Q.Explain, with examples, transactions that affect cash and transactions that do not affect cash. What is meant by cash and cash equivalents?

A transaction affects cash when it causes an actual inflow or outflow of cash and cash equivalents; a non-cash transaction changes profit or the balance sheet but moves no cash.

Cash and cash equivalents. Under AS-3, a cash flow statement deals with cash and cash equivalents. Cash comprises cash in hand and demand deposits with banks. Cash equivalents are short-term, highly liquid investments readily convertible into a known amount of cash and subject to an insignificant risk of value change — for example, treasury bills and very short-maturity (generally up to three months) deposits or marketable securities. Long-term investments and shares held for trading are not cash equivalents.

Transactions that affect cash. These result in an actual inflow or outflow of cash or cash equivalents, and appear in the statement:

• Cash sales and collection from debtors (inflow).
• Cash purchases and payment to creditors (outflow).
• Purchase of machinery for cash (outflow); sale of a fixed asset for cash (inflow).
• Issue of shares or debentures for cash (inflow); repayment of a loan (outflow).
• Payment of cash expenses, tax and dividend (outflow).

Transactions that do NOT affect cash. These change profit or the balance sheet but involve no movement of cash, and are excluded or adjusted out:

• Depreciation on fixed assets — a non-cash charge, added back to net profit.
• Goodwill, preliminary expenses or discount on shares written off — non-cash charges, added back.
• Bonus issue of shares — reserves are converted into share capital; no cash moves.
• Purchase of a fixed asset by issuing shares/debentures — an asset acquired without any cash outflow.
• Conversion of debentures into shares — one liability replaced by another, no cash movement. …

The classic error is treating depreciation as a cash outflow — it is a non-cash charge and is added back, never shown as a payment. Students also sometimes classify a bonus issue as a cash infl …