CASH FLOW STATEMENT THEORY
A cash flow statement is one of the three primary financial statements that provide insight into the financial health of a business. It shows how cash and cash equivalents are moving in and out of a company during a specific period. Unlike the income statement, which records revenues and expenses, the cash flow statement records only actual cash transactions.
Objectives of a Cash Flow Statement
• To determine the liquidity position of a business.
• To understand cash inflows and outflows from operating, investing, and financing activities.
• To assist in decision-making by analyzing cash generation and utilization.
• To reconcile the net cash flow with the opening and closing cash balances.
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CASH FLOW STATEMENT SECTIONS
The cash flow statement is divided into three major sections:
1. Operating Activities
o Related to the core business operations of the company.
o Includes cash receipts from customers and cash payments to suppliers, employees, and tax authorities.
2. Investing Activities
o Related to the purchase or sale of long-term assets such as property, plant, and equipment (PPE), investments, and loans given or received.
3. Financing Activities
o Related to cash transactions with shareholders and creditors.
o Includes issuing shares, borrowing or repaying loans, and paying dividends.
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DIRECT METHOD VS. INDIRECT METHOD
There are two ways to prepare a cash flow statement under operating activities:
1. Direct Method:
o Lists actual cash receipts and payments from operating activities.
o Preferred by some companies for its clarity, but requires detailed cash records.
2. Indirect Method:
o Starts with net profit from the income statement and adjusts for non-cash items and changes in working capital.
o More commonly used because it connects with the accrual accounting method.
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CASH FLOW STATEMENT TERMINOLOGIES
1. Cash & Cash Equivalents – Includes cash on hand, demand deposits, and short-term investments.
2. Net Profit before Tax & Interest – The profit calculated before deducting tax and interest.
3. Depreciation – A non-cash expense that reduces the book value of fixed assets.
4. Amortization – The process of gradually writing off an intangible asset.
5. Accounts Receivable – Money owed by customers for goods or services provided.
6. Accounts Payable – Money owed to suppliers.
7. Inventory – Goods available for sale.
8. Investing Activities – Transactions related to the purchase or sale of long-term assets.
9. Financing Activities – Transactions with owners and creditors.
10. Dividends Paid – Cash payments to shareholders as a return on their investment.
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20 CASH FLOW STATEMENT QUESTIONS & ANSWERS
GENERAL QUESTIONS
Q1: What is a cash flow statement and why is it important?
Answer:
A cash flow statement is a financial report that provides data about cash inflows and outflows during a specific period. It is essential because it helps in:
• Understanding the company's liquidity position.
• Tracking cash from operating, investing, and financing activities.
• Identifying cash surplus or shortages to make informed financial decisions.
Q2: What is the difference between cash flow and net income?
Answer:
• Cash flow refers to actual cash movement within a business.
• Net income (profit) is calculated based on revenue earned and expenses incurred, including non-cash transactions such as depreciation and amortization.
DIRECT METHOD QUESTIONS
Q3: How is the cash flow from operating activities calculated using the direct method?
Answer:
In the direct method, cash flow is calculated by considering:
• Cash Receipts from Customers
• Cash Payments to Suppliers and Employees
• Cash Paid for Interest and Taxes
Q4: Give an example of a cash flow statement using the direct method.
Answer:
Particulars Amount (NPR)
Cash Receipts from Customers 500,000
Cash Paid to Suppliers (200,000)
Cash Paid for Wages (100,000)
Cash Paid for Taxes (50,000)
Net Cash from Operating Activities 150,000
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INDIRECT METHOD QUESTIONS
Q5: How is the cash flow from operating activities calculated using the indirect method?
Answer:
The indirect method starts with net profit and adjusts for:
• Non-cash expenses (depreciation, amortization).
• Changes in working capital (inventory, accounts receivable/payable).
Answer:
Particulars Amount (NPR)
Net Profit 200,000
Add: Depreciation 50,000
Less: Increase in Inventory (20,000)
Add: Increase in Accounts Payable 30,000
Net Cash from Operating Activities 260,000
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INVESTING & FINANCING ACTIVITIES QUESTIONS
Q7: What are examples of investing activities?
Answer:
• Purchase of machinery.
• Sale of land or buildings.
• Buying stocks or bonds.
Q8: What are financing activities?
Answer:
• Borrowing money (loans).
• Issuing shares.
• Paying dividends.
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MISCELLANEOUS QUESTIONS
Q9: Why do we add depreciation back in the indirect method?
Answer:
Depreciation is a non-cash expense, meaning no actual cash is spent. It is added back to adjust net profit.
Q10: What does a negative cash flow indicate?
Answer:
A negative cash flow may indicate high expenses, but it can also mean a company is investing heavily in growth.
Q11: What is free cash flow?
Answer:
Free cash flow is the cash available after deducting capital expenditures, indicating the company's ability to reinvest or distribute profits.
Q12: How does the cash flow statement help in decision-making?
Answer:
It helps businesses manage liquidity, plan investments, and ensure they can meet financial obligations.
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