Preparation of Cash Flow Statement and it’s analysis

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 Preparation of Cash Flow Statement and Its Analysis

A Cash Flow Statement (CFS) provides a detailed summary of a company's cash inflows and outflows over a specific period. There are two primary methods for preparing a cash flow statement: the Direct Method and the Indirect Method.

Direct Method

The Direct Method lists all cash receipts and cash payments from operating activities. This method starts with the opening balance of cash and bank accounts and adjusts for cash transactions throughout the period.

Steps for Direct Method:

  • Start with Opening Cash and Bank Balances:
    • Begin with the cash and bank balances at the start of the period.
  • Add Cash Inflows:
    • Issue of Shares and Debentures: Cash received from issuing equity shares and debentures.
    • Cash Received from Debtors: Payments collected from customers.
    • Sale of Fixed Assets: Proceeds from selling long-term assets like property, plant, and equipment.
    • Other Cash Receipts: Any other cash inflows like interest received, dividends received, and other operating income.
  • Deduct Cash Outflows:
    • Payments to Creditors: Payments made to suppliers and vendors.
    • Payment for Liabilities and Expenses: Settlement of liabilities such as loans and payments for operating expenses.
    • Purchase of Assets: Cash spent on acquiring long-term assets.
    • Payments for Dividends and Taxes: Cash paid for dividends to shareholders and taxes to the government.
  • Calculate the Closing Cash and Bank Balances:
    • The net result after adding inflows and deducting outflows will give the closing cash and bank balances.

Indirect Method

The Indirect Method starts with the net profit or loss before adjusting for changes in working capital and other non-cash items. This method is more commonly used, especially when detailed cash transactions are not readily available.

Steps for Indirect Method:

  • Start with Net Profit Before Tax:
    • Begin with the net profit as reported in the income statement.
  • Adjust for Non-Cash Items:
    • Depreciation and Amortization: Add back non-cash expenses such as depreciation and amortization.
    • Impairment Expenses: Add back any impairment losses.
    • Other Non-Cash Items: Adjust for other non-cash items like provisions, unrealized gains or losses, and deferred tax.
  • Adjust for Changes in Working Capital:
    • Increase in Current Assets: Deduct increases in current assets (e.g., accounts receivable, inventory).
    • Decrease in Current Assets: Add decreases in current assets.
    • Increase in Current Liabilities: Add increases in current liabilities (e.g., accounts payable, accrued expenses).
    • Decrease in Current Liabilities: Deduct decreases in current liabilities.
  • Adjust for Non-Operating Activities:
    • Investing Activities: Include cash inflows and outflows from investing activities (e.g., purchase and sale of fixed assets).
    • Financing Activities: Include cash flows from financing activities (e.g., issuing or repaying debt, equity transactions).
  • Calculate Net Increase/Decrease in Cash:
    • Sum the adjustments to determine the net change in cash and cash equivalents.
  • Calculate Closing Cash Balance:
    • Add the net increase/decrease in cash to the opening cash balance to determine the closing cash balance.