Cash flow statement

The essentials

A cash flow statement shows the inflows and outflows of cash and cash equivalents during a period, prepared as per AS 3 (Revised). It classifies cash flows into operating, investing and financing activities. Cash equivalents are short-term, highly liquid investments readily convertible into known amounts of cash with insignificant risk of change in value, generally with a maturity of three months or less from the date of acquisition.

Key points

• Operating activities: principal revenue-producing activities, such as cash from customers and payments to suppliers and employees; income tax paid is generally operating.
• Investing activities: purchase and sale of long-term assets and investments; interest and dividends received (for a non-financial company).
• Financing activities: issue and redemption of shares and debentures, borrowing and repaying loans, interest paid and dividends paid (for a non-financial company).
• Indirect method for operating activities: start with net profit before tax; add non-cash and non-operating charges (depreciation, amortisation, loss on sale of assets, interest paid); deduct non-operating incomes (gain on sale of assets, dividends received); adjust for changes in working capital; then deduct income tax paid.
• Increase in current assets or decrease in current liabilities reduces cash; decrease in current assets or increase in current liabilities adds to cash.
• Sale of a non-current asset: the sale proceeds are an investing inflow; the profit or loss is adjusted in operating activities.

Exam tips

Prepare working notes for fixed assets, provisions for tax and proposed dividends. Keep signs clear: write inflows as positive and outflows in brackets.

Common mistakes

• Treating depreciation as a cash outflow.
• Showing the book value, instead of the sale proceeds, of an asset sold as the investing inflow.