Arrange the following in proper sequence while preparing Cash Flow Statement: (A) Net cash flow from operating activities (B) Cash flow from financing activities (C) Cash flow from investing activities (D) Calculate net profit before tax and extraordinary items in working note Choose the correct answer from the options given below:
(D), (A), (C), (B)
Understanding the Cash Flow Statement Sequence
The Cash Flow Statement is a crucial financial report that shows how changes in balance sheet accounts and income affect cash and cash equivalents, and breaks the analysis down to operating, investing, and financing activities. It helps users understand how a company generates and uses cash.
Preparing a Cash Flow Statement typically follows a standard sequence, especially when using the indirect method which is common. Let's break down the typical steps involved:
Steps in Preparing Cash Flow Statement
- Calculate Net Profit Before Tax and Extraordinary Items: This is usually the starting point for the indirect method. You need to adjust the reported net profit for items like tax expense and extraordinary items to arrive at the profit figure that will be used as the base for calculating cash flow from operating activities. This calculation is often done in a separate working note.
- Calculate Net Cash Flow from Operating Activities: This section deals with the cash generated or used by the company's normal day-to-day business operations. It starts with the Net Profit Before Tax and Extraordinary Items and adjusts it for non-cash expenses (like depreciation), non-operating items (like interest received or paid), and changes in working capital (like changes in accounts receivable, inventory, and accounts payable).
- Calculate Cash Flow from Investing Activities: This section reports the cash generated or used from activities related to the purchase or sale of long-term assets (like property, plant, and equipment) and investments not included in cash equivalents.
- Calculate Cash Flow from Financing Activities: This section covers the cash flow from activities that change the size and composition of the company's equity and borrowings. This includes issuing shares, buying back shares, issuing bonds, repaying loans, and paying dividends.
The net increase or decrease in cash and cash equivalents during the period is the sum of the net cash flows from these three activities:
\( \text{Net Change in Cash} = \text{Operating Cash Flow} + \text{Investing Cash Flow} + \text{Financing Cash Flow} \)
This net change is then added to the opening balance of cash and cash equivalents to arrive at the closing balance.
Arranging the Activities in Proper Sequence
Based on the typical preparation process, the correct sequence of the given items is:
- (D) Calculate net profit before tax and extraordinary items in working note
- (A) Net cash flow from operating activities
- (C) Cash flow from investing activities
- (B) Cash flow from financing activities
This sequence starts with the necessary calculation (D), moves to the core operating activities (A), followed by long-term asset changes (C), and finally changes in capital structure (B).
Summary of Cash Flow Activities
| Activity Section | Description | Examples |
|---|---|---|
| Operating Activities | Principal revenue-producing activities | Cash received from customers, cash paid to suppliers and employees, cash paid for taxes, cash paid for interest (under direct method or as per accounting standard choice). |
| Investing Activities | Acquisition and disposal of long-term assets and investments | Cash paid to purchase fixed assets, cash received from selling fixed assets, cash received from selling investments, cash paid to acquire investments. |
| Financing Activities | Activities changing equity and borrowing size/composition | Cash received from issuing shares/debt, cash paid to redeem shares/debt, cash paid for dividends. |
Revision Table: Key Cash Flow Statement Concepts
| Concept | Explanation |
|---|---|
| Cash Flow Statement | Reports cash inflows and outflows during a period, categorized by activity. |
| Operating Activities | Core business cash flows. |
| Investing Activities | Long-term asset/investment cash flows. |
| Financing Activities | Equity and debt cash flows. |
| Indirect Method | Starts with net income and adjusts for non-cash items and working capital changes. |
| Direct Method | Shows major classes of gross cash receipts and gross cash payments. |
Additional Information on Cash Flow Statement Preparation
Preparing the Cash Flow Statement involves analyzing changes in balance sheet accounts and comparing them with income statement items. The goal is to reconcile net income with the actual cash generated from operations and to show cash flows from other activities.
- Methods: There are two methods to prepare the Operating Activities section: the direct method and the indirect method. The indirect method is more common as it starts with Net Profit. Both methods result in the same net cash flow from operating activities.
- Working Notes: Often, detailed calculations are required in working notes for items like Net Profit Before Tax and Extraordinary Items, changes in individual working capital accounts, or details of purchases/sales of fixed assets.
- Importance: The Cash Flow Statement is important because it shows the company's ability to generate cash, pay its debts, pay dividends, and fund new investments. It provides a different perspective than the accrual-based income statement and balance sheet.
Important Questions from Cash Flow Statement
While preparing Cash Flow Statement, purchase of goodwill is treated as:
Identify the correct sequence of the following steps involved in calculating cash flows from operating activities of a company:
(A) Operating profit before working capital changes
(B) Cash generated from operations
(C) Income tax paid
(D) Net cash flow from operating activities
(E) Goodwill amortised
Choose the correct answer from the options given below:
Window dressing is a practice:
Which one of the following are correct in connection with the Common Size Statement?
(A) Expressed as a percentage on revenue from operation
(B) Horizontal analysis
(C) Vertical analysis
(D) Expressed as a percentage on total assets
Choose the correct answer from the options given below:
Dividend received is:
