Tag: Non-Cash Adjustments

The preparation of a Cash Flow Statement involves classifying and presenting all cash inflows and outflows of an entity under three distinct categories: Operating Activities, Investing Activities, and Financing Activities, as prescribed under Ind AS 7. Operating activities relate to the principal revenue-generating activities of the business, such as cash received from customers and payments to suppliers. Investing activities cover the acquisition and disposal of long-term assets and other investments, while Financing activities involve changes in the size and composition of Owners’ capital and borrowings. Two methods are permitted for preparation: the Direct Method and the Indirect Method. The Indirect Method is more commonly used in practice, as it reconciles net profit with net cash flow from operating activities by adjusting for non-cash items and working capital changes.

Procedure for Preparation of Cash Flow Statement:

1. Identify Cash and Cash Equivalents

The first step is to identify the opening and closing balances of cash and cash equivalents. Cash includes cash in hand and demand deposits, while cash equivalents include qualifying short term highly liquid investments under Ind AS 7. These balances provide the starting and ending points for preparing the Cash Flow Statement. The difference between opening and closing balances must ultimately be explained through cash flows from operating, investing, and financing activities.

2. Classify Cash Transactions

All cash transactions are classified into operating, investing, and financing activities according to Ind AS 7. Operating activities relate to principal revenue producing activities. Investing activities include purchase and sale of long term assets and investments. Financing activities include transactions affecting equity and borrowings. Proper classification helps users understand the sources and applications of cash. It also ensures that the Cash Flow Statement is prepared systematically and presents meaningful information about the entity’s financial activities.

3. Calculate Cash Flow from Operating Activities

Cash flow from operating activities is calculated using either the Direct Method or Indirect Method. Under the Direct Method, major cash receipts and payments are separately presented. Under the Indirect Method, profit or loss is adjusted for non cash items, non operating items, and changes in working capital. The resulting amount represents cash generated or used by normal business operations. This figure is important for evaluating the entity’s ability to generate sufficient cash from its principal activities.

4. Calculate Cash Flow from Investing Activities

Cash flows from investing activities are determined by analysing transactions involving long term assets and investments. Cash paid for purchasing property, plant and equipment or investments is treated as an outflow, while cash received from their sale is treated as an inflow. The relevant information is generally obtained from the Balance Sheet, additional information, and accounting records. The net amount represents cash generated or used for investing purposes and indicates how the entity is deploying resources for future growth.

5. Calculate Cash Flow from Financing Activities

Cash flows from financing activities are determined by analysing changes in share capital and borrowings. Proceeds from issuing shares or obtaining loans are generally cash inflows, while repayment of borrowings and certain payments to owners are cash outflows. Information is collected from the Balance Sheet and additional details. The net financing cash flow shows how the entity has obtained and utilised financial resources. It helps users understand changes in the company’s capital structure and financing position during the accounting period.

6. Calculate Net Change in Cash

After determining cash flows from operating, investing, and financing activities, the net change in cash and cash equivalents is calculated. The cash flows from all three activities are added together. The result may be a net increase or net decrease in cash. This amount is then added to the opening cash and cash equivalents. The resulting figure should agree with the closing cash and cash equivalents shown in the financial records. This step ensures proper reconciliation and accuracy of the Cash Flow Statement.

7. Present and Reconcile the Statement

The final Cash Flow Statement is prepared by presenting operating, investing, and financing cash flows separately. The net increase or decrease in cash is then added to the opening balance to arrive at the closing cash and cash equivalents. The closing balance should agree with the corresponding balance in the Balance Sheet. Required disclosures relating to significant non cash transactions and other relevant information are also provided according to Ind AS 7. Proper reconciliation ensures that the statement is complete, accurate, and useful for financial analysis.

Important Journal Entries Related to Cash Flow Preparation: