repayment of loans, and payment of dividend and interest on borrowings.
| Activity | Typical inflows | Typical outflows |
|---|---|---|
| Operating | Cash from customers | Cash to suppliers, employees, expenses, tax |
| Investing | Sale of fixed assets/investments; interest & dividend received | Purchase of fixed assets and investments |
| Financing | Issue of shares/debentures; loans raised | Repayment of loans; dividend paid; interest paid |
Two methods for operating activities. AS-3 permits the direct method (showing gross cash receipts and payments) and the indirect method (starting from net profit and adjusting for non-cash items and working-capital changes). The indirect method is the one most commonly used and examined; the worked example in this chapter uses it.
Steps under the indirect method (cash from operating activities):
- Start with net profit before tax and extraordinary items (compute it from the increase in the profit balance, adding back tax and proposed dividend if given).
- Add back non-cash and non-operating charges — depreciation, goodwill/preliminary expenses written off, loss on sale of fixed assets, interest on borrowings.
- Subtract non-operating incomes — profit on sale of fixed assets, interest and dividend received (these belong to investing activities).
- This gives operating profit before working capital changes.
- Adjust for changes in current assets and current liabilities (excluding cash): an increase in a current asset or a decrease in a current liability is subtracted; a decrease in a current asset or an increase in a current liability is added. …
The principal revenue-producing activities of a business and other activities that are not investing or financing; their cash effects form the most important par …
The acquisition and disposal of long-term assets and investments (other than cash equivalents), such as purchase or sale of machinery an …
Activities that change the size and composition of a firm's owned and borrowed funds — issue of shares/debentures, raising and repayment of loans …
A method of computing cash from operating activities that starts with net profit and adjusts it for non-cash items and chang …