The Format of Cash flow statement:
Cash flow statement
For the year ended on 31 Dec, 2011
Components of cash flow statement have been discussed below:
There are three main components of a cash flow statement
1) Operating activities
2) Investing activities
3) Financing activates
These are the main revenue producing activities of a business i.e. the activities of a running business that produce revenue for a business
What do operating activities indicate?
Operating activities are crucial for determining the success of a business’s activities. Negative cash flow from operating activities indicates the revenue is less than the expenses which are incurred to generate this revenue.
Examples of operating activities
- Increase or decrease in debtors
- Increase or decrease in notes receivable
- Increase or decrease in stock
- Increase or decrease in stock/inventory
- Increase or decrease in prepaid expenses
- Increase or decrease in creditors
- Increase or decrease in notes payables
- Increase or decrease in accrued expenses
Adjustments to net profit or net loss figure
As you know income statement is based on accrual concept or principle of accounting not the cash basis of accounting. Income statement includes some items that don’t concern with the movement of cash flows in the accounting period covered by cash flow statement. For example depreciation expenses are included in income statement but it doesn’t affect the cash flows of a business, this is just a bookkeeping entry. Since cash flow statement is based on cash accounting not accrual, you have to adjust some non cash items included in the income statement
The detail of these adjustments to net profit or net loss has been discussed below:
Depreciation expenses don’t affect the cash flows of a business. These expenses are deductions in income statement for the requirements of prudence principle. Since these expenses are subtracted from income statement, the amount of these expenses should be added back to net income or net loss for the purpose of preparing a cash flow statement
Provisions for doubtful debt Adjustments
Provisions for doubtful debt don’t affect the movement of cash in the accounting period related to cash flow statement. Provisions for doubtful debts are similar to the provision for depreciation or depreciation expenses. Provisions for doubtful debts are charged to income statement. Therefore, these provisions should be added back to net income or loss if there is an increase in these provisions whereas these provisions are deduced from net income or loss figure in the cash flow statement if there is a decrease in these provisions
Profit or loss on the sales of fixed assets Adjustment
For example a machine with book value of $5000 is sold for $6000
In this case, $600 is the cash inflow and profit on sale is equal to $1000. Because of the fact that $1000 is a book profit and doesn’t bring cash into the business (since the business will not get extra cash over $6000), these kinds of profits will be deducted from net profit or loss figure for the sake of preparing cash flow statement
In contrary to that the losses on sales of fixed assets are treated as the addition back to net income or loss in the cash flow statement
To sum up profits will be deducted from net income or loss figure. Losses will be added back to net income or loss because these profits or losses are not related to the cash flows of a business.
Here is the operating activities part of cash flow statement
Investing activities include all cash flows that are related to the purchase and disposal of fixed and long term assets
These activities expand or reduce the scale of production of a business
What do investing activities indicate?
If a business purchases more fixed assets as compare to the disposal of these long term assets or investment, it indicates the business is expanding or it is enlarging its operations
On the other hand, if a business is disposing more fixed assets as compare to purchasing or investing in fixed assets, it signifies that the business is contracting or it is diminishing its operations
Examples of investing activities
- Cash payments for the purchase of property, plant and equipment (which are fixed assets)
- Cash payments for the construction of fixed assets
- Cash payment for the purchase of other long term assets for example Shares, debentures etc.
- Cash receipt from sales or disposals of fixed assets
- Cash receipt from the sales or disposals of other long term assets for example Shares, debentures etc.
Financing activities include all cash flows that arise as a result of financing the business activities
A business can finance and start its activities or purchase its long term asset only from two sources one is from Capital and other is from Debts (these are long term debts or liabilities) Financing activities include cash movements caused by introduction of capital by owner (or owners) or getting long term debts and increase or decrease in capital and long term debts.
Examples of financing activities
- Introduction of capital by owner
- Injection of fresh capital in the running business
- Drawing or withdrawals by owner
- Bank loans (long term debt)
- Mortgage loans (long term debt)
- Discharge of or decrease in Bank loan or mortgage loan