Cash Flow Statement: Class 12 NCERT Guide for Accountancy

What is a Cash Flow Statement and Its Importance

The Cash Flow Statement is a financial report that summarizes the amount of cash and cash equivalents entering and leaving a company. Unlike the profit and loss account, which is based on accrual accounting, the cash flow statement focuses solely on actual cash transactions.

Importance:

• Helps assess liquidity and solvency of the business
• Shows how well the company generates cash to pay debts and fund operations
• Essential for investors and creditors to evaluate financial health

In Class 12 NCERT Accountancy, mastering the cash flow statement enables students to understand real cash movements beyond just profits.

Components of the Cash Flow Statement Explained

The Cash Flow Statement is divided into three main sections:

1. Operating Activities: Cash flows related to the core business operations. It starts with net profit and adjusts for non-cash items and changes in working capital. 2. Investing Activities: Cash flows from buying or selling fixed assets like machinery or land. 3. Financing Activities: Cash flows from transactions with owners and creditors, such as issuing shares or borrowing funds.

Each section provides insights into different aspects of the business's cash management.

Adjusting for Changes in Working Capital in Cash Flow Statement

Working capital includes current assets and current liabilities. Changes in these affect the cash position and must be adjusted in the cash flow statement.

• Increase in current assets (e.g., trade receivables, inventories) means cash is used, so it is deducted from net profit.
• Decrease in current assets adds cash back.
• Increase in current liabilities (e.g., trade payables, outstanding expenses) means cash is sourced, so it is added to net profit.
• Decrease in current liabilities means cash is used, so it is deducted.

These adjustments ensure the cash flow from operating activities reflects actual cash movements.

How to Prepare Cash Flow Statement: Step-by-Step Approach

Follow these steps to prepare the Cash Flow Statement:

1. Start with Net Profit before Tax and Extraordinary Items. 2. Adjust for Non-Cash Items: Add back depreciation, amortisation, and losses on asset sales; deduct profits on asset sales. 3. Adjust for Working Capital Changes: Add or deduct changes in current assets and liabilities as explained. 4. Calculate Cash Generated from Operations: Sum of above adjustments. 5. Adjust for Income Tax Paid or Refund Received. 6. Prepare separate sections for Investing and Financing Activities based on transactions.

Worked Example:

Given:

• Net Profit before Tax = Rs. 17,000
• Depreciation = Rs. 5,000
• Goodwill Amortised = Rs. 2,000
• Loss on Sale of Equipment = Rs. 3,000
• Profit on Sale of Machinery = Rs. 2,000 (deduct)
• Changes in Working Capital (net) = Rs. 7,000 (add)
• Income Tax Paid = Rs. 5,000
• Income Tax Refund = Rs. 3,000

Calculate net cash inflow from operating activities:

$$ \text{Operating Profit before Working Capital Changes} = 17,000 + 5,000 + 2,000 + 3,000 - 2,000 = 25,000 $$

$$ \text{Cash generated from operations} = 25,000 + 7,000 = 32,000 $$

$$ \text{Net Cash Inflow} = 32,000 - 5,000 + 3,000 = 30,000 $$

Distinguishing Operating, Investing, and Financing Activities

Understanding which transactions belong to each activity is key:

Example:

• Selling machinery of original cost Rs. 3,00,000 with accumulated depreciation Rs. 1,50,000 for Rs. 1,00,000 is an investing activity.
• Interest paid on long-term borrowing by a non-financial company is a financing activity.

Correct classification ensures accurate cash flow reporting.

Common Adjustments and Their Treatment in Cash Flow Statement

Some common adjustments include:

• Depreciation and Amortisation: Non-cash expenses added back to net profit.
• Profit or Loss on Sale of Assets: Profit is deducted; loss is added back.
• Income Tax Paid: Deducted from cash generated from operations.
• Income Tax Refund: Added to cash inflow.

These adjustments reconcile net profit with actual cash generated or used during the period.