Cash Flow Statement

2.1 Core concepts

• A Cash Flow Statement provides information about historical changes in cash and cash equivalents by classifying cash flows into operating, investing and financing activities; an enterprise must present it for each accounting period for which financial statements are presented (NCERT §6 intro, p. 241–242).
• Primary objective: to provide users with useful information about cash flows under three heads — operating, investing and financing — to assess the enterprise's ability to generate cash and its needs to utilise those cash flows (NCERT §6.1, p. 242).
• Benefits: evaluating changes in net assets, financial structure (liquidity & solvency), comparability across enterprises by eliminating effects of different accounting treatments, and balancing cash inflow–outflow (NCERT §6.2, p. 242).
• Cash = cash in hand + demand deposits with banks. Cash equivalents = short-term, highly liquid investments readily convertible into known amounts of cash and subject to insignificant risk of changes in value — must normally have a short maturity of three months or less from the date of acquisition (NCERT §6.3, p. 243).
• Investments in shares are excluded from cash equivalents unless they are in substance cash equivalents (e.g., preference shares acquired shortly before a specified redemption date) (NCERT §6.3, p. 243).
• Cash Flows = movement of cash in (inflow) and out (outflow) due to non-cash items, e.g., cash received on sale of machinery (inflow), cash paid to purchase machinery (outflow) (NCERT §6.4, p. 243).
• Purchase of marketable securities/short-term investments that constitute cash equivalents is NOT shown in cash flow statement — it is treated as cash management (NCERT §6.4, p. 243).
• AS-3 mandates classification into three categories: (1) Operating, (2) Investing, (3) Financing (NCERT §6.5, p. 243).
• Operating activities = principal revenue-producing activities of the enterprise; not investing or financing. Examples of inflows: receipts from sale of goods/services, royalties, fees, commissions. Examples of outflows: payments to suppliers, employees, insurance premiums, income tax paid (unless specifically identified with financing/investing) (NCERT §6.5.1, p. 244).
• For a financial enterprise, cash advances/loans made are operating activities; for others they are not (NCERT §6.5.1, p. 244).
• Investing activities = acquisition and disposal of long-term assets and other investments not included in cash equivalents. Inflows: sale of fixed assets/intangibles, repayment of loans by third parties, sale of shares/debentures of other enterprises, interest received, dividend received from investments. Outflows: purchase of fixed assets, intangibles, shares/debentures of other enterprises, advances/loans to third parties (NCERT §6.5.2, p. 244–245).
• Financing activities = activities that change the size and composition of owners' capital (including preference share capital) and borrowings of the enterprise. Inflows: proceeds from issue of shares, debentures, bonds, long-term/short-term borrowings. Outflows: repayment of borrowings, interest paid on debentures/long-term loans, dividends paid on equity & preference capital (NCERT §6.5.3, p. 245–246).
• Treatment of peculiar items (§6.5.4, p. 247): Extraordinary items (loss by theft/earthquake/flood) — disclosed separately under the activity they relate to. Interest paid, interest received and dividend received — for a financial enterprise these are operating; for a non-financial enterprise interest/dividend paid is financing while interest/dividend received is investing. Dividend paid by a non-financial enterprise is always a financing activity.
• Taxes on Income (§6.5.4, p. 247): generally classified as operating cash flows; however dividend distribution tax goes with dividend (financing), and capital gains tax on sale of fixed assets goes under investing.
• Non-cash transactions (e.g., acquisition of machinery by issue of equity shares; redemption of debentures by issue of equity shares) must be excluded from the cash flow statement and disclosed elsewhere (NCERT §6.5.4, p. 247).
• Proposed Dividend: As per AS-4, proposed dividend is shown in Notes to Accounts as contingent liability since it becomes a liability only after shareholders' approval. Previous year's proposed dividend, once declared in current year's AGM, is added back to net profit (under operating) and shown as outflow under financing activities (NCERT §6.6 box, p. 249).
• Indirect Method (§6.6.1, p. 250): start with Net Profit/Loss before Tax and Extraordinary Items. Add non-cash items (depreciation, goodwill written-off, provisions, amortisation, loss on sale of fixed assets) and non-operating expenses (interest paid). Deduct non-operating incomes (interest received, dividend received, profit on sale of fixed assets). Then adjust for working capital changes — increase in current asset = deduct; decrease in current asset = add; increase in current liability = add; decrease in current liability = deduct. Deduct income tax paid. Add/deduct extraordinary items. The result is Net Cash from Operating Activities (NCERT §6.6.1 + Exhibit 6.4, p. 251–252).
• Direct Method discloses major classes of gross cash receipts and gross cash payments; the indirect method is used by most companies in practice (NCERT §6.6, p. 249).
• Ascertaining cash from investing & financing activities (§6.7, p. 258): all major items of gross receipts, gross payments and net cash flows must be shown separately under each head. Profit on sale of fixed assets is deducted from operating profit but full sale proceeds appear under investing; similarly loss on sale is added back to operating profit.
• Preparation (§6.8, p. 261): the net of (A) Operating + (B) Investing + (C) Financing = Net Increase/Decrease in Cash and Cash Equivalents. Adding opening cash & cash equivalents gives closing cash & cash equivalents, which must match the balance sheet figure.

2.2 Definitions to memorise

2.3 Diagrams / processes to remember

• Exhibit 6.1 (p. 246): Tree diagram showing Cash Inflows vs. Cash Outflows for each of the three activities — useful to memorise classification of items at a glance.
• Exhibit 6.2 (p. 248): Format of Cash Flow Statement showing A + B + C structure plus opening and closing cash & cash equivalents.
• Exhibit 6.4 (p. 251–252): Proforma of Cash Flows from Operating Activities (Indirect Method) — Net Profit before Tax → add non-cash & non-operating expenses → less non-operating incomes → Operating Profit before Working Capital Changes → adjust for working-capital movements → less Income Tax Paid → +/- Extraordinary Items → Net Cash from Operating Activities.
• Illustration 5 (p. 258): Machinery Account + Accumulated Depreciation Account method to find purchase/sale of fixed assets — standard CUET problem-solving framework.

2.4 Common confusions / NTA trap points

• Interest/dividend received vs. paid for a non-financial enterprise: received = investing; paid = financing. Many students wrongly classify all interest under operating.
• Proposed dividend is NOT shown in cash flow statement at the time of proposing; it is shown only when declared (in next AGM) — previous year's proposed dividend is added back to net profit and shown as financing outflow.
• Profit on sale of fixed asset = deduct from net profit under operating; full sale proceeds appear under investing. Loss on sale = add back to net profit under operating; full sale proceeds still under investing.
• Purchase of marketable securities / short-term investments that constitute cash equivalents is NOT shown as cash outflow — it is cash management.
• Acquisition of machinery by issue of equity shares is a non-cash transaction — excluded from the cash flow statement entirely.
• For a financial enterprise (bank/NBFC), interest paid, interest received and dividend received are all operating; dividend paid remains financing.
• Working capital adjustments direction. Increase in current asset = deduct; Decrease in current asset = add; Increase in current liability = add; Decrease in current liability = deduct. The single most-inverted rule in CUET (NCERT §6.6.1, p. 251).
• Cash equivalents threshold. Maturity ≤ 3 months from acquisition (NCERT §6.3, p. 243).
• Income tax paid. Generally classified as operating; capital gains tax on sale of fixed assets goes to investing; dividend distribution tax goes with dividend (financing) (NCERT §6.5.4, p. 247).
• Profit on sale of fixed asset. Deduct from net profit under operating; full sale proceeds appear under investing — splitting the same transaction (NCERT §6.7, p. 258).

2.5 Journal entry templates

A Cash Flow Statement is not a journal — it is a derived statement. The templates below are journal entries behind the most-tested cash-flow scenarios.

(a) Sale of machinery at a profit (NCERT Illus. 5, p. 258)

(b) Depreciation for the year (NCERT §6.6.1, p. 250)

(c) Issue of equity shares (financing inflow — NCERT §6.5.3, p. 245)

(d) Repayment of long-term loan (financing outflow)

(e) Interest paid on debentures (financing outflow for non-financial enterprise — NCERT §6.5.4, p. 247)

(f) Dividend received on investments (investing inflow)

(g) Acquisition of machinery by issue of shares — non-cash (NCERT §6.5.4, p. 247)

(h) Income tax paid (operating outflow — NCERT §6.5.4)